Life Sciences Conversions in Real Estate

Among the key legal issues to be considered when converting office to life science space are credit enhancements, expansion/contraction options, use segregation, and zoning.

By Matthew Weinstein, Chair, Real Estate Lease Structuring, Cozen O’Connor

One of the hottest topics discussed in real estate circles today pertains to whether life science conversions can save the perceived imminent obsolescence affecting large swaths of the office sector. Obsolescence is nothing new. Obsolescence, however, in the real estate world, prior to COVID, typically took years to achieve. The prospect of remote work was, no doubt, a growing trend for years. COVID, however, acted as an accelerant the likes of which the real estate sector and, in particular, the office sector had not observed in the career of most real estate professionals.

While architects and engineers have for years aspired to design the holy grail of buildings with unlimited flexibility, the fact of the matter is that few office buildings can instantly convert to life science uses. While the focus of real estate professionals has gravitated toward addressing design issues in office conversions, and they are undoubtedly important, such design issues are not the only issues to be considered in a life science conversion project. As will be discussed in this article, there are a number of legal issues a typical office lease may not contemplate that should be assessed and addressed in life science conversions.

For purposes of this article, life science space comprises laboratory space, research and development space, and cGMP space. While there may be an office component as well, the requirement of the life science portion of the premises is the true design driver, and, as such, creates unique issues not otherwise found in traditional office leasing.

It is important to change a developer’s thought paradigm when contemplating life science space such that it is viewed as its own asset class of real estate rather than a subclass or derivative use of office space. By way of example only, while floor load may be a factor in office leasing (particularly in server rooms, file rooms, and library areas, such as they exist in the digital age), floor loads of office space have been assumed in the design of a traditional office building. However, a typical life science space may house heavier equipment which increases the floor load, resulting in the need for additional reinforcements. An office building with industrial bones (e.g., an old newspaper building or quasi-industrial site) may facilitate an easier and more cost-effective life science conversion. Below is a discussion of several of the key legal issues surrounding office to life science conversions.

Credit Enhancements

Life science conversions are more expensive than a simple office build out. Whether it be landlord work or tenant improvement allowance, the amount of funds designated to potentially stripping the building, upgrading base building facilities, and related expenditures creates quite a bit of increased costs. The willingness of landlords to fund such costs or of a lender to loan funds toward a conversion may be dependent on the financial viability of the tenant. As many life science tenants are startups or early-stage companies, the need for a credit enhancement is necessary in many cases. Some companies will elect to put up a cash deposit and many more will elect to cause the issuance of a letter of credit.

Until recently, the main reason to request a letter of credit pertained to the tenant’s creditworthiness. However, with the recent string of bank collapses, particularly Silicon Valley Bank and other lenders with considerable life science and tech exposure, the astute landlord will now need to underwrite the liquidity of the bank issuing the letter of credit. The ability to cash out the letter of credit and swap the letter of credit with another bank should be considered. The parties should consider more than simply a tenant default as a trigger for a landlord being permitted to draw on a letter of credit. This is particularly important as many lenders look to the continued existence of a line of credit in underwriting a loan with a landlord.