The 1.7 million-square-foot Research and Development District from San Diego-based life science real estate developer IQHQ is not only expanding substantially the glut of available space downtown but also dragging down its lender in the process.
The pioneering project that promised to make downtown San Diego the new center of gravity for scientific advances is fast approaching completion and the sobering reality that the market is as stubborn as ever.
Instead of making a splashy debut, the 1.7 million-square-foot Research and Development District (RaDD) from San Diego-based life science real estate developer IQHQ is not only expanding substantially the glut of available space downtown but also dragging down its lender in the process.
“RaDD has been in development for more than four years and we believe 0 percent of the 1.7 million square feet is leased,” Citi analyst Benjamin Gerlinger wrote in a May 29 research note downgrading the stock of the project’s publicly traded lender, Bank OZK.
IQHQ, through a spokesperson, declined to comment for this story.
A banner for leasing is installed at the IQHQ Research and Development District (RaDD) project along the waterfront. (K.C. Alfred / The San Diego Union-Tribune)
RaDD takes up six blocks of the former Navy Broadway Complex, an expansive swath of prime real estate south of Broadway between Pacific Highway and Harbor Drive with unrivaled proximity to San Diego Bay.
In September 2020, IQHQ acquired the leasehold for the federal land from Manchester Financial Group, paying $230 million for an 8.7-acre portion of the complex. Shortly thereafter, the firm also bought from Manchester a connected block reserved for a public park. The life science real estate developer later entered into an agreement with the city of San Diego to build and manage the park.
Starting just north of Ruocco Park, RaDD includes five lab and office buildings, including one 17-story tower, and the public park, as well as a paseo that travels the length of the property. While most of the campus is meant for researchers, one of the buildings, nicknamed the “Alley,” is designed as a public-facing venue, and will feature a variety of food and beverage options, retail stores and other attractions.
The project has been billed as a dynamic, urban life science city on the waterfront, radically distinct in both location and design from the ordinary projects concentrated 15 miles north in San Diego’s celebrated science cluster. It was to be the next north star for the biotech industry, drawing in pharmaceutical giants from other markets and serving as a catalyst for a new industry to take hold in a downtown market historically defined by finance firms and government entities.
Except that hasn’t happened yet. Some say it never will.
“The concept of bringing life science downtown, at this point, is kind of (dead on arrival),” said real estate analyst Gary London, a principal of local firm London Moeder Advisors. “That was kind of a pipe dream. It might have been real if the market stayed as it was during the height of COVID, when life science companies were prospering and expanding. In a post-COVID environment, there is compression in that industry … and it certainly suggests that the idea of geographically relocating or expanding to a new cluster area, from North City to downtown, is not going to happen.”
The IQHQ Research and Development District (RaDD) project along the waterfront earlier this month. (K.C. Alfred / The San Diego Union-Tribune)
Technically, RaDD isn’t done yet, leaving space for potential optimism about prospective tenants. The city, through a spokesperson, said it has not issued certificates of occupancy for the buildings.
But passersby can plainly see that everything is nearly finished and signs of life are minimal.
Others have also taken notice.
Gerlinger, the Citi analyst, sent up a flare, warning in two research notes that the project’s lack of tenants is a major concern for its lender, Bank OZK.
“IQHQ’s RaDD building is largely completed with no known tenants — and likely faces an uphill battle of both location and ramping occupancies in more desirable areas of San Diego,” the analyst wrote in his second research note on May 30.
In August 2022, Bank OZK loaned $915 million to IQHQ for construction of what the bank recently indicated is a $1.9 billion project. The money is due to repaid by August 2026, or in 27 months, property records and regulatory filings show. The loan, Gerlinger said, is likely the bank’s largest individual loan.
The analyst’s initial research note on May 29 suggests that IQHQ will not be able to fill the research space in time to make good on its loan, given typical rent concessions and tenant build out periods. Gerlinger estimates that, even if leases were signed now, it would be 17 to 25 months before the developer starts collecting rent.
It doesn’t help that the project is entering the market amid exceptionally high downtown vacancy rates and lukewarm demand.
More than 29 percent of downtown office space is vacant, said Joshua Ohl, who is the senior director of market analytics for real estate tracker CoStar. It is the highest vacancy rate that CoStar has recorded in more than two decades.
The vacancy rate doesn’t reflect under-construction projects, including RaDD and the Campus at Horton. When considering those developments, 36.5 percent of downtown office space is available for lease, Ohl said.
And, when biotechs do sign big leases, they continue to show a singular preference for the established cluster. For instance, Pfizer earlier this year inked a 15-year lease for 230,000 square feet of space at a new research campus in Torrey Hills.
“The (RaDD) location has been rejected numerous times by sizable pharmaceutical companies opting to reside/expand in the Torrey Pines area,” Gerlinger noted.
The analyst’s unflattering assessment of the RaDD project prompted an immediate response from Bank OZK. The bank, in a regulatory filing, reiterated confidence in the project, “based on the excellent location, high quality construction, experienced sponsorship and its strong capital partners.”
The bank’s regulatory filing also touted “several” signed leases for RaDD’s retail component. The retail space, concentrated in the four-story Alley building facing the USS Midway Museum and Navy Pier, is a fraction of the overall footprint — or 150,000 square feet, according to Citi.
IQHQ has yet to announce retail tenants or signal a potential opening, but there is some evidence to suggest that the company is having more success leasing its waterfront storefronts.
The Alley building at IQHQ’s Research and Development District (RaDD) project, as pictured earlier this month. (K.C. Alfred / The San Diego Union-Tribune)
“It is an absolutely gorgeous development,” said Grant Tondro, who is the co-founder of Mason Ale Works. “It’s one of those things you look for in terms of critical mass of some really good anchor tenants all in a tight-knit area. All that stuff makes the project incredibly attractive.”
Tondro is in active lease negotiations for an 1,800 square-foot tasting room in the Alley building, with the goal to open a Mason-branded storefront early next year, he said. Tondro said he is aware of a handful of other retail and restaurant tenants in various stages of the leasing process.
The San Diego Padres events business, Petco Park Events, is also operating a 7,800 square-foot meeting room space at RaDD called Eve.
Blocks away, the mixed-use Campus at Horton finds itself in a similar position with a growing roster of retailers attached to the project — but no known life science or office prospects.
The prevailing wisdom seems to be that a humbling pivot is on the horizon.
The best path forward, according to the local real estate analysts and the Citi analyst, is for IQHQ to ditch life science and market the property to standard office tenants.
“They’re going to go out at some point into the (speculative) office market and they’re going to solicit and attract general office tenants. That has to be their main strategy going forward,” London said. “It will be the most attractive space in downtown San Diego, if not the entire region. … It will lease up at the expense of other office buildings in downtown San Diego.”
While seemingly a simple shift, RaDD’s identity change will come at a considerable cost.
IQHQ’s lender, Bank OZK, is valuing the project at $2.35 billion, according to the regulatory filing, based on a July 2022 appraisal that likely assumes lease rates that will be impossible for the developer to secure for standard office space.
Gerlinger, the Citi analyst, cited industry consultants who estimated a $2.50 per-square-foot difference between premium lab-ready space and best-in-class office space, or $6.20 a square foot compared with $3.70 a square foot (plus operating expenses).
“The total project would see a clear valuation compression,” Gerlinger wrote. “It would imply a price valuation compression of roughly 40 percent — if fully leased and refinanced into a permanent market.”
By that math, IQHQ’s life science gamble would be valued at $1.4 billion, or a half-billion dollars less than the $1.9 billion project cost.