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Joe Cavaluzzi is a contributor to Real Estate New Jersey, from which this article was excerpted.

The life sciences, including pharmaceutical companies and biotech, have been a crucial part of New Jersey’s economic growth both historically and during recent economic expansions. Their space requirements have created demand across all types of New Jersey commercial and industrial real estate. In fact, New Jersey is home to more pharmaceutical companies than any other state in the country, or any other country in the world, according to the HealthCare Institute of New Jersey, a Bridgewater-based industry trade association made up of 25 pharmaceutical and medical technology companies.

But the state has been feeling the pressure from other, less expensive and less tax-laden regions in eastern Pennsylvania as well as southern and other northeastern states that are experiencing growth and gaining critical mass in the life science segments of their economies. The American pharmaceutical industry has grappled with layoffs and spending cuts and recently released statistics showing that drug makers continue to struggle with the discovery of blockbuster medicines.

In addition, many of the major pharmaceutical companies with a significant New Jersey presence are trying to cope with the competition from generic drug companies. The Food and Drug Administration approved only 17 new drugs last year, matching the lowest number of newly approved compounds since the peak of 53 approvals a decade ago.

The New Jersey real estate markets have felt the trickle down impact of all this, primarily from its largest tenants, which have slowed their activities. Landlords in the Garden State remain anxious for life science tenants and are willing to work with them through tenant improvement concessions that recognize the high facility investment many of these companies must make to operate.

The state remains a strong market for these companies with modern buildings that meet their needs, especially in the suburbs, and a strong skilled work force. The problem is that it is becoming a less exclusive club and New Jersey’s high costs of living and doing business are dulling its competitive edge.

As far as the current state of New Jersey’s life science market, the prescription drug icons, including Pfizer, Schering-Plough, Merck and Johnson & Johnson, seemed to announce a merger or co-agreement with an upstart biopharmaceutical company almost on a weekly basis as they searched for new products over the past two years. Consolidation more than growth seems to drive activity in pharmaceutical real estate these days.

According to the HealthCare Institute, employment as a percentage of New Jersey pharmaceutical industry employment fell slightly during 2005 in research and development, down two percentage points to 13%, and more precipitously in sales and marketing, where it dropped seven percentage points to 16%. Although clinical development employment rose four points to 14%, corporate administration, at 26% and manufacturing-quality control, 15%, remained unchanged.

Overall capital expenditures in 2005, meanwhile, were $2.2 billion, a significant increase over the prior year, with 48% of it going to new construction. In all, HINJ member companies participating in this year’s survey reported 128 facilities, located across 15 counties and 72 municipalities in 2005. Last year saw little new construction.

Dan Loughlin, a Murray Hill-based managing principal of the Staubach Co. and director of its life science practice group, breaks life science clients into three categories: big pharma, generic drug companies and biotech.

“On the big pharma front there is a cost-containment mentality; a sensitivity to any kind of capital spending. That sensitivity is driven by competition and by changes in the political environment,” Loughlin says. “Also, sales and marketing constraints imposed on pharmaceutical companies are resulting in fewer acquisitions of new office facilities to support sales and marketing. Pharmaceutical companies are leveraging their existing assets to deliver better cost efficiency. They are moving from leased facilities back to their own facilities. I see that trend continuing in 2007.”

However, Loughlin says that generic drug companies are taking up some of the slack by leasing bigger and more modern facilities over the past two years in an effort to recruit professional staff from big pharma companies.

“I see a better outcome for biotech due primarily to licensing and from big pharma companies that seem to be investing outside their own internal R&D initiatives and reaching out into third-party companies,” he says, citing Abbott Labs acquisition of KOS Pharmaceuticals near Princeton.

And generally speaking, suburban facilities remain in demand. Major pharmaceutical companies continue to look to New Jersey for space that accommodates R&D, sales and marketing and developing, and manufacturing, although Loughlin says most manufacturing on any large scale is done overseas in places that include Ireland, Singapore or even Puerto Rico, where companies get favorable tax treatment.

“On the office end, our suburban office costs are comparable to any other area they would be looking at. The general cost of construction is the same no matter where you go. There might be differences in land and labor costs, but they are small factors in the overall scope of things,” he says. “They are still focused on suburban campus properties, but sales and support staffs normally are headquartered in major metropolitan areas.”

Tom Giannone, a senior director at Cushman & Wakefield of New Jersey, East Rutherford, says the life science company news in New Jersey is a mixed bag.

“In general I would say we’re holding steady. If you look at the big employment picture, we’re probably at the same level of pharmaceutical and biotech jobs as a year ago. But that’s not necessarily good news,” Giannone says. “Biotech is a growing industry and unfortunately we’re not seeing the growth in New Jersey. I think there just is not a lot of venture capital out there. Biotech companies are holding onto money to spend on R&D.”

Julio Villavicencio, senior vice president of Jones Lang LaSalle in Parsippany, says he represents a pharmaceutical firm that plans to expand by one million sf within its current campus over the next couple of years, although he declined to identify the firm.

“The trends are the open space environment, a workstation environment that fosters a more collaborative approach to work. Companies are looking for additional conference rooms and lounge areas for people to work in teams,” Villavicencio says.

Giannone, meanwhile, doesn’t think rent will be the issue in the year ahead but concessions will, because the growth likely will come from the biotech companies that must make major capital investments in space to fulfill their clinical development role.

Rick Heilmann, vice president of the Garibaldi Group in Chatham, says landlords are accommodating and eager to do business with the life science companies, and they are developing the facilities that meet their requirements.

“Life science companies are seeking concessions in the form of larger landlord tenant allowances. Free rent is great, but it burns off quickly. The biggest assistance a landlord can provide is in tenant improvements,” Heilmann says. “The second thing, and it’s a financial matter, too, is that tenants want landlords to be as flexible as possible so they can grow or, if their R&D doesn’t work out, retract in the same building.”

But, bottom line, will tenants find a kinder New Jersey? The state continues to get good grades from pharmaceutical and biotech executives for the quality of the space it offers. According to the HealthCare Institute’s 2006 annual economic report and survey, 21 of the member companies responding rated New Jersey’s available space excellent (1), very good, (6) or good (9). Quality of life and work force also garnered good ratings. But the executives were less positive about tax incentives, with more of them rating the state’s efforts fair to poor that excellent to very good.

That comes back to the opening question of how the state can turn around its image as expensive and less friendly than it might be to business and curb the brain drain as companies look elsewhere for locations. Like so many businesses in New Jersey, landlords are most frustrated by the state being seen as business-unfriendly, a place where tenants are frustrated by tax burdens.

“The capital that life science companies have to put into these facilities is off the charts,” Heilmann says. “Their concern is, do they invest all of this money in a building where the state isn’t going to be there to support them with tax incentives. The state’s labor pool is strong, but it’s being tapped by other states and it’s not enough to draw new businesses. I think Trenton has to wake up. The administration has to realize that the high-level talent is slowly being pulled out of New Jersey.”

New Jersey, says Staubach’s Loughlin, remains expensive but that’s only part of the problem and more an issue for manufacturing, which has been moving out of state for decades. “I still think the labor force here and the quality of life bode well for the state,” he says. “What’s happening, in part, is that as big pharmaceutical companies continue to chase growth through merger-and-acquisition activity, you see a lot of them either expanding or relocating R&D facilities into the biotech cluster areas like Cambridge, MA, Southern California and even Research Triangle Park in Raleigh-Durham.”

Many are optimistic that Gov. Jon Corzine’s administration is focused on creating a technology business-friendly environment and will offer incentives to attract pharmaceutical and biotech companies to relocate or remain here. But the dynamics of a changing industry could make it a less reliable source of growth both for the New Jersey economy and the state’s real estate markets, at least in the short term.

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