(Bloomberg) -- It seemed like a smart real estate play in the wake of a global pandemic: build life-science labs to satiate soaring demand for space to develop medical breakthroughs. Bank OZK was among those to bet big on the industry, most notably through a sprawling San Diego waterfront complex. 

The Little Rock, Arkansas-based bank’s sudden 17% stock plunge, after a Citigroup Inc. downgrade flagged challenges with that San Diego district and other commercial-property risks, suggests that flare-ups from the embattled real estate market aren’t going away anytime soon.

Wall Street investors poured money into life science developments through the pandemic as advances in the medical field fueled demand for space. What’s more, the thinking went, labs often require employees to be on-site — insulating the properties from the impact of remote work that sapped demand for traditional offices. Many life science projects broke ground without tenants, assuming that growth would persist as research funding surged. 

But the funding pipeline has slowed. Venture capital for life sciences fell 24% globally in 2023, with a 20% drop in North America, according to brokerage Cushman & Wakefield. 

Bank OZK faces “largely idiosyncratic” exposure to life sciences relative to peer banks, Citigroup analyst Benjamin Gerlinger wrote in a report Wednesday that cut his rating to “sell.” The loan of most interest is $915 million tied to the Research and Development District on San Diego’s waterfront, developed by IQHQ Inc., Gerlinger said.

“RaDD has been in development for more than 4 years and we believe 0% of the 1.7 million square feet is leased — indicative of a difficult life science construction lending market,” Gerlinger wrote.

A spokesperson for IQHQ declined to comment. Bank OZK representatives didn’t reply to multiple requests for comment.

Supply Glut

The boom in the development of life science buildings has created a supply glut. Nearly 16 million square feet (1.5 million square meters) of vacant lab space is forecast to arrive in US markets this year, creating excess space in Boston, San Diego and the San Francisco Bay area, according to brokerage Jones Lang LaSalle. 

“Supply has outpaced demand across markets, putting leverage back in tenants’ hands and allowing start-ups to push for shorter terms,” JLL researchers led by Maddie Holmes, Amber Schiada and Mark Bruso wrote in a May 15 report. “It is likely the market could take three to four years (or more in some submarkets) to return to a market where landlords and tenants have equal leverage in negotiations.”

There have been earlier signs of struggles with life science loans. KKR Real Estate Finance Trust reported in April that it’s in the process of taking ownership of a Seattle life sciences building through a deed-in-lieu of foreclosure.

Office and life science fundamentals are the weakest of any real estate asset class, Green Street said Wednesday.

“The life science supply-demand picture is poor and a rebound in rental rates is not expected until ‘26,” researchers led by Peter Rothemund wrote in the report.

--With assistance from Bre Bradham.

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