Medtech Real Estate 4163

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

Whether considering relocation to a new space, expansion in an existing space, or consolidation of facilities, medical device executives must take into consideration the complexity of their operations and their unique needs for elaborate building systems and operational flexibility. A company's physical facilities and geographic location must support its intended operation and strategic direction. This article outlines key variables to consider when selecting real estate for a medical device manufacturing operation.

Assessing Facility Needs

Every facility is unique. Therefore, conducting a thorough assessment of a medical device manufacturer's facility requirements prior to evaluating candidate properties can simplify the decision-making process. Steps that need to be taken when conducting a facility-needs assessment include outlining a company's business goals, quantifying its space requirements, identifying various departmental functions and the number of employees in each area, evaluating power requirements, and determining the relationships among functions in order to plan for efficient space usage.

Prior to selecting a facility, medtech executives must have a thorough understanding of how the separate functions of the company operate within their given spaces. For example, company leaders might want to consider whether advantages could be realized by consolidating certain research and development (R&D) and production functions in a new facility.

A facility-needs assessment enables executives to quickly determine what improvements a candidate facility would require to bring it up to the standards of the company's operations. To name just a few, such improvements might include building cleanrooms; installing or upgrading compressed-air lines, gas lines, lighting systems, electrical circuitry, plumbing, or information technology (IT) infrastructure; or modifying the building's format to meet warehousing, private office, and open space needs.

In addition to all these requirements, company executives must clearly define their motivations for acquiring new space, the level of urgency associated with the relocation, financial expectations and limitations linked to the move, and their anticipated business growth plans. Only with such an assessment in hand can company leaders hope to evaluate the merits and disadvantages of individual facilities.

Evaluating Locations

No facility exists within a vacuum. Therefore, taking into consideration the community in which a building resides is of paramount importance. In conducting a location analysis of prospective sites, executives should consider the strategic direction of the company with respect to its manufacturing, laboratory, R&D, and office uses. Determination of the functions that will be performed at a given facility and which site attributes best support the intended functions will dictate the company's best geographic fit. Some location considerations include the following.

According to a survey conducted by the nonprofit CEOs for Cities, two-thirds of college-educated adults aged 25 to 34 decide first where to live, then where to work.¹ A medical device company seeking to attract employees should consider both the tangible and intangible factors associated with a particular location.

The location analysis process helps executives determine location advantages and disadvantages by evaluating historical data and forecasts for various criteria associated with a geographic locale. During this process, manufacturers must be on the lookout for out-of-date or contradictory data (see sidebar). Ultimate site selection decisions are made by considering which locations offer the greatest net sum of advantages.

Comparing Buildings

After a company has conducted its facility-needs assessment and location analysis, the next step is to define and contrast the pros and cons of existing or future property candidates within a selected location. This can be done in a methodical fashion by listing and weighting each relevant attribute of a property. Building attributes that have particular relevance for medical device operations include standards compliance, flexibility, speed, collaboration, facility needs, utility requirements, and environmental considerations.

Standards Compliance. A medical device company's facility must not prevent the manufacturer from complying with regulatory requirements such as FDA's quality system regulation, good laboratory practices (GLP), bioresearch monitoring rules, or certification procedures for voluntary standards such as those of the International Organization for Standardization.

“In a manufacturing environment in which you have to formally validate your device, you also have to formally validate your environment, which means validating building systems,” says Don Chigazola, director of operations for Medtronic Inc. (Minneapolis) at its facility in Santa Rosa, CA. “There are very, very strict regulations around validating, say, an exhaust or compressed-air system. If that compressed-air system is going to be blowing air directly on your products, you have to validate that it is not adding anything to your product that you don't want added. Therefore, careful attention to a building's elements, such as its heating, ventilation, and air conditioning (HVAC) system, is a crucial preliminary step in evaluating a medical device's facility needs.”

Y. King Liu, PhD, president of the University of Northern California (Petaluma, CA) and internationally known biomechanics and biomaterials researcher, plans to conduct trials for V-Bond, a composite bone cement used in joint replacement and the treatment of osteoporosis, in China. “What differentiates this business from any widget business is that the potential effect of failure is catastrophic for the human patient,” he says. “In biomedicine, reliability is king. The design, manufacture, and service of the biomedical device should be done under concurrent engineering principles and be as close to zero-defect as possible.”

Liu says that his main concern during discussions with the builder of his facility in China is that it adhere to the good manufacturing practices (GMP) and GLP regulations promulgated by FDA.

Flexibility and Speed. The medical device industry demands flexibility and speed in all areas, including manufacturing, R&D, laboratory, and office operations. “We need to be able to flip the whole facility around every 18 months, if necessary, and can't be tied to a particular configuration for a long term,” says Brad Sorenson, vice president of operations at Boston Scientific Corp. (Natick, MA). “It's critical that we are able to remap power grids, electrical power, pressurized gases, water, and air. We need multiple connections and fast connects.

“Mobility is a big deal,” he adds. “We launch products and keep reiterating. Our production space needs to be about as mobile as you can get.”

“The one single characteristic that I would point to in an ideal building is an extremely flexible infrastructure—one that can support frequent reconfiguration,” agrees Chigazola.

Buildings with open areas, whether for manufacturing or office space, enable such flexibility. “Our office areas are cubicles with modular furniture systems,” Chigazola says. “When we tried to utilize leased facilities where there was little open space and private, hard-walled offices, it was more difficult to support what we needed.”

But internal flexibility is not the only concern. Open areas that allow higher-density use result in increased parking requirements. Ann Brown, real estate manager at Medtronic, says, “A lot of buildings will not support the parking needs, so parking all those people becomes a challenge for us.”

Collaboration. Often desirable for a medical device company, colocation of company functions makes collaboration more feasible. Enabling design experts, manufacturing experts, quality experts, marketing experts, and other critical stakeholders to interact on a regular basis can save time and resources.

“It is ideal to get all operations in one location,” Sorenson says. “When we are spread out, it's inflexible and hard to get continuity and crosspollination. There are hidden costs and inefficiencies with buildings in different locations—even if that other building is as close as five miles away. My priorities would be to get everything under one roof or, secondly, to get a campus setting.”

Brown concurs. “Ideally everyone wants to be under one roof in a city because there is so much collaboration,” she says. “Our departments are huge, but they have to work together. A lot of times when there is growth, you have to pop a whole department out of a building.

“I don't know anyone with extra time on their hands today,” she adds. “Everyone is being asked to do more with fewer resources. When they have to spend time driving around trying to catch people, they lose productivity.”

Facility Needs. As mentioned before, it is critical for medical device companies to determine which functions will be performed at a given facility and which building attributes best support the intended functions. After all, different functions require different environments. In a manufacturing environment, cleanrooms protect products. In a laboratory environment, exhaust hoods, emergency showers, and other safety items protect people. “A third environment is one that combines both of these spaces,” says Chigazola. “If you are working with active pharmaceutical ingredients and you are manufacturing with those materials, you are now combining both the cleanroom and the laboratory. So you are providing both product protection as well as employee protection.”

In manufacturing environments, layout is a key factor when choosing a facility. “Manufacturing space at the center of a building is a huge advantage,” says Sorenson. “All support functions should be around this operation instead of in a linear design. A big, square, open manufacturing space is the key, as nooks, crannies, and pillars only serve to inhibit your ability to be flexible. We want good flow in the operation, meaning product needs to be able to enter and exit the operation without excess transportation.”

In medical device R&D, it is often necessary to isolate certain functions. According to Sorenson, “In R&D we don't want a lot of clear spaces like in manufacturing. We want a lot of smaller rooms to be partitioned off to keep certain operations separate. For example, we may want the use of certain chemicals restricted to a certain area so that we don't risk mixing them with others.”

A building's structure should enhance the ease of operations. Sorenson points out that building controls should be maintained outside of the manufacturing environments. In this way, accessing the controls does not disrupt the cleanroom environment.

Another concern is the accommodation of suppliers. “An important factor is the infrastructure and traffic patterns into a building,” Sorenson says. “We have trucks coming to deliver, and we can't shut production down while a truck is unloading.”

Utilities Requirements. Looking at existing utilities in a building is one way to narrow the decision regarding facility selection. When evaluating prospective properties, company leaders should consider the age and efficiency of the building and its existing systems, including the HVAC, roof condition, power supply, exhaust systems, and the electrical, plumbing, and IT infrastructure. A major component of such considerations should be the amount of money required to bring these items up to the company's specifications. Facilities in which costs would be substantial can be eliminated from the list of prospective properties.

Although there are often costs associated with a facility move, relocating a company's operations can yield savings if done correctly. Jim Happ, president of Labcon (Petaluma, CA), says his company was able to realize such savings in its relocation to its current facilities, where Labcon develops, prototypes, and tests products. “Our energy use decreased by 20% and our output increased by 20% by relocating operations to a building that offered the ability to improve our systems,” he says.

In addition to basic utilities, a building's IT infrastructure is playing an increasingly important role in the selection of facilities to suit a medical device company's operations. “Having the building prewired to support an IT system, such as using fiber, is especially important in a laboratory environment where many instruments connect to a network,” Chigazola says. “It is important that employees throughout the building can access data in real time.”

Sorenson also attests to the importance of an IT infrastructure. He notes that an automated building management system allows centralized monitoring of building systems throughout the world. “You have got to know what's happening without walking around and looking,” he says “When we walk in the first thing in the morning, we may have a call from Natick, MA, letting us know that one fan isn't running properly in our Santa Rosa, CA, facility.”

Another major necessity is clean power, particularly for medical device companies working with expensive equipment and running experiments that cannot be interrupted. “Our power must have no surges, spikes, or dips because we cannot have machinery turning off due to fluctuations of current,” Happ says.

Clean power is also crucial for Medtronic. According to Chigazola, “We have some very expensive instrumentation that we are supporting. We have to have a clean power source, meaning no fluctuations. Sometimes we even condition the power coming in to make sure that we are not getting any spikes. We do require emergency power systems so that if we lose power, a generator kicks in. When you have very sensitive equipment in which a test cannot be interrupted—even for a second—then you connect that equipment to an uninterrupted power supply, which is basically a bank of batteries.”

Environmental Considerations. Medical device companies also have a facility concern that is ubiquitous in the real estate world: the existence of environmental problems at any potential location. “The most common things that we run into are the environmental issues,” Brown says. “Hazardous materials: asbestos, lead, lead paint, lead dust—all that stuff that you can run into. Chemicals, chemical contamination, groundwater contamination, soil contamination—that's probably been my biggest headache in acquiring and disposing of real estate. Sometimes you look at a property, and it's great for all kinds of reasons. It meets the location criteria, the size criteria, but it has environmental problems. We've walked away. We aren't willing to expose our employees to those issues, and we aren't willing to assume liability for those issues.”

Lease Negotiations

When a medical device company chooses a space and negotiates a lease with the property's landlord, it wants to achieve full rein when it comes to its operations. This includes having permitted use for all the materials used in its production, as well as achieving maximum flexibility and control of operational expansion and contraction to accommodate growth.

Medical device companies will find that leases for industrial property involve terms and conditions of agreement that are highly individualized for each situation. Such terms are usually the subject of much negotiation between landlords and prospective tenants because they involve large amounts of money and complex rights. Often there are legal, tax, accounting, architectural, and engineering factors included in a lease.

The structure of a lease agreement can have major economic and legal implications for a medical device company. The company that is seeking to control costs and limit liability associated with building maintenance will usually seek a gross lease. Such leases typically require the owner to pay for the basic expenses of the property, such as real estate taxes and assessments, insurance on the building, and certain maintenance and repairs on the structure, side walls, and roof of the building.

On the other hand, a net lease requires that the tenant pay some or all of the taxes, insurance, and maintenance charges. There are three general levels of net lease: a standard net lease, a net-net (double net) lease, and a net-net-net (triple net) lease. Under a net lease, the lessee will pay some or all of the real estate taxes and assessments on the property, in addition to other responsibilities. A double net lease provides that the lessee pay some or all of the taxes and assessments and either some or all of the insurance premiums on coverage agreed to in the lease. A triple net lease requires the lessee to pay for the taxes and assessments, some or all of the insurance premiums, and the repairs and maintenance costs agreed to in the lease. A hybrid version of a net lease may require a tenant to pay charges for taxes, insurance, and maintenance in excess of a certain amount, which is specified in the lease.

There can be advantages to a net lease, particularly in cases in which tenants want to manage and control their own costs of maintenance and repairs. In situations in which a facility has multiple tenants, a net lease can help tenants separate costs and ensure that one tenant does not incur expenses related to another tenant's use of the property.

There are numerous terms that must be analyzed in the process of entering into a lease. Executives must have a thorough understanding of all terms and concepts defined in the lease, as well as a strong grasp of the true economic, market, and legal implications of a lease. Economic implications include the value and financing of the space, as well as the financial consequences of each individual lease term. Financial consequences can include time spent fulfilling lease obligations. Market implications include the allowed use and functionality of the property's space, and legal implications include terms and covenants that are enforceable by law.

Flexibility in lease provisions can be especially important for start-up medtech companies that may be anticipating rapid growth. Such companies may require short-term leases that allow them to move if their size requirements change.

However, no matter the size or age of a company, given the frequency of expansion, contraction, and retooling of operations in the medical device industry, certain key terms in the lease agreement can greatly affect the functionality of a building. These provisions are largely a function of the type of building and nature of the negotiations between landlord and tenant. Examples of lease terms that provide greater flexibility include the following.

Prior to entering lease negotiations, medtech companies must identify the provisions that are of the highest priority. Likewise, it helps to know which terms have more latitude during negotiations so that concessions can be made in order to make the company a more attractive tenant to the landlord. When negotiations are complete, a medical device manufacturer must be confident that it has secured a space that meets the economic, functional, legal, and location criteria that were established during its initial needs assessment.

Conclusion

The ultimate success of a company's facility relocation, expansion, or consolidation hinges on the expertise of the team it brings together to coordinate the project. Such an assemblage should include people with experience in facility engineering, operations, legal and financial negotiation, and real estate evaluation. By bringing together a qualified team, manufacturers can secure the desired caliber and type of space at an acceptable price and on satisfactory terms.

Reference

1. “Attracting the Young, College-Educated to Cities,” presented at the CEOs for Cities national meeting (Chicago: May 11, 2006); available from Internet: www.ceosforcities.org/rethink/research/files/CEOsforCitiesAttractingYoungEducatedPres2006.pdf.

Christy Hirsch and Paul Schwartz are commercial agents with Orion Partners Ltd., a regional commercial real estate brokerage services firm with offices in Northern California.

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