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Demand for flexible office space is growing as technology disrupts working practices and business structures, says Tom Goodwin.

Historically, established real estate fund managers prioritised the perceived needs of their investor client base – and almost certainly paid less attention to those of their end customers, the occupiers of properties. A desire to secure predictable cashflows was paired with the offer of stability and security to tenants, resulting in long, inflexible leases. For some occupiers, that model remains relevant: many businesses require a degree of certainty over costs. But others favour a more flexible model that enables them to grow into, or withdraw from, space as business needs demand.

The requirement for a more flexible approach is growing as technological advances drive rapid change in the way individuals work and the ways in which businesses are organised. As a result, the type of workspace businesses require is also changing. There are going to be fewer big firms and those that remain will be less likely to sign long leases. Flexible office space will most likely account for a growing share of the market, and investors need to understand this increasingly important segment.

Structural changes drive demand

Demand for flexible office space is being driven by a number of structural changes in the labour market, including the increasing prevalence of flexible working practices. In the UK, for instance, the Work Foundation estimates at least one third of the entire labour force works remotely all or some of the time, a figure that equates to roughly ten million people1. It also found that by 2015, nearly 40 per cent of organisations had embraced mobile working; a figure it expects to rise to over 70 per cent by 2020.

Technology has been a key enabler of this trend. With super-fast broadband, smartphones and other mobile devices increasingly ubiquitous, the Work Foundation suggests we may be approaching a “tipping point” where mobile working becomes the norm.

Technology also allows small businesses to grow extremely rapidly, and is helping larger companies to become more efficient as they open up their networks and shrink in size. These trends are spurring demand for flexible working space.

The increasing prevalence of start-ups has been yet another important driver. In the UK, for instance, there were nearly 658,000 new companies formed in 2016, up from around 440,000 in 20112. Indeed, company formations have been rising strongly since the late 1990s3.

At the same time, the ranks of the self-employed are expanding. In the UK, the total number of self- employed increased from 3.3 million people (12 per cent of the labour force) in 2001 to 4.8 million (15.1 per cent of the labour force) in 20174. While not all of these people are involved in the type of work that requires office space, data on the number of freelancers suggests many are5.

The current economic uncertainty arising from the ongoing Brexit negotiations perhaps creates an environment in which more firms favour the flexible model. These occupiers will become accustomed to the high levels of customer service, frictionless decision making, and potentially significant interaction with other businesses within the workplace that exists across much of the ‘new’ shared office market. If and when these businesses move to more traditional leased space, they are likely to expect a significantly better customer-oriented experience.

Forthcoming changes to accounting standards may also drive a significant increase in the number of tenants seeking flexible office solutions. Under IFRS 16 and effective from the 1st January 2019, companies in more than 100 countries will be required to bring all major lease commitments onto their balance sheets, including real estate leases. This could drive an increase in serviced office space demand to minimise rental liabilities on balance sheets.

Adapting to disruption

The rise of co-working and shared office space is a disruptive force that will undoubtedly affect real estate fund managers’ decision making. Already, a shift is taking place in the degree and nature of customer service provision by traditional landlords. The surge in shorter and more flexible leases and a closer relationship between investors and occupiers has, if nothing else, caused landlords to rethink the need to provide a better quality of service. This is evident in less time being taken to agree leases, landlords engaging directly with occupiers to create a more productive and mutually beneficial relationship, or changing the roles of building management staff towards hospitality and away from security or caretaker-dominated functions.

Beyond those fund managers committed to delivering material improvements in the customer experience, some organisations have taken the bold step of launching their own operations to compete with new entrants. However, the plethora of new providers are yet to suffer an economic downturn, and it is likely that not all operators could withstand the weakest points of the cycle, when their occupiers are likely to take advantage of flexible lease provisions and reduce occupancy.

The high fixed costs of what is, by and large, a management-intensive operating business, is at odds with the uncertain revenue streams these businesses rely on. So there are two issues for fund managers to think about. Firstly, investors launching their own operations need to be comfortable that they are not moving outside their circle of competence, or dedicating excessive resources to a business area that is highly specialised and carries significant operational risk. Secondly, even landlords considering letting space to serviced office occupiers need to form a view on the prospects for each particular operator. Some will inevitably fail when they encounter challenging conditions.

 

1Working Anywhere, A Winning Formula for Good Work?’ The Work Foundation, Lancaster University, January 2016.

2Startup Tracker’, StartUpBritain, March 2018

3Incorporated Companies in the United Kingdom’, June 2016, Companies House

4Trends in self-employment in the UK’, Office for National Statistics, February 2018

5Exploring the UK Freelance Workforce in 2016’, Kayte Jenkins, IPSE & Small Business Research Centre Kingston University, February 2017.

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