Changes to working practises and business structures have major implications for the serviced office sector, presenting opportunities for real estate investors who understand the dynamics, argues Chris Urwin.
2 minute read
The serviced offices sector, though by no means new, is undergoing a period of significant growth. The way we work and the ways in which businesses are organised are evolving rapidly, driven by technological advances. 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.
In many markets, lease lengths have been shortening for several years for different reasons. Occupiers value the transparency and simplicity inherent in flexible lease structures, which enable them to grow, downsize, or relocate their businesses quickly. Short leases can be an especially attractive option for start-ups and small businesses.
Although serviced-office space can appear more expensive than traditionally leased space per square foot, flexible space is generally taken on a ‘one fee covers all’ basis. In other words, the extra costs of traditional leases - such as security, reception and cleaning costs, as well as reinstatement costs at the end of a lease - are avoided.
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.
The increasing prevalence of start-ups has been another important driver. In the UK, for instance, there were over 600,000 new company formations in 2015, 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 rose to almost 4.8 million in June 2016, an increase of almost one million since late 20084. 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 are.5
Operators claim occupiers make sizeable savings by only paying for the cost of space they use. Regus describes this as a movement to viewing “property as a service” and suggests cost savings of 60-80 per cent are possible for clients.6 There is independent research backing up these claims. A report by the Chartered Institute of Purchasing and Supply7 found average savings of almost 80 per cent. That is perhaps no surprise when you consider that Unwired Research found that over 50 per cent of office desks were unoccupied at any one time.8
For property owners, the service-sector tenant may be of increasing value since leases can be signed on attractive terms. WeWork , for instance, often signs 15-year leases though these can be in exchange for up-front leasing concessions, notably fit-out costs.9
Demand for flexible office space has been robust in the face of the weak economic conditions of recent years and structural drivers remain strong, although landlords need to be cautious of the covenant strength offered by providers of serviced offices.
Taking on serviced office tenants requires careful consideration: not just the suitability of the property and location, but also of the quality and appropriateness of the operator. Companies such as WeWork have largely fixed liabilities (long leases), meaning they are vulnerable to declining revenues in the event of an economic downturn.
At the same time, there is a high service component to what most users of flexible office space pay for, just as people staying in hotels expect to be well cared for. Assessing operators’ abilities to meet such expectations may not be in a traditional real estate investor’s skill set. However, with the universe of traditional office leases set to shrink, those that fail to build such capabilities are likely to be disadvantaged.
1 “Working Anywhere, A Winning Formula for Good Work?” The Work Foundation Lancaster University, January 2016.
3 “Incorporated Companies in the United Kingdom”, June 2016, Companies House
4 “UK Labour Market”, August 2016, Office for National Statistics
5 “Exploring the UK Freelance Workforce in 2015”, John Kitching, IPSE & Small Business Research Centre Kingston University, April 2016.
7 “The True Cost of the Flexible Office”, Chartered Institute of Purchasing and Supply, 2003
8 RBS, op. cit.
9 “WeWork Operating Overview”, Eastdil Securities, Q4 2015. WeWork often takes relatively large leases, average of 50,000sqft. This is unusually large, Deloitte figures show an average of 20-25,000sqft in Central London.