Cleo Folkes Kaushik Shah
Flexible office space providers or those that deliver ‘space-as-a-service’ are major tenants in many cities around the world. Manhattan and London are particularly well-serviced with a boom in space taken by such operators. When there is a boom, there is often a bust. But even when the balloon bursts, the world will be a different place. For small and big landlords, and for flex-space operators alike.
With the flex-space offering, tenants have their need for ease of leasing and lease-flexibility filled. Landlords of large offices see empty space let-up on long leases to the operators. A more dynamic environment is created, and tenant base is diversified. But landlords of smaller buildings now suffer much higher vacancy as many their former occupiers move to flexible space. They face a smaller pool of clients. There is no turning the clock back.
In the previous two articles we set out the business model of flexible office space providers and the threats and opportunities they might provide, and the eco-system that is being created. WeWork claims to create a community and doesn’t simply let office space. It provides a space for living a life, not just work. Space-as-a-service and lifestyle.
As property becomes more and more like an operating asset as investments go into more alternative, less traditional properties, landlords get more comfortable operating in this way. Many have decided they want a piece of the action and start up their own ventures.
Landlords Get In On The Game
Providers of flexible, co-working space are getting competition from traditional large landlords that own large buildings (such as property companies, property agents) as they evolve their business models and jump on the bandwagon. They are driven by the need to redefine relationships with their occupiers.
There is a clear, belated, recognition that the traditional landlord-tenant approach is altering. The flex-space operators business mix is becoming diversified. The hunter becomes hunted!
The core letting business continues to offer traditional fixed-term leases but with more flexibility built in through breaks. Unsurprisingly, space use and design now reflect modern working practices. Considerable thought is being given to how teams work best, how work-flow and movement is made more efficient and how communications are made easier.
In addition, some of these new frontier operators are capable of owning their own buildings, and sometimes do so. They will undertake joint-venture developments with owners keen to let vacant or refurbished space. An interesting new feature is in ‘participating leases’, where the upside (or downside) is shared between operator and landlord. This is similar to ‘turnover rent’ type leases. The underlying hard property factor is clear to see: the flexible space operator is another option for the current investor to help monetise vacant space, or by helping to remove structural void costs.
Turbulence and Disruption
The new operator model has a strong bias towards branding. Operators deliver their own vision of the space. Its services delivery is aligned to its end users to attract existing and new occupiers, thus removing the traditional agent role. This is called disintermediation.
For the owner-landlord, the brand operator effectively becomes the tenant, the letting agent and the leasing operator as a ‘three-in-one’.
Operators do far more than simply let space. They are equally technology-savvy. They understand the fragmented and imperfect nature of the real estate market place. They capitalise on opportunities such as leveraging or enhancing the use of CRE databases. The potential exists for blockchain technology for market intelligence, information sharing, data exchange or for gathering, verifying & comparing data. These factors drive competition and transparency.
They know that their varied tenant base provides them with data that is valuable for the long term – much more than yields or valuations that traditional property investors appear to think about.
What does this mean for large-scale investors and landlords? In many respects, no change! For example, in terms of property location, build quality and sustainability we have a status quo.
In terms of the market place, there are steep, continuous changes. The scale of operators is ballooning, and new formats arise. The power of branding and technology comes to the fore. Operational complexity rises steeply. Long-term impact of demographic changes on office space demands should be considered. Specific factors investors that own office space should consider are:
- Floor Space: design & uses
- Lease: structure, length, pricing, terms, flexibility, etc
- Occupier base: mixed
- Portfolio: more diversification away from traditional occupiers
- Risk sharing: with brand-lease operator
- Market: space absorption, holistic approach, etc
- Investment Analysis: Cashflows and Valuation to reflect underlying changed business model and economics: an ‘Operational Approach’ to office property cashflows and valuation (think in terms of RevPAR, stabilised occupancy, EBITDA, capitalisation rates/stabilised yields, etc). The static rent roll type analysis is long gone. The cashflow is now much more business operating driven than the ‘fixed income’ investors often aimed to get from real estate. The assumptions and complex variables are both non-property and property specific.
The office property cashflow begins to resemble an operating business – a new frontier subject to innovation and disruption.