Investors are looking for more niche, fast-growing real estate areas, to maintain returns. Increasingly, they see opportunities in the flexible office sector, argues John Williams.
A lack of data around the supply and demand of flexible and coworking spaces has somewhat clouded the market view in recent years, as the traditional real estate market continues to misunderstand the key drivers behind the growth of flexible offices.
For so long, commercial property has been viewed as a secure long-term investment, which required minimal input. But with investments in the more conventional real estate sectors providing lower returns than they once would have done, investors are increasingly looking toward more niche, fast-growing areas, to maintain higher levels of return. A recent survey of investors found that of these specialised areas in real estate, 14% plan to invest in flexible office businesses, giving a very clear indication of the interest in this market at present and a key driver in the flex space revolution.
Landlords too are looking at a very different landscape. Nearly all of the UK’s top landlords – Land Securities, British Land, and L&G to name a few – have recently announced their first, branded forays into flex space. The market for flex space has evolved over time to encapsulate a variety of different services which now include serviced offices, executive suites and hybrid spaces (incorporating both private office space and coworking). And while this market has been growing relatively fast at 10%+ each year, it is in fact hybrid space that has been expanding more quickly at 20%+. Flexible office centres reporting a hybrid solution now make up 15% of the industry while those only offering a traditional serviced environment fell to below 60% in 2018 for the first time.
What is very different for this element of the office market for investors is trying to ascertain the value that the operator brands represent. Two of the UK’s largest operators recently attracted significant investment – LEO and TOG – and the brand was very much part of an intellectual property asset with non-tangible value. This is a radical shift in thinking for a sector that has remained unchanged for more than 120 years.
Valuations
There are also those that believe that the flexible workspace market should be valued differently – this would include not only valuing the amount of ‘contracted revenue’ achieved by renting the space to the end user but also the other income achieved through other services such as IT, administration, reception facilities, meeting room hire etc. According to Giles Fuch, of Office Space in Town, this variable income can make an additional 10 to 15% on top of the contracted revenue for the space.
There are other misconceptions to correct about the valuation of flex space by investors. Firstly, the length of tenure for users of flex space compared to office tenants using a conventional lease. The market has always seen users of flex space as being SMEs or start-ups that only utilise the space for a year or so. But in fact, the average length of tenure is now two and a half years, more for some operators, with a portfolio of clients that range from large, international corporates to start-ups. And this diversification of client base increases the stability of revenue, reducing risk and giving access to a greater spread of sectors from which to access future clients.
Larger Players
The flexible workspace industry remains heavily weighted towards independent and localised providers. However, we have seen that some of the larger operators are looking to expand quickly or are making bold statements about future expansion plans. You will have all probably read about WeWork – one of the most high-profile growth businesses in the world – but there also firms such as TOG, valued at around £500 million by Blackstone, and now Spaces, part of serviced office giant IWG, has announced plans to open another 150 spaces.
The reality is its popularity is increasing rapidly and companies of all shapes and sizes (think Amazon, Sky and Network Rail to name just a few) are dropping traditional leased buildings in droves and turning to flex space – last year demand in this segment of the market grew by 30% in the UK. Corporates are choosing to use this space for the benefit of being able to up and down size over time without the risk of committing to a long-term lease.
Businesses need to be able to react rapidly to change as financial market instability and radical changes in technology start to make a real impact when it comes to business planning. The need to minimise CAPEX, promote growth and maintain an agile approach are objectives that flex space helps companies achieve while retaining focus on core business functions.
This article originally appeared on CFA - HERE.
