These are heady times for the flexible workspace market. Landsec and Legal & General are the latest property owners to launch their own flexi offerings, following the likes of British Land and the Crown Estate into this ever-growing sector.
What these property owners recognise is that flexible workspace is one of the best ways to attract tenants to their buildings and ‘incubate’ them for future growth. The idea is that as these flexible tenants grow and require more space, they will take it somewhere else within the property owner’s portfolio.
Most property owners realise they need to embrace the flexible workspace sector and many, like L&G and Landsec, are doing so by launching their own operations. Not every property owner has the resources or will to do this, but that doesn’t mean the flexible sector has to pass them by. In fact, there are several ways in which they can get involved.
The first is the oldest and simplest to understand: a traditional lease to an operator. With flexible workspace now acknowledged as an integral part of the office market, many property owners are happy to include this type of transaction in their portfolio.
Another option is for property owners to run their own operation. This means they take on all of the risk of doing so in a dynamic and sophisticated market. They will, however, benefit from retaining all profits, having complete control over the space and, it is hoped, the loyalty of their tenants.
Others have invested in an existing operator as Blackstone did last year purchasing a majority stake in The Office Group in a deal that valued the operation at £500m. Brockton and The Carlyle Group have also opted to go down this route of “buying in” knowledge and a sound business.
Then, there is the increasingly popular trend towards property owners and operators entering into joint venture/management agreements. These can be best described as the outsourcing by a property owner of the sales/marketing and ultimate revenue generation of their space to a flexible workspace operator under the terms of an operating agreement. These agreements are quickly becoming a favoured route for commercial property owners as they can provide returns in excess of ERV and are a lower risk than directly investing in a flexible workspace operator or running their own operation.
Management agreements by their very definition are not property transactions. Rather, they are a service agreement between two parties and this needs to be understood from the outset. If not, there can be issues with valuation, lending criteria and legal points on the agreement (especially if the lawyers involved don’t fully grasp the ‘non-property’ nature of the transaction).
Given the vast array of flexible workspace products in the market, where a property owner decides to partner with an operator it is imperative they find the right partner for each asset. Historically, operator choice was limited and those making proactive approaches to property owners generally became the operator of choice out of necessity. However, times, operators and flexible products have changed. An understanding of both the asset and the options available will ensure that the best possible returns are made.
If a property owner is considering entering into a joint venture management agreement, they need to be clear about their partner’s income expectations, as well as their own. How returns are prioritised between the parties will need to be established. There are operational and property costs to consider as well as the rewards and how profits are shared. The precise details of the profit-sharing agreement will depend on a multitude of factors, including the share of costs and risks that each party is assuming. All of this sits within what is known as the ‘waterfall of returns’, which will be set out in detail in the agreement.
‘Space as a service’ has always been at the forefront of the flexible workspace sector and property owners need to understand how this is disrupting the market. They should be thinking about their product as more just the provision of property. To some extent this evolution from ‘property’ to ‘space as a service’ has been driven by generational change. Unable to get a foot on the property ladder, millennials have begun to prioritise experience and lifestyle as highly as career development. This has led to an ever-growing focus on well-being and mental health in the workplace. In less than ten years, millennials will make up three-quarters of the global workforce, according to Deloitte, so the demand for collaborative and communal workspaces and on-site amenities such as gyms, meditation rooms, lunchtime yoga classes and cafes will only increase. Such services can be provided profitably and increase tenant loyalty – meaning flexible workspaces can generate income that might be well in excess of a property’s ERV.
This is a market that is only going to grow and property owners who refuse to embrace it are at risk of missing out. Capital Economics forecasts the UK market could be worth at least £62bn by 2025. The successful property owners of the future will be the ones who think carefully about who they are going to work with and why. It may no longer be enough to simply grant a traditional lease to a tenant. Property owners will need to view their space as a service and perhaps work in partnership with flexible workspace operators if they are to truly see the significant returns this rapidly expanding sector has to offer.
Douglas Green is a director at GKRE