As the market started to mature, business models had already begun to evolve as operators learned lessons from the casualties and more about what their customers wanted.

A year into the pandemic, many operators are now looking to de-risk and move away from traditional leases to management agreements, while landlords are weighing up whether to bring in someone else to manage their flexible space or do it themselves.

The question is: which model will be the most sustainable as we emerge from the latest and hopefully final lockdown and return to work?

Flexible workspace providers that own their own properties are among the least affected by the crisis because they do not face the same pressure to pay rent at a time of little to no footfall. But this only applies to a handful of brands in the market, including businesses such as Office Space in Town, Workspace and out-of-town specialist BizSpace.

BizSpace chief executive John Spencer says owning freeholds puts operators in the best position to grow but that it is unlikely that operators will be able to switch to this approach from another one.

“My view is that the growth in the market will be around the freeholders or the very long leaseholders,” he says. “You need the cash to make that happen, so I don’t think you’ll see operators move to a freehold model.”

The most common model in the market going into the pandemic was operators working on a traditional lease within a building.

Fixed contracts

Committing to a fixed rental contract sets operators up for the best of times and the worst of times, says HEWN director Will Kinnear.

“If you get a good rent, and a good rent review, you actually make really good money – the arbitrage is great and the returns are good,” he says.

I don’t think you’ll see operators move to a freehold model

John Spencer, BizSpace

“If you get it wrong, either by signing the wrong deal in the first instance, or the rent review goes up, then you’re in big shtook.

“I can name on one hand the number of operators looking at leases at the moment.”

Kinnear says operators’ turnover will take a hit coming out of the pandemic because while there is high demand for flexible workspace, there is also a plethora of available space on the market, which will suppress workstation rates for some time.

Operators that rely on high density in their spaces to keep the books balanced are likely to take a short-term hit while social distancing requirements remain in place.

Operators with smaller centres are particularly vulnerable to this as they have less access to breakout areas they can lean on for more space if needed.

“If you’re taking a lease where the rent is too high and the arbitrage is based upon high density, then they’ll be squeezed massively,” Kinnear predicts, adding that it is unlikely to be a long-term issue.

Landlords, too, are reconsidering the benefits of having operators in their building on a traditional lease. A long-standing point of contention is that when the letting is to an SPV set up by the operator, that vehicle can be dissolved at any time, leaving a hole in their building and their income.

BizSpace’s Spencer says landlords are “very” wary of this. “There’s no covenant strength with that and, therefore, I don’t see that being a good growth model for an operator, because I don’t think that it is equitable in terms of the landlord. I think that will morph into management agreements or turnover leases, which will be a stronger model going forward in that market.”

 

Lack of flexibility

Cushman & Wakefield head of flexible workspace Emma Swinnerton says some landlords have also been burned by operators taking advantage of the ongoing moratorium on commercial evictions.

“There might be some nervousness around working with different operators because of how they’ve behaved in the last 12 months,” she says. “I think if landlords want to get into this themselves, the element of having control over what happens in their building and to be able to build relationships is key.”

There might be nervousness around working with different operators

Emma Swinnerton, C&W

Swinnerton thinks management contracts will be the way forward for the sector coming out of the pandemic.

“Most operators at the moment are either not expanding or where they are expanding, they’re deliberately saying they will only do it on a management agreement.”

She adds that the biggest obstacle to this model taking hold is that the grey area of how to value a building with a flexible workspace tenant is even greyer when that tenant is working in partnership with the landlord and sharing the associated risk.

“It’s not just landlords; it’s the valuers and the lenders that have to get comfortable with valuing these spaces on the basis of an operating income, as opposed to just a rent and a covenant associated with the rent,” she says.

But not everyone is convinced by the change of direction. Techspace property director Robert Ryan says he thinks management agreements will only materialise “on a couple of floors in very big buildings, to give them a bit of character”.

He adds: “I’ve spoken to several landlords in the past nine months about management agreements or partnerships, and not a single one of them has crystallised – not just with us, with anybody.

“Most freehold owners of property are relatively conservative, private investors. They tend not to want to get involved in the operation of the property, they just want a nice, easy 10- to 15-year lease and to make profit on time.”

Landlord solutions

Mark Furness, chief executive of flexible workspace proptech outfit essensys, says landlords providing their own solutions will also play a significant part in the market going forward.

“Most of the global real estate brands are starting to figure out they have the option to self-perform,” he says.

The occupier customers changed and they’re going to vote with their feet

Mark Furness, essensys

“It’s not because they were desperate to change; I wouldn’t suggest that a 20-year lease with an upward-only rent review at 10 years was a bad business model for landlords.

“I think the occupier customers changed and they’re going to vote with their feet. That’s leading them to have to respond.”

The pandemic has undoubtedly accelerated change in the flexible workspace market and it is clear that relationships between operators and landlords are going to be central to the market’s evolution moving forward.

Whether landlords start making the long-discussed leap into management agreements remains to be seen but, for the time being at least, the general consensus is that the days of operators taking traditional leases could be over.