Philip Grace: Serviced Offices No Longer a “last resort” for Landlords

Philip Grace, founder of UK serviced office company i2 Office, shares his views on the London serviced office market and his key predictions for 2016.

In 2015, circa 10% of real estate transactions in London were taken up by the serviced office sector, roughly 1.25m SQ. Compare that to 2014 when it was 792k SQ. (7% of the market) and in 2013 when it peaked at 436k SQ., 4% of the market.

So, conservatively, 2.4m SQ. of serviced office space has been added in London over the last three years, which has increased serviced office supply.

It shows that the serviced and flexible office sector has come a long way and it’s here to stay. Although not so long ago, landlords regularly rejected the serviced office covenant.

“The tenant of last resort”

It was said many times, ‘it could wear my building out’ or ‘it’s the tenant of last resort’. Now proven not to be the case, serviced offices inflated traditional office demand last year and, it could be said, has propped up the property market for the last three years.

During 2015, we saw strong growth in workstation rates, fuelled by strong demand and a growing economy. Today there is a great deal of choice in the sector, from Regus and LEO to WeWork, meaning ‘one size, one style’ no longer fits all.

With such strong growth in the serviced office industry over the last five years and high demand from clients in late 2015, similar to that which the market experienced pre-Lehman, the sector has enjoyed a boom.

However, during that ‘boom’ time, preparation needs to have been made for the inevitable economic cycle.

An eye for costs

Indeed, is the landscape changing just when things are starting to look really positive?

Many serviced office providers could be faced with upwardly only rent reviews. From £52.55 for typical prime City Grade ‘A’ space in 2011, the same space might see rent costs increase to the mid to low £60s, a 25% uplift.

Then there are business rates, and current forecasts suggest a transitional 20% uplift in business rates after the revaluation exercise.

Operators should have an eye for costs. Typically >60% of a serviced office company’s turnover, when they solely trade property leases, can be made up of ‘fixed property costs’ – rent, business rates, service charge, and utilities.

This leaves 40% of turnover to deal with central overhead, people, servicing clients, IT, depreciation, dilapidations, repairs, cost of money and profit. This needs to be closer to 50% of turnover, similar to that evident in Asia.

A cautionary word on coworking

As such, does anybody really manage to profitably monetise ‘coworking space’ in high-grade buildings, when all the costs of supply are taken into account? It seems to be the must-have, but there is no such thing as a free lunch.

And, a focus on the TMT sector could be dangerous. We’re already seeing some tech companies move away from the favoured ‘Shoreditch-style’ locations; rents are no longer affordable for some of the trendy start-up companies, linking this back to financial liquidity; for how much longer will tech companies be awash with investment cash?

Even in London, the most mature flexible office market in the world, prices per workstation could be impacted if demand wanes and leads to greater supply.

In my view, the future for the serviced office industry is a portfolio consisting of freehold, leasehold, joint ventures and management agreements. Landlords need to take a more active role in what is now a mature industry. Institutions should be prepared to self-deliver and work more closely with the major serviced office providers.

2016 is the time to consolidate, to take stock and prepare. Continued growth at the top of the market could be dangerous if not carefully thought through and well financed.