Flexibility the key to the future
Currently most offices are still largely traditional, with the tenant committing to a multi-year lease with limited options to expand or contract during the committed term. In the most mature markets flexible workspace represents up to 7% of total office stock. London is leading the charge on this front with 6.9% of all office space being consumed on a “As a Service” model, followed by Amsterdam (6.3%), San Francisco (4.7%) and New York city (4.5%).
As a comparison Auckland sits at less than 2% with the entire flexible workspace supply of New Zealand representing less than 1% of total office stock. These levels however are set to explode over the next decade with global real estate firm JLL predicting that flexible workspace will represent 30% of total office stock by 2030. The increased demand combined with an overall increase in vacancies have led commercial property owners to further look into partnering with operators to provide the amenities that tenant want through partnership models, be it management agreement or franchise, or getting into flexible workspace management themselves.
But with limited track record to assess the benefits of partnership and even more limited expertise in the market to deliver in house, how can landlords assess how to best leverage this shift in customer requirements?
Workspace as a Service
The key to flexible workspace is to consider the provision of office space no longer as a leasing model but rather a service model. The key drivers for demand from an occupier perspective are:
- Flexibility: Where typical leases would provide for five-to-ten-year commitment, flexible workspaces offer tenants the ability to scale up and down sometimes at a month notice. This change requires to focus on designing fit outs that are versatile, can easily be transformed at a minimal cost.
- No capex outlay: This is one of the biggest drivers for occupiers. For most businesses the allocation of cash to income generating activities is critical to success. Especially when traditional offices have a typical utilisation of only 52% there is a clear benefit for businesses to lessen their total capex outlay on office space and re-allocate part of this previously spent capex on activities that will drive income
- Increased utilisation: Due to the on-demand nature of flexible workspaces, they provide the user with a 100% utilisation. Considering total workplace costs are generally 7% of a company’s total costs, an occupier can significantly optimise office utilisation by incorporating flexible workspace into their portfolio. From a landlord perspective this means that they can provide a lower cost option to tenant while still receiving higher rent. For example, a building that didn’t offer flexible workspace would need to provide more space to accommodate the same requirement, therefore becoming more expansive for a tenant.
- Ease of transacting: Typical leases take much longer, require more resources and are much less attracting to tenants than the service agreements typically used in flexible workspace transaction. Where the average lease is close to fifty pages and needs expansive legal review before it can be executed, flexible workspace agreements are similar to IT service provision agreements and generally do not require any legal input to be signed. Where leases take several months to be executed the average sale cycle of a flexible workspace solution is 21 days.
- Financial benefits: Through higher utilisation and lower capex requirements flexible workspace provide an overall cheaper alternative than traditional leases both operationally and on the balance sheet. Especially since the introduction of IFRS 16 rules that now capture the entire lease liability on the balance sheet as opposed to service agreements being treated only as operational costs.
The list of benefit from a tenant side goes on and it is no wonder that the global players in the industry have reported historical demand in the recent months. With the benefit for tenant being clear there is no question that landlords who provide flex in their buildings will outperform their peers. Between the options of outsourcing the management to existing operators or creating in-house ventures how can landlords assess which solutions are best suited for them to deliver flex amenities to their tenants?
In house operation Vs outsourcing
In recent months we have seen an acceleration of franchise partnerships signed by global flex space providers which further demonstrate the growing appeal of this model. But is outsourcing the best solution for landlords? We have compared below the two scenarios:
The main benefit of outsourcing to an existing operator is that it is easy, typically quicker than setting it up yourself (Although not always the case) and will generally deliver a return faster given the existing operator will have customers on their books already.
However, it can also be costly – most providers charge 10% to 15% on gross turnover – it provides less control especially for integrating the flex component to the overall leasing strategy of the building, and it can be more hassle depending on the quality of the provider.
It also can be difficult to manage risk given the operator will often demand full freedom to run the operation under its business model and will be less capable of adapting to specific requirements. For example, it might be beneficial for a landlord to offer a highly discounted rate for a large portion of the flexible workspace in order to accommodate a large lease over the balance of the building, but the flex space operator may not be inclined given this would not be beneficial for their operation. Outsourcing also gives much less visibility as the knowledge of the customer base remains with them.
Furthermore, in the context of New Zealand there is limited numbers of flex space providers with depth of expertise with IWG being the only operator providing solutions to both corporates and SMEs. Partnering with global providers can be difficult when they typically invest limited resources into understanding the local market.
In house operation
The best local example of a successful in-house operation is Precinct Properties’ Generator co-working. The integration of the co-working operator into Precinct’s operations has enabled them to retain a competitive advantage by providing seamless integration between the traditional leasing and flexible workspace offering. When thinking about in-house operation landlords should consider the following key metrics:
- Layout density – typically between 6.5 sqm and 8 sqm per workstation. Although this may seem like very high densities the combination of occupancy and utilisation result in an effective density of 10 sqm to 12 sqm per occupied seat
- Pricing – a key component of delivering strong yield is pricing management. Ensure to provide a mix of inventory varying in sizes & quality (Internal Vs external offices) to offer choice
- Capex investment – critical to achieving good return is making clever choices in the use of materials, design of services and power and data. Typical costs from a standard base build condition range from $1,300 psm to $2,500 psm
- Add on services – one key differentiator of flex space Vs traditional space is the provision of services. Ensuring you have a mix of services – permanent office, co-working desk, pay as you go office and meeting room, IT & T, printing facilities, plant rental etc… will help achieve super return without requiring much resources to set up and operate
- Leveraging your existing resources – in house property manages can be a very good way to think about how to resource your flex space offering without incurring additional cost
- Wow factor and optimisation – Many flexible workspace providers do not think enough about the importance of customer experience. The key to successful flex offering is to ensure that the space provides a wow factor without impacting the layout density. It is critical to ensure the design is driven by inventory metrics rather than the other way around.
- Sales & Marketing – finally you will need to think about how to market the space. In today’s digital world it does not require much marketing investment provided it is done correctly. Furthermore, due to the nature of flexible workspace the spend require will decrease overtime as the occupancy reaches mature levels.
Flexible workspace in numbers
So, what does a typical operation look like from a number’s standpoint? Our analysis below provides average financial forecast for typical flexible workspace operations in the Auckland region for an A grade asset. For lower grade assets the mechanics are the same except the cash payback may be longer given the increased ratio of fit out cost to rent. The long-term margins however tend to be higher depending on the level of service revenue.
Note the figures below have been adapted to reflect a landlord operator situation:
- Capex investment – $1,500 to $1,900 per sqm per annum
- Operational cost (Excl. rent) – $450 to $650 per sqm per annum
- Gross revenues – $1,200 to $1,700 per total sqm per annum or $1,500 to $2,125 per sqm per annum
- Gross profit – $750 to $1,050 per sqm per annum
- Opening Occupancy – varies between 15% and 45%.
- Monthly occupancy growth – 3% to 7%
This will heavily depend on how the operation is set up and the extend of current resources. If we look only at marketing most operators spend between $10k and $20k per annum on marketing with a one off spend for pre-opening marketing of $15k to $20k.
Overall, it is clear that the owner/operator scenario delivers more benefit for the owner provided expertise can be sourced to help with the strategy, design and construction of the site. Although it is a relatively simple business to operate there are key errors that must be avoided in the planning stage to ensure strong returns are achieved.
If you are a landlord or a tenant with surplus space wanting to explore what flexible workspaces could do for your business, we can certainly help. We have the strongest expertise of any New Zealand firm in this regard employing experts with over 20 years combined experience – Pierre Ferrandon – Gwynn Hoskins
If you would like to know how we can help you get in touch with us for a chat.