The growth of the serviced office

March 2018 | EXPERT BRIEFING | SECTOR ANALYSIS

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A change in the way we work, ever-improving technology and a shift in workplace culture are just some of the key drivers in changing the way we do business faster than ever before. This has been reflected in the real estate market by a rise in demand for flexibility for a business and its physical operating arrangements.

The serviced offices sector is now ranked as the seventh largest subsector of the UK real estate market, according to a recent PwC report. This is echoed by the high volume of investment into this area – particularly in London – where providers of serviced offices were the biggest takers of office space in the first half of 2017. What do serviced offices look like and why are they so popular?

Traditional office leases are changing

Since the 1980s, the general trend of commercial property leases has seen a dramatic reduction in the average length. According to research carried out by MSCI Inc in November 2017, new leases granted last year were for an average of 7.1 years, a startling reduction from an average of 25 years three decades ago. In addition, just over 40 percent of commercial property leases contain break clauses – though this is more common in leases of industrial sites than office leases.

It can be noted that the average length of commercial leases hit lows during the financial crisis in 2008 and 2010 and have gently risen since, but this is merely a statement of confidence in the market rather than a change in the trend. Fundamentally, landlords are now working in a market where tenant flexibility has to be borne in mind and reflected in the products provided. Understanding why this paradigm shift has happened helps explain the growth of the serviced offices market. So why have commercial lease lengths shortened?

The growth of creative and tech businesses triggered a change in working styles and office needs. Allied to this, the rise of remote and online working in even the most traditional employer companies means that tenants’ space requirement are shrinking or variable and hot-desking is increasingly prevalent. Generation Y is now at the forefront of business and employers are benefitting from their ease with technology and the ability to work remotely. With this, there is an expectation of a standard of living which has resulted in a mood towards improving the office environment for workers.

A growing awareness of the health and happiness of office workers has been recognised by the development community – thanks to work such as the UK Green Building Council’s Wellbeing Lab – and by employers. The effect of this is employees are encouraged to take advantage of flexible working, but employers are also often prepared to pay a premium for modern, well designed office space for their staff.

What are serviced offices?

The concept of a ‘serviced office’ has been around for some time and was traditionally seen as a desk solution aimed at entrepreneurs, consultants and SMEs drawn by lower costs, collaborative working areas and the flexibility of being able to book on a monthly basis. The flexible office industry has matured over the last 15 years so that it now provides a sophisticated and complex variety of options for tenants.

One of the benefits to the tenant of this model is the all-inclusive rent, which eliminates concerns about unforeseen costs such as dilapidations or high service charge costs. Another is the ability to expand and contract office size according to workflows, taking on more space when workloads and high and then releasing surplus space at the end of a project. It can also form part of a disaster recovery plan and can be useful as a temporary HQ when established buildings expand to a new city.

Virtual offices, which are aimed at start-ups who benefit from an official address, phone number and meeting rooms when interacting with clients, have become increasingly popular and serviced offices, where tenants purchase desk space plus any additional services they require such as wifi, reception services, access to meeting rooms and print facilities. This is really where the sector has garnered interest.

Initially, the majority of the buildings used for flexible serviced offices were tired, tertiary stock. In the last two years, however, this has changed and a good proportion are now new-build blocks in smart locations, or historic buildings with high quality re-fits. They are also increasingly found in regional centres as well as in London. They are in the locations that people want to work.

Investment

The long-term demand for flexible workspace is driven by global trends towards innovation, agility and remote working. Along with hotels, care homes and student accommodation, serviced offices have become a newly defined real estate asset class in its own right. As part of this, the sector has recently attracted significant inward investment in terms of M&A consolidations and also new ventures.

With the standard of fit-out and design of the properties used for serviced offices increasing in line with the appetite of companies looking to take on space and benefit from all the advantages that a serviced office has to offer, the end of 2017 and the start of 2018 has seen big investment into the sector.

In January 2018, Office Space in Town Limited, a serviced office provider led by founders Giles Fuchs and Niki Fuchs, sold an 80 percent interest in a portfolio of high quality office premises worth £161.7m to RDI REIT Plc. This innovative deal involving plc money follows on from a spate of private equity money recently entering the sector, notably Blackstone’s purchase of a majority stake in The Office Group, and Carlyle’s purchase of three properties in London for development into serviced offices.

Conclusion

There is a real excitement around the serviced office sector, and with good reason. It is an offering that has aligned itself to the changing needs of business and how companies operate. The upturn in investment into the sector and the fact that it is being backed by private equity money are solid signs for continued growth. Although the greater flexibility for tenants would appear to be to the detriment of landlords, the model allows landlords to rent at a slight premium, which is further good news for investors looking for high yield returns. In the words of real estate entrepreneur Giles Fuchs, “serviced offices allow out of area companies to enter a market with limited financial exposure that they could not otherwise have entered. This applies regionally, nationally and globally. This explosion has just started”.

Paul Kenny and Tom Purton are partners and Gareth Wynne is an associate at Travers Smith LLP. Mr Kenny can be contacted on +44 (0)20 7295 3385 or by email: paul.kenny@traverssmith.com. Mr Purton can be contacted on +44 (0)20 7295 3277 or by email: tom.purton@traverssmith.com. Mr Wynne can be contacted on +44 (0)20 7295 3690 or by email: gareth.wynne@traverssmith.com.

Paul Kenny , Tom Purton and Gareth Wynne

Travers Smith LLP