What is the value of flexible office?
Flex is a must-have to retain and attract tenants in a post-covid office market. It’s not a question of if or when landlords roll out a flexible proposition – many already are and so ‘How?’ and ‘How fast?’ are now key considerations. But the big picture questions are now under greater scrutiny than ever: what type of flex should I consider? And how much will it impact valuations?
As landlords and asset managers refine their propositions to meet occupier requirements, they’re left looking for answers about how flex impacts the valuation of their assets. On a recent panel, industry leaders discussed what it means to unlock the value of flexible real estate. Spoiler alert: there’s no definitive answer. Tune in to the full conversation here.
On the Panel:
– Susan Freeman, Partner, Mishcon de Reya, Moderator
– Scott Homa, Director of US Office Research, JLL
– Brandon Medeiros, Co-founder, Alidade Partners
– Chris James, VP, Business Development, essensys
There is currently no standard valuation framework that exists for flexible real estate in the industry. Although flexible workspace has a long history, the model has only caught steam in recent years. There is a nebulous definition of what flexibility is. Depending on who you ask, flex could be coworking, spec suites, shorter-term leases, or other forms of non-traditional long-term lease agreements.
According to Brandon Medeiros, who consults landlords on how to implement flexibility, “there are fundamental questions we need to answer to understand profitability models” around flexible workspace. The offering across the flex spectrum is not the same across the board.
Brandon offered some questions to consider when thinking about profitability:
– What do shared environments do?
– What is the multiple on rent that can be achieved on any flex product?
– What’s the cost to achieve that multiple of rent?
– What terms will people agree to?
A Gap in Understanding of the Flex Model
In recent research published by Verdantix, 53% of landlords claim to offer premium flex workspace propositions, highlighting the fact flex is more than a buzz term. But this leaves a significant minority of landlords, who are yet to adapt. According to Chris James, there’s a significant disconnect between how landlords understand flex and what they have to provide. They get stuck on the length of terms rather than focusing on the serviced offering that is the crux of a flexible proposition.
Rather than focusing on the shift from longer to shorter terms, landlords successfully adapting are focusing their attention on the value flexible options offer their tenants. Flex is a sticky product. Occupiers will continue to renew within a very stable product. Serviced, premium, move-in-ready options offer occupiers a more comprehensive range of workspace options, which helps retain them long-term. Rollover or renewal becomes less of a problem for landlords so long as their occupiers have what they need within that portfolio.
Bridging the Gap
According to Brandon Medeiros, “operators are too focused on margin rather than Net Effective Rent, which tends to be a question for owners.” He recommends describing the products as their Net Effective Rent, which considers the things that require agreement among the industry. For example, what is the downtime? What is the vacancy rate? What is the second-generation CapEx? Is the product competitive compared to all the conventional offerings in the portfolio? When we get to those definitions, we’ll understand what flex is, and be able to communicate that clearly to equity and debt partners.
Speaking of lenders, when it comes to operator models and underwriting flexible office assets, Scott Homa said, “it’s how the lenders are getting involved in the underwriting of management agreements. They don’t want to take your word for it; they want data and a few years of trailing P&Ls as they would for a retail tenant”.
According to Scott, so far, underwriting hasn’t shown price discovery of management agreements. There are little to no data points to validate any percentage of flex in an asset. “All investors had their thesis before Covid around the sensitivity and correlation between the share of rentable building area leased by a flex space operator and any impact of value and liquidity that was associated with that.” Historically, a cool factor was associated with the synergies and foot traffic a flexible offering, such as WeWork, could bring to the asset. But above a certain percentage is when the risk aversion set in among lenders. New research by Verdantix states that 40% of landlords surveyed believe having at least 15% of their portfolio as flex space can lead to the greatest portfolio value.
The tides have changed. Many employers are shifting to hybrid models and giving office space back, leaving landlords scrambling to stay afloat in a challenging demand-led environment. Alternatives are limited if they aren’t open to flex agreements or offering some level of flexibility for existing tenants and larger prospects that can grow within the asset or their portfolio
The Next Frontier
Investors looking at the management agreement component will see bright spots among those operators that are effective in delivering service and amenity-rich offerings that cater to a broader ecosystem. The ability to attract customers and grow occupancy while scaling the model is a value-add.
Technology is a critical factor in capturing operating data that can help tell a clear story about occupancy, retention, and monetization of services. It is also essential to support the pillars of an effective operation, such as secure digital infrastructure, flexible operations, occupier experience, and space management. Without these elements, the complexity and risk of managing flexible real estate becomes exponential.
The panelists agreed there was no definitive valuation framework for flexible office models. While it’s early days for the flexible real estate industry, there’s a tremendous opportunity for the market to consolidate the meaning of flex. Landlords and owners must take a stronger hand in aligning lenders to their flexible office proposition to see progress in favorable valuations of flexibility.
In the meantime, operators need to clearly articulate their offering to owners and help them understand what products they’re selling and how they are valuable to occupiers. Once the owners and landlords are on the bandwagon, they need to help bring their debt and equity partners along on the journey.
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