Avoid a void 2.0
The pandemic has understandably driven an increase in demand for a wider range of flexible solutions and minimisation of capital expenditure. This is driving an increase in the number of short-term leases and management agreements as well as the gradual return to flexible workspace take-up. With an increase in the amount of ‘grey space’ coming back to the market, occupiers are also picking up ‘ready to go’ space more easily.
The landlord strikes back
Back in 2019, Avison Young produced a report called Avoid a Void which looked at how landlords were responding to the boom in the flexible workspace market. Back then we were seeing an expanding WeWork and several rapidly growing offerings. The conclusion that we came to was that traditional landlords were looking for new ways to market their properties to challenge these flexible occupier solutions, but in a well-balanced market landlords were very cost-conscious with regards to the capital expenditure required to reap the benefits of speed of letting, and a minimal return on investment. This meant that plug and play space was limited to the smaller end of the market, and in those locations – primarily in central London - where the rental premium would justify the outlay.
FLEXIBLE WORKSPACE OFFICE TAKE-UP
CAT A or CAT B? That is the question.
As supply levels have increased and flexible occupier solutions have been in greater demand, more and more landlords have pivoted away from the traditional blank canvas shell and core and Cat A fit out where tenants are left to provide themselves with a working finish Cat B fit out.
At the smaller end of the market, this is driving an increase in show rooms, basic furniture provision, post-acquisition design as well as fully fitted ‘plug and supply’ space – much of which is fuelled by the circular economy.
The upside of this is a far more collaborative approach between landlord and tenant when it comes to the use of space, greater provision of communal space and the ability to replicate elements across a portfolio. Occupiers gain many of the upsides of flexible workspace including speed of moving and ability to visualise space, but without the association to a provider or intrusion from other businesses – sometimes competitors. It also has the benefit of reducing up-front and dilapidation costs, while maximising occupancy.
One size fits all
From the landlord’s perspective, in a market with relatively plentiful supply, ‘plug and play’ provision is driving viewings, attracting more tenants, with some offices being let quickly after work, when the Cat A finish had been sitting on the market. This is driving down void rates, and increasing the potential for occupier retention in the medium term.
In London and the larger regional cities the evidence base is increasing, with a selection of indicative anonymised deals shown in the chart below.
Given the broad nature in the type of fit-out from basic Cat A+ to fully fitted/plug and play transactions, rental premiums are also broad and will depend on the length of the lease, although the cost of the fit-out will generally be rentalised over a 3-to-5-year period.
CAT A+ OFFICE TRANSACTIONS – RENTS, PREMIUMS & LEASE LENGTHS
Most premiums vary widely between £2 psf to £8 psf depending on the level of demand and the quality of the fit-out but average at around £5 psf. Rent-free periods also tend to be significantly less generous than a conventional lease, at a 25% to 50% discount, thereby providing an additional landlord premium on the net effective rent. Landlords will generally offer shorter lease terms for CAT A+ - a 5-year term and a 3 year break is the most common - but this is something that is occurring across conventional leases and fit-outs in any event.
With the cost of fit-out not differing greatly between London and the regions, the premiums that landlords charge are also similar. This provides an advantage in London as increased costs are less of a proportionate increase in rent to the tenant when compared to London’s much higher traditional rents.
The level of CAT+ provision is increasing throughout the UK office market, to match the demand for flexible occupier solutions. With this there is a growing trend towards greater customer care and service, putting pressure on landlords to position their assets accordingly. Whilst this has implications on capital expenditure, evidence suggests that this has potential upsides for both landlords and tenants, reducing voids and providing a rental premium, whilst giving occupiers an ‘off the shelf’ solution. Landlords need to take an active role in positioning their space to occupiers or risk falling behind.