Will flexible offices’ rapid growth impact office rents?
Green Street suggests flexible offices are creating headwinds for the office sector, but rents will not be impacted.
Flexible office space is growing fast, and not just through WeWork’s headline-grabbing global expansion, fuelled by funding from SoftBank. In a research report published in November 2018, real estate consultancy JLL notes that Europe’s flexible office space sector is set to grow by up to 30% per year over the next five years, pushing the total market size of the flexible office space sector in Europe to 10 million square metres.
In London alone, JLL estimates that flexible office space has more than doubled since 2014, representing 20% of total office take-up, while in central business districts across Europe, JLL expects that the market share of flexible offices is likely to exceed 15% in the next five years.
One question raised by the rapid growth of flexible offices, with their far higher density than traditional offices, is whether they will have an impact on office rents. Commercial real estate research firm Green Street Advisors, in a 2018 report focused on the impact of flexible offices in central London, concludes that although flexible offices will create ‘headwinds’ for the office sector as a whole, the impact on rents - in central London at least - will not be as dire as feared.
Green Street’s calculations come in lower than those of JLL: Green Street reckons that the take-up of flexible office space in central London in 2017 was 17% of total office space, reaching a similar level in 2018, and that flexible office penetration in the central London market will be closer to 10% by 2030. At that level, and based on an assumption that total central London office stock remains flat, Green Street’s projection is that there will be a 3% vacancy rate in central London offices.
“A vacancy rate of 3% signals a tight market,” says Rob Virdee, co-author of Green Street’s report. “At that level there will be some rental tension. Currently, vacancies are about 3.5% for West End offices and about 5% for City offices. In our base case scenario, flexible offices are not going to be that much of a disruptor.”
Although the impact on rents in central London may not be as severe as some have feared, suggests Virdee, the impact on business models is more noticeable: “Flexible offices are disruptive because of fact that others are changing their business models. Traditional office landlords are moving into the flexible space or moving towards providing flexible office leases.”
Examples of standalone brands operating in central London include Storey, established by British Land, and Myo, launched by Landsec in January 2019, while other traditional landlords such as Great Portland Estates are providing flexible offices under their existing brands.
Generally, explains Virdee, office leases are becoming shorter, partly in response to demand, but partly also in response to the strong growth of flexible office. Whereas traditional leases are around 15 years, often with breaks at five or ten years, flexible office providers work in the 0 - 5 year range, besides providing flexibility in terms of how much space is taken.
Duration mismatch risk
“Flex is here to stay,” says Virdee. “It’s in vogue at the moment, because of all the space that WeWork is taking. But we would highlight the fact that the duration mismatch (between long leases taken out by operators and the short leases of end-customers) could be a problem. At the moment, the growth in supply has been met with a lot of demand from independent entrepreneurs and small and medium-sized enterprises (SMEs). But a lot of that SME growth has already happened and, if it turns, it could go in reverse quite quickly. In a downturn, some flexible office providers could find themselves in a sticky situation.”
The future of flexible offices will be discussed further at GRI Offices 2019 in November in London.