As the flexible office market continues to evolve, Paul Daniels considers the practicalities for those seeking a “walk-in, walk-out” lease.
The evolution of the flexible office market had already been accelerating before the arrival of Covid, but the pandemic has presented different challenges and opportunities for business tenants and landlords. One resulting change has been the increased use of “walk-in, walk-out” or “managed leases” which look to fill the gap between serviced offices and the conventional office space. What is a managed lease and why are landlords and tenants attracted to the concept?
Landlord and tenant perspectives
From a landlord perspective, they are reacting to tenant demand for space which is ready to move into but the design of which can be more custom-built to reflect their needs.
This demand is often from growing businesses which have developed within serviced office or co-working space but now want space to which they can attach their own brand identity. The market has seen an increased shift towards hybrid working and landlords see the need to compete with the growing flexible office market but without wishing (nor having the skills) to create a serviced office or co-working space of their own.
One challenge for tenants taking a conventional lease of a shell and core space can be the level of capital expenditure required to fit out the space, even after landlord incentives. With lease terms getting shorter, the period over which such capital costs can be written down is reducing. With the cost of potential dilapidations at the end of the term, the net cost of taking a conventional lease is effectively increasing.
Conversely, a “walk-in, walk-out” landlord can often relet the same space with substantially the same fit-out, refreshed for a new tenant, extending the period over which it is able to generate a return on its initial capital outlay.
Ultimately, procuring fit-out works is not the core business of most tenants, and moving office can be a drain on a tenant’s time and productivity. In contrast, many landlords will already have their favoured project managers, contractors and suppliers who can better manage the delivery of the fit-out works (including material or labour shortages) and who will wish to retain the goodwill of a landlord which can generate them repeat business.
Leasing practicalities
What does a managed lease look like and how does it differ from a conventional office lease?
First, in line with the flexible office market, we are increasingly seeing landlords adopting more “user-friendly” forms of leases, similar to service agreements or licences used by serviced office providers. Lease terms are typically between one and three years and will be excluded from the security of tenure provisions. The rents are charged on a square foot basis, not by desk, and will generally be on an inclusive basis, allowing landlords to include an amortised cost of fitting out the space and incentives, such as the landlord paying the stamp duty on the lease. This helps tenants with their cash flow by spreading such costs during the term of the lease.
Rent deposits are often less for managed offices, typically two to three months, as opposed to three to six months under conventional leases, depending on the financial strength of the tenant.
Managed office tenants will usually pay on a monthly rather than quarterly basis and can either pay their own rates and utility suppliers, including data connections, or pay an inclusive rent including rates, service charges and internet supply. This will depend on the space and the provider. Importantly, tenants are not responsible for the initial installation and commissioning of these connectivity services to the property, so avoiding the challenge of securing wayleaves. This allows tenants to “plug-and-play” from day one. The ongoing management of the office, such as security, cleaning and waste disposal, is often managed by a third party, removing this potential drain on the tenant’s resources. Different workspace providers offer varying levels of services, from IT upgrades to organising team events.
The increasing market norm is for any repairing obligation to be subject to fair wear and tear, which contrasts with many conventional leases that require “substantial repair and condition”. However, many managed office providers will charge an “exit fee” or “reinstatement charge” to return the space into the required condition where any damage is beyond fair wear and tear. This still provides greater certainty and less negotiation than a conventional lease dilapidations claim. As the office is supplied with the fit-out and fixtures and fittings in place, these are usually recorded in an inventory attached to the lease and will form part of the tenant’s repairing obligation but, again, subject to fair wear and tear.
Negotiating terms
When it comes to the negotiation of managed leases, this will largely depend on the form of lease issued by the landlord and whether it is in a conventional or more modern format. From experience, tenants of managed leases often don’t engage a lawyer to undertake their negotiations or due diligence on the property, which reduces both parties’ costs and tends to speed up the transaction. As with any negotiation, the negotiating positions of the respective parties will also be key.
Be under no illusion, managed leases are not about to replace conventional leases. Tenants who either require larger offices or are able to commit to longer-term leases will still pay less per square foot than tenants of managed lease space. What managed leases provide is another option to businesses wishing to have their own bespoke space but which are unable or unwilling to commit to an office space for longer than three years because they require greater flexibility. As such, managed leases reflect the evolution in the office market, and it is positive that an increasing number of landlords are embracing the concept to add a mix of flexible office space to their portfolio to satisfy this demand.
Paul Daniels is a partner in the real estate team at law firm RWK Goodman