COMMENT: As occupiers return to the office in ever-growing numbers, the flexible office market is likely to see rapid growth. Not that expanding quickly in the sector always ends well. It doesn’t. But as the market develops, and as operators look to protect themselves and share more of the upside with building owners, traditional leases are giving way to a new model: the operational management agreement.
Those occupiers which opt to partner with building owners offering managed services, rather than choosing to use those provided by flexible workspace operators, will benefit from the owners’ property expertise, economies of scale and – crucially – the operational efficiencies that come with having direct control of the building and plant.
A managed service arrangement involves occupiers outsourcing their property management to the building’s owner, without the need for intermediary operators. This level of service demonstrates good management and more engaging, longer-lasting occupier relationships. There are also important wellness considerations here, particularly regarding the extent to which factors such as the quality of fresh air can be circulated and measured throughout the building.
Core and flex
Until now, most operators have expected a building owner to take on much of the risk by paying most of the capital costs, while being protected by contracting via a special purpose vehicle. Building owners are prepared to accept these arrangements where they provide amenity and ‘core and flex’ options for longer-term occupiers, and where there is an expectation of receiving ‘super profits’ above the traditional market rent.
Examples of such transactions can be seen in our portfolios, including our partnership with work.life at 120 Aldersgate Street, EC1, and at Runway East at 101 Victoria Street in Bristol, both completed in 2021.
But if occupiers’ changing office requirements are to be met, offices provided by intermediary operators should, in our view, form part of a wider office investment strategy. Occupiers who partner with well-funded owners able to offer not just operator-run flexible offices, but fitted, work-ready spaces, such as LGIM Real Assets’ Capsule brand, are choosing a leasing option that offers the ability to flex up and down, both within buildings themselves and across investment portfolios.
For more mature occupiers (those typically seeking more than 5,000 square feet on terms greater than five years), open plan Cat A offices documented by a traditional lease remain an important leasing option. However, we are seeing greater demand for turnkey solutions, where the building owner partners with the occupier to create a bespoke fit-out. This is often financed by the building owner, with the cost amortised over the lease term.
Embrace the evolution
The future of the flexible office market can no longer be defined by short-term agreements. Instead it will be about choice and the ability to offer occupiers a wider variety of solutions including serviced, managed, fitted work-ready, open plan Cat A and turnkey.
Increasingly we are seeing these as the type of products needed to build long-term relationships between occupiers and office owners. Those office owners which choose to do nothing will merely create greater investment risk for themselves, compared with those who keep ahead of the market and implement an evolving suite of creative solutions.
Andrew Mercer is office sector lead at Legal & General Investment Management
