COMMENT Despite the intense pressures of the past year, the flexible workspace industry looks set to emerge resilient from the pandemic, already prepared to meet the demands of an increasingly footloose post-Covid workforce. It should come as little surprise, then, that the model is drawing increased attention from traditional CRE landlords, who have faced months of uncertainty.
However, often lacking the specific sector know-how to replicate the model alone, landlords are increasingly partnering with operators that specialise in serviced office space through joint ventures and management agreements.
But the growing appetite for joint ventures among landlords and operators has once again highlighted the absence of a consistent valuation model for serviced offices. A standardised framework for valuing serviced offices and flexible workspace is needed now more than ever to help the sector reach its full potential, allowing both landlords and operators to benefit from the model in the post-Covid era.
Punished for progress
While Covid-19 is set to accelerate growth in the UK serviced office market, the sector has a history of substantial expansion dating back further than the past year.
Growing by 31% between 2008 and 2016, the UK serviced office sector is a long-standing global leader and has previously been projected to reach a valuation between £62bn and £126bn by 2025. So it may seem as though landlords partnering with operators to enter into the sector and enhance the potential of their assets will be sitting pretty over the next few years, but this ignores previous estimates that the sector could have been undervalued by as much as 20%.
Valuation methods have thus far failed to keep pace with the evolution of the industry, meaning serviced office operators risk being punished, rather than rewarded, for bringing more innovative models to market. At the same time, landlords embracing the model lack the ability to gauge the true value of their assets. It’s clear that, as the sector emerges as a solution to the pressures of Covid for many landlords, a consistent valuation method is required.
Several pioneering approaches have sought to resolve this issue for serviced offices. Like hotels, this type of office provides a service as well as a space – including IT and reception facilities, business support functions, clerking, franking and the rest. Only frameworks which amalgamate these multiple revenue streams can accurately distil the valuation of a serviced or flexible office.
Our own formula, honed through years of experience in the sector, seeks to unlock the potential of serviced offerings to attract income beyond standard office rents and could provide a framework for valuation. This formula combines contracted and variable income, which account for approximately 85-90% and 10-15% of total income respectively.
This preponderance of contracted income should alleviate concerns about the shorter average lease lengths of serviced office space. Indeed, with the flexibility of shorter leases proving attractive to today’s fleet-footed tenants, these concerns can be turned on their head. Moreover, flexible models which accommodate multiple clients in the same building will minimise the impact of any single client taking their business elsewhere – a typical problem for traditional office space.
Realising potential
Taking all this into account, our formula values a serviced office building using EBITDA equal to the market rent for the property valued at prevailing yield for that building, rent, location and operator’s covenant (ability/experience) plus 90% of the remaining EBITDA valued at, say, 7% yield, depending on centre maturity and trading history.
Using 90% of the variable income allows the final 10% to act as a safeguard for income which could be affected by market fluctuations; this 10% may be at a much higher yield.
The serviced office sector looks set to provide many pressured landlords with a solution in the wake of Covid, as workers look to return to the office with greater flexibility and businesses seek to reduce long-term real estate commitments. But the enduring lack of a valuation model for the sector has once again emerged as an issue – one which has long been in need of a solution. With a suitable valuation framework, such as the formula detailed here, as well as a wave of new joint ventures, the sector will stand a far greater chance of realising its potential for exponential growth post-pandemic.
Giles Fuchs is chief executive at Office Space in Town
