Office building landlords and investors are fighting to restore their properties’ occupancy and cash flow to pre-pandemic levels. Acknowledging that the workplace has reached an inflection point is an important step in the journey. With the rollout of hybrid policies and the technology to support them, today’s tenants have more choices than ever regarding how —and when—their office works for them.
Long-term leases from blue chip tenants may no longer be the sure-fire proposition it seemed to be in the past. Now, landlords are wondering how to add flexible (e.g. “coworking”) space products and services to meet evolved tenant preferences. Before the pandemic, it was more common for landlords to outsource to flex-space operators. But many operators suffered deeply when offices emptied out amid worldwide lockdowns. Fast declining occupancy rates pushed those with limited capital into distress, including some big names in the industry. In their wake, investors and landlords have increasingly stepped into the space themselves.
The strategy is a sound one. Global research on flexible space shows 41% of tenants expect to increase their use of flex space in their post-pandemic business strategy. The number one priority for the workforce—even ahead of salary— is work-life balance, and with most corporate workers getting a taste of hybrid or fully remote working throughout the pandemic, 63% of employees now state they prefer a hybrid model vs. working from home or work exclusively. And while office remains somewhat traditional for now, 30% is expected to be flexible in some form by 2030.
Flexible workspace is a decades-old concept. But modern flex gives landlords numerous service delivery options, each with their own set of risks and rewards. From a traditional sublease to a flex operator all the way to a self-perform/owner-operator scenario and other options in between, the challenge is determining which approach is right for an individual asset or portfolio of buildings.
Where do I start?
Landlords who can move past the old perceptions plaguing the flex model—primarily the effect on building image and questionable creditworthiness of tenants—are positioning themselves for great success, if they can get over the technical and operational hurdles.
Dealing with multiple tenants and shorter leases is an operational and financial challenge and opting to deliver a full-service flex offering requires landlords to take cues from the hospitality and leisure industry, where a comfort level may not reside.
One thing is for sure – landlords contemplating this shift need to either have the stomach for operating risk, a high capital commitment, or both. There are significant risks to subletting that space to a traditional flex operator or self-managing the flex offering. In the traditional sublease-to-operator model, there’s little to no control of the space and a significant risk of default by the operator while the self-perform model has a higher output of capital and saddles the landlord with 100% of the risk.
In some cases, landlords like Tishman Speyer, Boston Properties, Irvine Company, British Land, NSI, Landsec and CapitaLand are stepping in to run the spaces under their own brands. More commonly, however, landlords are turning to management agreements with flexible space operators that allow flex office operators and landlords to share revenue. This arrangement offers a higher potential in both occupancy and income during a market downturn.
The new management agreement
New style management agreements are focused on aligning incentives for landlords and operators, and this approach is emerging as the most popular way to offer flexible space to the market. Under these arrangements, the flex operator provides limited or no upfront capital but agrees to share the majority of operating income with the landlord up to a target performance threshold, after which the operator is rewarded with more favorable splits. When constructed fairly and effectively, these arrangements can be mutually beneficial.
Adding flex to an asset strategy allows a landlord to create environments that adapt and morph to changing occupier needs, no matter what stage of the business lifecycle they’re in. Get it right, and landlords generate income from a much wider demand stream, often tapping into dynamic new tenant clusters. With all the discussion around risk, the greatest risk resides not in the reputation of a flex operator, but in the building’s location. Flex landlords with best-in-class locations, with plenty of amenities, are the ones who will successfully incorporate flexible space offerings.