Investors Step Up Scrutiny of Flex Office Space

JLL research predicts that 30% of the US office market will comprise flexible space by 2030.

One of the drivers behind this growth, ironically, is the uncertainty in the economy. “It’s not just a reflection of current circumstances, such as the ongoing trade war or Brexit, but the rapid shifts in business that make it hard for companies to know what they are going to look like from year to year, never mind in three-, five- or 10-years’ time,” according to Ben Munn, global head of flexible space at JLL, author of a recent post on flex space.

Cost reduction for businesses is another reason flex office space is expected to continue to flourish. Co-working investments are expected to maintain momentum over the next five years as corporate real estate executives continue to view flexible workspace as a necessary offering for their employees and crucial to operational cost reductions, according to a Cushman & Wakefield report about corporate perceptions of the value of flexible workspace and co-working strategies. Companies generally see it as cost-neutral and a way to reduce their real estate costs, according to David Smith, Americas head of occupier research at Cushman & Wakefield.

Investors have taken note of this growth and are stepping up their evaluations of the business and operating models to see what works best. “They have their magnifying glasses out,” Munn writes. “The question is what comes next.”

This increased scrutiny comes as more players enter the market. It’s not just real estate investors becoming more interested with flexible space, Munn reports, but private equity players are also assembling operating businesses. “Even though this market has been around for decades, it’s going through a rapid evolution,” Munn says. “The momentum will continue to bring new models, players, and customers into flex space.”

WeWork’s Troubles

Inevitably in a relatively new space, certain providers will experience trouble—with WeWork being the example that comes immediately to mind. To a certain extent, though, the market has shrugged off WeWork’s problems. Zach Aarons, for instance, a partner at PropTech Venture Capital fund MetaProp, told GlobeSt.com in an earlier article.

“Another flex office provider could come in and take the leases on the cheap or the landlords will take back the keys and try and do it themselves,” he says. “I think everybody in CRE is looking at what opportunities are there.”

Other providers flounder because they didn’t get their pricing or branding right, according to Munn.

The Best Approach

These challenges are adding urgency to investors’ quest to find the best approach.

There is existing research on the subject. A report last year from CBRE looked at office transactions, and found that 40% of buildings with flexible space traded at a higher value than the average office building in the market while 52% of buildings traded on par with the market average. This was, though, not a definitive link. As CBRE pointed out, flexible space is more common in newer or renovated office buildings, and that could account for the boost in pricing among some of the properties. Also, office spaces in general have seen an upward trend in pricing as well.

Despite the uncertainty, investors are pushing to put more rigor around valuations, taking into account the strength of the operator as well as the income premium, Munn writes in his post.

There is also a focus on operating models. Listed flexible workspace group IWG, which owns the Regus brand, has typically leased office space. But it’s now seeking to expand through franchising, Munn says.

Some landlords are offering flexible space in their own office buildings. In some cases, landlords are operating their own flexible workspace brands, building an in-house team to manage the space, he writes.

Other landlords are operating in partnership with flexible workspace providers. The flexible workspace element might be launched with the provider’s branding, or as “white label” space, with no provider branding, meaning the flexible workspaces appear integrated with the landlord’s offering, according to the post.

In short, there is a mix of models on the market right now that investors must evaluate. “Everybody is either spinning up their own brands, buying a company, spinning out their own brand or partnering with any operator that’s not named WeWork,” Aarons says. “There is a flurry of activity.”

Munn believes most landlords will prefer management contracts or partnerships in the future, in line with hotels. “The likelihood is that the self-operating model for landlords will be limited,” he says.