Data is key for values, growth and investment in the flexible office sector

Disruption across the office market over recent years has been widely reported with the topic capturing most headlines being the polarisation of demand. However, looking beyond this a key thematic trend is the increasing importance and role of the flex sector. Driven by an increasing and sustained level of demand from businesses, both big and small, the flexible office sector has continued to grow over the last five years, even with WeWork reducing its floorspace.

Increasing demand for flex  

Savills has reported that flex office take-up across the UK reached 839,000 sq ft at the end of Q3 this year, which is the highest level at this stage of the year since 2019, with London alone seeing 12.5 million sq ft of take-up by flex operators over the last ten years. However, what this data does not capture is how much take-up flex providers are now seeing within their centres and there is no central tracking of how much space is being taken by occupiers within serviced and managed space.

Interestingly, the increased demand from operators is not simply about the flexibility needs of businesses, but growing expectation and requirements, particularly in the sub 10,000 sq ft range, that this space will be fitted and ready to occupy, and more increasingly, managed.  

We have therefore inevitably seen the type of flex product on offer diversify as operators respond to more discerning requirements as well as landlords themselves offering fitted and managed space. For example, GPE has set a target of 50% of their office portfolio being managed space. In addition, British Land, LandSec and Grosvenor can also point to growing percentage targets within their respective office portfolios as they respond to the changing demand dynamic in the market. 

The flexible office sector has in fact evolved to such a degree that it is now widely accepted as an established part of the office market rather than an ‘add-on’ and we anticipate that this demand for flex will only continue to grow over time, but further investment is needed to support this.  

Unlocking further growth in flex 

Despite the growth in demand, the lack of transparency and shared data across the flex market has presented a challenge for investors and valuers, affecting the continued progress of the sector moving forward. Without this insight landlord returns and operator valuations and exits will be impacted.

For the sector to progress and evolve further there needs to be a greater knowledge of occupancy levels, average length of stay and, in particular, the net returns that the sector can generate. The metrics in terms of lease-up rates and incentives are favourable and the perceived wisdom is that occupancy levels in flex are higher and the average length of stay is at least comparable to ‘traditional’ office leases. Most significantly, in many cases there is a premium rental return provided. Given this performance, it is no wonder investors in the sector are left frustrated that flex is valued at a discounted yield to traditional multi-let offices. 

We consider that the traditional approach to valuation of flex is also undermining investment in the sector. Moving away from the split yield approach to the DCF (Discounted Cash Flow) method of valuation will align the sector with other operational asset classes, while benchmarking income, costs and profit margins gives greater confidence when assessing underlying value. Whilst we are aware that operators are beginning to collaborate and share data between themselves, this is very much the tip of the iceberg. In the same way that the hotel industry has an independent body to capture this data, the flex sector needs something similar across the wider market in order to give some insight into underlying performance.

Last resort or prime opportunity? 

There also remains a misconception that flex is seen as a last resort, but the undeniable growth across the sector and the fact that we have seen an increase in landlords entering the flex market in order to access demand for this type of product speaks volumes. We therefore need to be looking at the flex sector as an opportunity to create value and offer something for all occupiers. One such example is Chancery House, FORA’s office building near Chancery Lane. Prior to their acquisition in 2019, it was a secondary office building. It now offers 130,000 sq ft of premium flexible workspace, close to being fully occupied, with gross quoting rents of £275 to £285 per sq ft.  As demand evolves there will be attractive repositioning opportunities emerging to create improved performance and returns for investors.

Brand matters 

Brand recognition and reputation will also play an increasingly pivotal role in the flexible office sector. This relates to attracting both new investment and growing occupier demand. Whilst we have seen a move towards B2C marketing, with adverts for operators on the tube and podcasts, general public brand recognition of operators is still well below that of other operational asset classes. To this extent we see that direct parallels and lessons can be made to the Build to Rent sector, which is also an operational asset class of similar maturity.   

Flexible workspaces are here to stay and are an ever increasing part of the wider office market, but for the sector to gain greater investment interest and maturity, data is going to be fundamental in order to build investor confidence in the asset performance, the brands that operate in the space, and the underlying valuation of the buildings and businesses that operate within it. Only then, will we begin to see flex result in the premium that we expect.