Copyright: David Lawson
Published: Property Week Oct 2007
It was deja vue all over again when Mark Dixon announced last month that Regus would benefit from the storm blowing through global finance markets. Occupiers will opt for short-term space while they wait for the dust to settle, he said. They are already doing so in the US.
That sounds remarkably similar to a business plan which failed so badly almost a decade ago. It works when businesses are expanding but if widespread recession kicks in, finance directors clear the decks of anything they can cut or sell quickly. Short lets are usually an easy chop.
So are we in for another slump? Probably not, as the underlying economy remains strong, although if this develops into a full-blown crash, all bets are off. ‘If the ship sinks, we all drown,’ says David Alberto, managing director of Avanta.
But this veteran of two previous crashes sees no sign of an iceberg approaching the Titanic. Even if there were a crisis, small firms which make up the bulk of tenants always ride out such storms, says Tom Stokes, managing director of Evans Easyspace. He continues planning to open a new business centre every month.
Parts of the West End might be expected to whither as hedge funds and private equity firms contract. Market leader Executive Offices prefers says it is too early to comment but Jonathan Price, managing director of fund manager Business Centre Capital, believes this would hit only a small number of centres in Mayfair and St James's, and overall demand has been so strong that operators will have few worries.
The credit crunch will squeeze anyone relying on debt to buy, build or refurbish but most big operators are awash with cash. Regus made more than £50m in the six months to June; Evans has the deep pockets of its parent company and institutional backers; Avanta has similar backing from major investor Kenmore; and MWB Business Exchange has no bank loans, relying entirely on cashflow, says chief executive John Spencer.
Where debt is taken on, it is often at conservative levels, says Alberto. Lending terms may be hardening but rates could rise 50% and still be manageable because gearing is generally low. He cites Avanta’s £9m development in Manchester backed by loans from Anglo Irish Bank and HBOS on a 75% loan/value ratio plus half the fitout costs. ‘I haven’t heard a peep from the banks about changing terms,’ he says.
Clouds gathering over property could actually benefit the sector because operators will finally get a look-in as prices fall, says Price. Alberto has not bought a building in London for almost a year but is salivating at the chance of bargains to maintain Avanta’s ratio of equal holdings in freeholds, leases and management agreements. Business centres will have a strong bargaining position, as they effectively take on the tenancy as well as the lease.
Bigger problems would emerge if tenant demand fades, cutting cashflow and pressuring operators which take conventional leases. They need to pay landlords even where occupier fees are sliding. This is the business model that led to collapses in the last recession.
MWBEX chief executive John Spencer detects no weakening yet and is another operator planning expansion, although he must be comforted that only 12% of his portfolio. There is even less concern outside London’s hothouse markets, where that proportion will be even lower. Overflow space, another key area and usually the first to go, is also less important, says Jim Venables, managing director of Officebroker.
Dixon predicts that gains from tenants taking temporary space will more than outweigh any losses Regus suffers. Price adds that professionals made redundant in recession have a habit of starting up again on their own six months later – and they provide potent demand for serviced space.
One big difference to the last crash lies between the extremes of leasehold and freehold. Firms like Avanta and MWBEX have been developing partnerships where they take responsibility for space but are not locked into conventional rents. They share profits with landlords. This is less profitable in good times than a traditional lease but when crisis looms the rent burden falls along with occupier fees. In other words, operators have already hedged their bets against recession.
So can the sector rest easy? Is Dixon likely to be right this time? That depends. A property slump might be a good thing, bringing prices and rents down. A full blown economic recession, draining away tenants for maybe several years, would not.
Alberto doesn’t see indicators of a major slump, although it will probably take 12 months to see through the chaos. Occupation levels could remain relatively level – admittedly at lower rents - until certainty returns. But demand will then resume its long upward trend.