Regus buys management specialist to handle problem office space
Pioneer returns to continue managed office space revolution
Demand for mixed use could benefit serviced offices
Consolidation forecast among serviced office operators
Copyright: David Lawson - first published Property Week October 2006
Regus buys management specialist to handle problem office space
The giant awakes. Regus was born screaming, wakening the property industry to something startlingly new called serviced offices. Others joined the cacophony but the baby went quiet, weakened by a severe case of excessive growth. Now fully recovered, the noise level is again reaching epic levels.
Plans are afoot to double UK business with more than 100 new centres. Another 40,000 workstations will be added across the world and talks are under way to invest millions on investment funds to take a stake in Regus properties ranging across Asia, Europe and the US. It is all great news for the rest of the industry, which has thankfully given up carping about living in a giant’s shadow and accepted the benefit of enjoying the reflected glory. Hidden behind the headlines, however, is a fascinating move which has cost chief executive Mark Dixon only a pocketful of change.
While all the shouting was going on about boom and bust, Richard Douglas and Peter Cookson were quietly nursing along a much smaller operation which anticipated a different approach to leasing. Managed Office Solutions was set up as a joint venture with Savills in 1999 to handle surplus space for clients, a concept that has now begun to dominate the industry. As the name indicates, this involves taking on property and farming it out to occupiers rather than offering the conventional serviced office model. Most big names have moved into this field but Regus appears to have decided it was better to buy established success rather than create its own.
While there has been some notable consolidation within the serviced office operator market, this move by the world’s largest supplier to acquire the UK’s leading managed office operator is the first of its kind. For a mere £1.85m, Regus has acquired a business with an annual turnover of £1.65m on more than 350,000 sq ft of property ranging from 15,000 to 350,000 sq ft across London and the Thames Valley up to the Midlands. More importantly, it is taking on the accumulated experience of Douglas and Cookson to guide the Regus Netspace concept which will look for more buildings to serve large tenants.
Regus already has relationships which involve taking responsibility for business centres created by developers such as Arlington. MOS is not a partnership but an acquisition. although it will continue to run under its own name. The business model involves taking corporate space under management contracts which it sub-lets to occupiers on all-inclusive terms. Where available, existing infrastructure such as fit-out and furniture is recycled into the deal and any shortfall bought in. This unique approach offers accounting advantages by avoiding write-downs on unamortised capital expenditure.
Being bought by Regus was attractive to MOS because it not only increases exposure to corporate clients but also provides significant financial backing to accelerate the growth of the business, says head of sales Patrick Maher. One project already under discussion involves Regus and MOS co-operating on a serviced office centre, large scale managed office lettings and a communal conference facility. ‘There is potential to provide the corporate occupier with expansion space in varying sizes in the short to medium term without having sterilised the space or sub-letting it on a basis that may be restrictive,’ says Maher.
Will Douglas and Cookson be advising on Regus space? ‘Not specifically, but MOS will be spearheading operations in the managed sector of the market and as an execution team for its Netspace product,’ he says. MOS will continue to grow across the UK and expansion into Europe and the US is being planned for the near future. The exact locations will to some extent be driven by specific corporate client requirements.
After a dip in the market for serviced space during the early part of the decade, Maher now expects plenty of scope for Regus and MOS to grow as occupiers and tenants become more attuned to a hassle-free approach to accommodation. A convergence of factors is driving the sector, he says. Changes in working practices, outsourcing, work/life balance pressures, globalisation, mergers and acquisitions, technology developments such as internet and telephony, demand for increased security and restriction on travel have all profoundly affected the location, specification, quantity and duration of office space needed by organisations in recent years.
MOS tips for aligning real estate with operational needs
Pioneer returns to continue managed office space revolution
A pioneer of serviced offices is back in harness. Peter Allport, widely credited as the founder of modern UK business centres, has been away ‘recharging his batteries’ during a traumatic five years for this fledgling sector.
So what changes has he noticed? Not a lot, it seems. The market crashed but is back to the buoyancy he enjoyed in happier days. The firm has a different name - Executive Offices [EO]. Regus claimed the former HQ label when it took over the US arm. But EO is close to the original UK core Allport founded with outgoing chief executive Peter Kershaw in the Nineties – plus some additions. In fact, he must sometimes wonder what if anything much has changed.
A bright new generation is trumpeting ideas such as taking over surplus space and re-letting on short contracts. The latest wheeze involves tapping international investment funds to finance or buy business centres. Allport watches it all with bemusement. He and Kershaw persuaded funds to back international expansion in the late Nineties - long before the current stampede. More than a decade before that, while still at Lambert Smith Hampton, he set up his first business centre in London’s Piccadilly and wrote reports forecasting huge changes.
IT advances would mean companies no longer needed to crowd executives together. They could work anywhere, he said. Outsourcing would boost surplus space but also feed demand from thousands of consultants. There were countless back street cubby holes behind doors crowded with brass plates but Allport realised the new breed of tenant would demand a better deal, preferably with more flexible leases. He advised Frogmore Estates on the first HQ franchise outside the US, and then bought the operation with Kershaw in 1996. They went through a series of mergers and buyouts before the UK arm recently emerged as Executive Offices, owned by Morgan Stanley Real Estate Fund [MSREF].
But guiding principles remain unchanged. Allport has no plans to rival old combatant Regus or new ones like MLS in a race for sheer scale. Expansion is on the cards but quality takes precedence over quantity. Openings will also be limited to cities like London, New York and Paris which can support multiple centres and reap the economies of scale. Size is not a key measure of success, says Allport, pointing out that individual EO centres were more profitable than any big rival. Emphasis on quality is indicated by the fact that international expansion will be based on the firm’s ‘six star’ brand, Argyll, which it bought last year. Demand for the best space is so strong that an 11,500 sq ft building in Birdcage Walk, St James’s, has been bought as the tenth London site in a growing portfolio of period listed buildings in Belgravia, Mayfair and the City.
One difference Allsop has noticed is how the market has matured, with tenants now demanding flexibility in rents as well as lease terms. The firm bought Corpnex to provide ‘affordable’ space and is developing a mid-level brand called Palladia. Agreement has been reached to operate DSG International’s 15,000 sq ft former London office in Farm Street, Mayfair, on a management contract. A ten-year management agreement has also been reached with GE Commercial Finance Real Estate to refurbish and operate 25,000 sq ft at 15 Old Bailey. A joint venture with Grosvenor and RBS/Omega Land will form a further Palladia centre at Lothbury, in the City.
EO is maintaining a tradition established 20 years ago for taking over surplus property, long before the current ‘new’ trend says Allport, who is bemused by reports that he ‘wants nothing to do with managed space.’ This misunderstanding may spring from his insistence on calling everything ‘flexi-leasing’. Who owns space is irrelevant, he says. Leasehold, freehold, joint venture or managed, the key is service to tenants.
He veers into heresy for a surveyor, insisting this is not part of the property sector at all, but a service industry. ‘Managed space is like running a hotel, although tenants stay longer,’ he says. Allport’s views that business centres are not property investments may not be shared by all its partners nor, perhaps, by owner MSREF. They see a way to squeeze out better returns than conventional leasing. But that could be said of other hot investment sectors like hotels and nursing homes, neither of which is tagged by property analysts.
The future of managed space is bright, says Allport. ‘It is now a mature market but there is still a long way to go as working practices change and outsourcing increases,’ he says. He dismisses homeworking, pointing out that tenants welcome the interaction of a business centre. But he doubts forecasts that they will be among the first real estate investment trusts. They seem to offer the right characteristics, such as focus and cash flow, but will not sit comfortably with other property REITs because income comes from short-term fees rather than long-term rents. He does, however, forecast more consolidation. Those who have jumped on the gravy train over the last few years will find business is not so easy when harder times come around, he says.
Demand for mixed use could benefit serviced offices
Flexibility is one of those buzz words rattled off nowadays to summarise all that is great and good about modern business property. Leases, layouts, even payment terms are all far more negotiable than in the bad old days of take it or leave it. Business centre operators rightly claim they sparked the revolution by offering an alternative to traditional long-lease space, bundling heating, lighting, rates and administrative services in a single fee for periods as short as a few weeks. But some are in danger of suffering from their own inflexibility.
Serviced offices are still the most common way of selling short-tenure space but many tenants are drifting away from all-in packages, often handling their own secretarial demands from modern desktop PCs. Landlords and investors drawn into the sector need to explore variations on the original theme or face being swamped by a tide of other newcomers and swiftly expanding big names.
There are still gaps ripe for exploitation. Mixed use development is as revolutionary as flexible letting and Orega, a dynamic smaller operator, has found what appears to be a natural link. Tough new planning rules leave many developers in unfamiliar waters by demanding a mix of business space and homes on inner city sites. Commercial developers can stick to the bits they know and call in a housebuilder for the rest, but the position is usually reversed on these sites. Residential developers are in control, and they often lack the expertise to let and then sell on commercial space.
Orega was planning its first London operation when the opportunity emerged to get in on the ground floor of a mixed scheme in Wandsworth. It approached the developer, Chartbrook, and agreed to take over the ground and first floor commercial space as a17,000 sq ft business centre. This could become a significant trend for developers, as planners are more likely to grant permission for mixed use and pre-letting as a business centre eliminates the risk of speculative development.
Getting in early has another bonus, says Paul Finch, joint managing director of Orega. Operators are not normally involved until fit-out, making the best of a bad job with services which ultimately lead to occupier dissatisfaction and impact on later profitability, he says. Partnering a development from the outset means key features such as air conditioning can be designed in to suit highly cellular layout. This kind of extra efficiency could provide an edge to better compete in an increasingly crowded market. Orega is negotiating two more schemes as part of plans to expand outside its south-east base.
Outsourcing is another key issue which has yet to be fully exploited. Management agreements and joint ventures are now almost commonplace but these have tended to focus on landlords and large occupiers looking kick-start new schemes or offload surplus space. Huge potential exists for a more active role with tenants. Operators tend to wait for occupiers to find them rather than go out and do some active fishing. They could learn a lesson from Instant Offices, which stepped outside its role as online broker to find, fit out and manage 17,000 sq ft of short-term space for the Metropolitan Police in the Telegraph Group’s HQ in London’s Victoria. This follows a similar deal for Transport for London earlier this year, also in Victoria.
MWBEx, the UK’s second largest business centre company, has gone even further to serve specific occupiers. It went out and found almost 28,000 sq ft in Leeds, took a 15-year lease at £21/sq ft and simultaneously agreed a five year licence with the NHS to provide a managed centre. Chief executive John Spencer is not disappointed by the fact that no similar deals have been done since then. It is not from lack of demand, as inquiries pour in at a rate of four or five a month. ‘We just haven’t been able to find the right property,’ he says.
This throws a light on increasingly heated arguments whether business centres are part of the service sector or the property industry. ‘You can have the best service but still fail without the right location,’ he says. He has no doubt that this will be a rich vein of business in future. Major names are increasingly looking for short-term property as they adjust to a new business environment where demand for space can fluctuate. Changes in accounting regulations have also brought conventional leasing onto balance sheets.
Business centres can generally handle demand for up to 20 or 30 workstations but requirements are soaring above this threshold and will require a new approach. The NHS and Centrica, another tenant provided with space in Leeds, have effectively been given a complete outsourcing package. They went to MWBEx looking for a way to sort out property requirements but it could be dangerous for operators to sit back and wait for approaches. Conventional landlords have got wind of this change and it won’t be long before they pile in with similar offers.
Consolidation forecast among serviced office operators
Agents have a standard argument against managed business space. When times are bad, tenants jump ship: when things look up, they lock into long leases before rents rise. Such cynicism is wilting as booming demand matches that for conventional offices. This is reflected in soaring fees, the all-in charges which substitute for conventional rents. Levels are rising by 1.5% a month in central London and 1% across the UK, says John Spencer, chief executive of MWB Business Exchange [MWBEx].
He is surfing this wave with new centres in London, Bristol and Newcastle, boosting the firm’s portfolio above 1m sq ft and maintaining number two slot in the business centre league. Regus is not ready to cede top place, planning to double its centres in the UK over the next three years, while MLS is coming up fast on the rails.
The number of UK workstations is expected to reach 200,000 by the end of 2006 compared with around 125,000 at the turn of the millennium, seemingly dominated by the top three. They have increased market share from 23% to 27% over the last couple of years through takeovers and organic growth, says property consultant DTZ.
But not all the cream is at the top. Business Centres Association chairman Tony Waldron says growth is more broadly based, with mid-level firms like Abbey, Evans EasySpace, Business Environment and Orega all opening new centres. ‘Single-centre operators have been leading the real expansion of the industry during the past two to three years as well as taking the lead in innovation with new customer-facing products and services such as all-inclusive packages, loyalty schemes and intranet websites which allow occupiers to market to, and network with, other occupiers,’ he says.
How long many will remain independent is another matter. DTZ is convinced the sector is moving into long-awaited consolidation as the market improves, with more than £600m of mergers and takeovers since 2004. Cash is running freely. Regus negotiated a massive new credit facility when buying itself back from venture capitalists Alchemy and has declared an appetite for 100 more centres. MLS is determined to close the gap and aims to raise money from a stock market float to create a national chain. MWBEx is already spending proceeds from its floatation on new centres.
Small operators must be rubbing their hands with anticipation of fat cheques but managed space veteran Philip Parris suggests they should not plan any luxury cruises just yet. The vast majority of recent investment has come from buyouts at HQ Executive Offices, Regus and Bizspace. While individual centres are also changing hands, he thinks this will not be a big factor in future.
‘Mom-and-pop’ outfits will struggle to match strict requirements by the big chains for location, size and specification. Relations with tenants are also important in this people-oriented business, and new managers could wipe out years of goodwill. Even obscure areas like compatibility of IT systems can make or break prospects for takeover.
Simply hoovering up any centre that comes on the market led to the crisis which crippled the US market. Parris is concentrating on expanding Harvard Offices in careful steps, ensuring each new centre meets his needs. A more likely scenario will be mergers between mid-sized operators with a good fit, much as when Executive Offices bought Argyll to access top quality West End centres. There could be stiff outside competition, however. Investors are taking a more serious interest as a series of deals has provided hard evidence of what these businesses are worth, says DTZ.
Fears that supply might outstrip demand have also faded. Managed space and serviced offices are now an accepted part of the property market and on the shopping list for far more firms seeking space, says Rob Hamilton, MD of specialist agent and manager Instant Offices. Parts of central London are running at capacity, with new centres filling before they have opened, pushing rents ever higher, he says. The only potential dampener is that Regus is driving for higher occupation levels on all its centres.
Could the bubble burst? Not according to Philip Dodson of agent Office Planet. The last boom was driven by dot.com mania, when IT firms piled into serviced offices and just as quickly dropped out a couple of years later. Analysis of key London markets shows a firmer foundation, with almost three-quarters of tenants from mainstream business. This is a key reason why investors are flooding in, attracted by more solid long-term prospects. There is also less polarisation between small startups and big companies, says Dodson. Medium sized professional services now take up most space with demand for 10 or more desks common. Fees have risen to around £1000/workstation/month in hotter parts of the West End, £600-700 in Soho and Covent Garden and £500-700 in the City.