Copyright David Lawson - Property Week 2004
Serviced business space rents are beginning to recover as demand eats away rampant oversupply. Average occupancy rose 2.25% in 2003, reversing more than two years of decline, according to a national survey by the Business Centres Association revealed exclusively to Property Week. This lines up with bullish views by top serviced office suppliers which report vacancy rates holding steady or falling But the survey gives a more comprehensive view of the sector, as the BCA represents a wide spectrum of 650 centres across the UK ranging from converted workshops to city centre offices. And the national average hides some surprises.
In the North-east, for instance, occupancy reached more than 97% last summer before settling at 94% by the end of the year. Even that may be understating demand, according to Tom Stokes, managing director of Evans Easyspace, which has opened 22 centres across the Midlands, North and Scotland since 2001. ‘There was a considerable increase in demand last year and it is now racing ahead even further,’ he says.
The message should please the wider property market. ‘Serviced space is a leading indicator for property,’ says Jonathan Price, managing director of Close Business Centre Capital. ‘What happens today will happen across the board in two years,’
It may not be so welcome to tenants who have enjoyed 50% rent cuts in the last two years as landlords fought to let space. ‘The good news is that very few tenants are leaving because of rent increases,’ says Jane Gwillim-David, BCA chair and head of serviced office chain Longford. But it is too early to ‘start jumping up and down’, she adds. Not everyone is basking in recovery according to the BCA survey, which showed that occupancy fell from 82% to 63% in the South-east, and the West End and central London levelled at 75% after climbing last summer.
‘Things are stabilising but the market is still very patchy,’ she says. Areas like the Thames Valley have a long way to recover after being devastated by withdrawal of US and technology companies even before 9/11.
Top-slice serviced office operators are less cautious. HQ says occupancy is holding steady at 80% and demand is at its highest level since the late Nineties. Argyll’s up-market centres in the West End are up to 85% as space is taken up by finance and property consultants boosted by the recovery, says sales director Neil Hindwood. MWB Business Exchange has raised its list prices by 20% and still held onto more than 60% of renewals, according to general manager Tadhg Flanagan.
At the other end of the spectrum, Easyspace and its southern equivalent Workspace Group point out that the average small business which makes up the bulk of tenants has been remarkably resilient to economic downturn. It is the plethora of smaller operators in between that have suffered. With a vast amount of space on offer with little to differentiate one centre from another, landlords can only slash rents to attract tenants.
The BCA survey shows prospects were looking much brighter half way through 2003, with occupancy rising almost everywhere except a few areas like East Anglia. But then interest tailed off. ‘I can only guess that tenants rushed through decisions before the summer holidays and then dragged their feet towards the end of the year, as things seem to have improved again since then,’ says Gwillim-David.
Widely varying performance has a lot to do with the different mix of tenants across the country revealed by the survey. Only 18% in the North-east are in the relatively depressed IT sector with the rest spread across the spectrum. In Greater London that rises to almost a quarter, with another 27% in banking and finance. The West Midlands has 30% in banking/finance and the same in human resources, which has also been depressed by the economic downturn.
But those weaknesses could turn to strengths. Hindwood says HR is bouncing back strongly while Gwillim-David believes the government is becoming a major player. A freeze on conventional leasing while ministers consider mass movement of jobs has boosted occupation in London to almost 20% of the serviced market. This could percolate outwards as business centres in the regions become a first step to relocation.
Recessions are painful but they do have one great benefit: you quickly find out if you are really providing what customers want. During the good times it is easy to believe everything is rosy when there are queues at the front door. But that may be because tenants are making do when space is in such short supply.
It’s a message that hit home in the last couple of years, with many serviced space operators slashing rents and radically altering business plans as tenants deserted in droves. So how do a couple of beginners with only a single building get it so right that they walk away with the top award from the Business Centres Association?
Firstly, Zach Douglas and Paul Finch are not exactly newcomers. They learned the ropes with Regus before taking over a 39,000 sq ft former Pfizer HQ in Staines, west of London, to set up Orega. And starting up in a slump proved more of an advantage than calculated lunacy. A five-year stint with a top landlord taught them what not to do, says joint MD Douglas. ‘Many sell space like boxes. Tenants are offered so much per workstation. We decided to reverse the process, finding out how firms operate and working back from that to match the space to their needs. We often tell them how many workstations they need.’
He is quick to point out that they learned a great deal from Regus. Founder Mark Dixon broke the mould and showed that anything was possible if it was the right idea. But their ideas were different. And right, if an average 85% occupancy level during the worst market for 20 years is any indicator. Now the pair want to capitalise on this success with a second centre in nearby Chertsey and are planning up to 10 across the UK.
One hint that they can match ambition with success comes from the BCA award, as this is decided each year by customers’ votes. It is no guarantee that the path will be smooth as previous winners MWBEX might indicate. But it does show Orega is providing what the market wants – which is a pretty good start.
Starting in a recession proved a boon as it showed Douglas and Finch they could not just provide more of the same. They opened in an area already awash with serviced space and had to offer something more. That evolved from basic lessons at Regus then further education by the two partners with a top supplier of office furniture and a design-build operator.
The first priority is that customer service is critical, says Douglas. ‘They have to trust us. We are part of their company rather than just landlords. Our staff are the first to meet their clients, so we are their public face. That is why we never use temps and spend so much time on training.’ The second is rejection of production-line selling. ‘No client wants the same as the last. Each is unique,’ he says. But one thing everyone wants is freedom from controls set to suit the landlord – the ability to grow and shrink to match their needs rather than protect someone else’s cashflow.
One client in the legal sector grew rapidly from 15 to 45 staff, which meant complete change of layout from open-plan to part-cellular. Orega was part of the decision-making on what would be needed, sending in architects and space planners to make suggestions. It then did the refit. Another factor which drew customer’s votes for the award was transparency. Orega work on a cost-plus basis, says Douglas. Clients are quoted on the price per square feet they need and given a breakdown of all charges including rent, rates, dilapidations and various other services.
Some operators worry about being too open, as it can limit their ability to cut outgoings in hard times while maintaining a single fee. That misses the point of this kind of accommodation, says Douglas. ‘When we started up, everyone was cutting services like flowers in reception and free coffee. We provided more.’ It paid off. Orega charges about the same as local rivals - £400-500 for an average workstation space of 70 sq ft - but the approach helps keep tenants. Average tenure is above the sector average at more than 18 months, which reduces the cost of churn, voids and transactions.
But the firm has is making one major change. ‘We have realised that leasing is not the best solution,’ says Douglas. ‘Leases are pegged to the highest market level every five years. When demand falls, you are bound to have problems.’
Partnerships with landlords overcome this flaw. The Chertsey centre involves a 10-year management agreement with owner Taylor Clark Properties, who offered the new 19,000 sq ft office building when Orega was plotting its next move. Douglas and Finch are hoping this will be the first of a national chain and are in the market for similar deals.
Relationships between tenants and landlords are notoriously bad - so bad that governments regularly charge in as champion of the underdog. No-one comes out unscathed. Rented housing was blighted for a generation by rent controls and commercial property now looks threatened by reforms.
Landlords bear much of the blame for enforcing onerous leases and lumping costs on business occupiers and serviced space is meant to be an escape route. Yet there is a surprising amount of bad blood, and again that is mainly down to lack of insight.
Tenants hate surprises, says Richard Smith, MD of Serviced Office Search, one of the sector’s leading advisers. They want fully inclusive deals so they can budget accurately. They are happy to pay for things like meeting rooms, secretaries and video-conferencing when needed but don’t like being hit by hidden extras.
Too many operators see the service as making money from mark-ups, says David Saul, MD of Business Environment Group. ‘It leaves a bad taste in the mouths of tenants and tars everyone.’
‘A pet hate is being overcharged, especially to mobiles and outside UK,’ says Smith. ‘But tenants must remember that they are saving the cost of purchasing, maintaining and updating phone systems that are usually top of the range.’ On the other hand, they usually pay standard BT rates, so they are missing out on whatever special rates they could negotiate directly.
Saul is experimenting with a pricing system at his new City of London centre which includes free calls to UK land lines. Around 90 workstations have joined since the scheme started in January and a 25-station client is about to sign up. Other hidden extras such as adding use of equipment to charges for meeting rooms are also eliminated.
Transparency is pointless unless the service is good value, however. Serviced space may not carry the burden of conventional leases but is still expensive if not used properly. Even more sophisticated bigger firms are coming to rely on advisers like SoS for independent appraisal, particularly in the ‘minefield’ of larger towns where choice is so varied, says Smith.
That choice is becoming even more complex as operators come up with new ideas. MWB Business Exchange spotted a gap between the ‘virtual’ offices, which provide simple drop-in and call-forwarding services, and more conventional serviced space. It iinvolves renting individual desks in shared offices. ‘Many small firms would like a five-star service but can’t afford their own office,’ says MWBEX general manager Tadhg Flanagan.
Like the BEG all-in service, this springs from feedback showing some resentment among customers that they were over-paying – one reason why occupancy rates collapsed in the last few years. The sector is finally learning to respond to customers rather than repeat mistakes common among conventional landlords. Some operators feel they can provide a glossy building in the right location and wait for tenants to crowd in. ‘Small companies don’t want premises that are all glass and marble,’ says Ian Kibby, marketing director for MLS. ‘They want good value.’
Better customer service would also be nice, particularly when it has been touted so loudly. ‘We don’t stand around chatting in corridors with potential tenants but spend time finding out what they need and then taking them around centres to show how they meet those needs,’ he says. MWB is so concerned about maintaining relationships that it recruits staff mainly from leisure, hotel and travel sectors. Flanagan is one: ‘I came in from airlines,’ he says.
Technology
New technology has become vital for even the smallest firms and serviced operators see this as an important way to attract new tenants. HQ has launched a service called SmartNumbers which offers a single number for land line, mobile phone, voicemail, fax and email. Normally this kind of portable number – which tenants can keep even if they move - is available only to large companies through bulk-buying. Technology director Karen McCoun says the fax-to-email function has been a particular hit.
Better internet connections are the priority for many operators. MLS points to the fact that it can arrange for a broadband connection into its centres far beyond the limit of most small tenants. It is also for their exclusive use rather than being clogged by ‘contention’ – where many users are using the same connection.
All tenants have access to a help-desk and the dedicated IT support team is being spun off to offer support and independent specialist advice in areas such as computer supplies. BEG also offers these ‘big pipes’ but Saul is more circumspect about hands-on support, pointing out that operators can risk losing tenants if they make mistakes with IT and should leave this to outside contractors.
Evans Easyspace and MLS have launched web-based systems to link tenants. Evans clients will be able to log on to view their own accounts as well as tap into special offers the business will be able to negotiate on their behalf. ‘At a particular site you get people trading amongst each other – it’s a form of networking where people get to know each other and buy each other’s products,’ says managing director Tom Stokes. ‘Through our website we’ll be able to extend that to everybody within Evans Easyspace so that someone at a site in Glasgow will be able to buy a product from a company at a site in Yorkshire.
As serviced space moves out of recession a new business model is emerging which could have a significant impact on the rest of the property sector. Several leading players are moving away from buying or leasing space and setting up partnerships with landlords. This could help soak up empty space, although not every operator believes it is the way serviced space will develop over the years.
MLS is one of the most prominent fans. Set up in 1998 by entrepreneur Paul
Williams with a single building in Putney, the firm has expanded throughout
the recession and now has 33 centres across
The firm is switching exclusively to management agreements in an attempt
to reach a balance of equal proportions of its portfolio in leased, freehold
and managed space. That will be part of a push outside the south-east. MLS
is already in
Jonathan Price, MD of Close Brothers Business Centres Capital rates MLS highly. ‘They read the market better than many others, concentrating on the middle sector between basic space and plush office,’ he says. As Kibby points out: ‘Small tenants do not want glass and marble. They have better things to do with their money.’
That does not preclude plush addresses. Around 45,000 sq ft is being converted
in
Agreements like this vary according to circumstances. ‘No two are the same,’ says Kibby. Some involve rent-sharing with the landlord, where MLS will pay for some or all the fit-out. In ‘more difficult’ locations, a separate company is set up to run the centre and MLS takes a fee.
Landlords are also being canvassed by other big names like MWB Business Exchange.
‘Contrary to many headlines, we are not selling out,’ says general manager Tadhg Flanagan. In fact he is looking for another six to 10
centres, mainly around
The parent property group will offer opportunities in its buildings. Even
where it is selling, such as the
Not everyone is taking this path, however. ‘Management deals sound ideal because landlords are taking all the risk,’ says David Saul, managing director of Business Environment Group. ‘But are they just a passing phase in a difficult market?’
He suspects that when conditions improve, owners will want to sell or revert to conventional letting, and pressure will be brought to get business centres out. The only way to be confident is with an iron-clad, long-term contract. ‘But what impact does that have on funders?’ he asks. Tying into such deals is bound to have an impact on values and reduce liquidity of assets, which may concern lenders and investors.
Saul prefers freeholds. ‘If we have problems, we can sell,’ he says. Further
strength comes from offering tenure ranging from serviced space and flexi-let
to conventional leases. That enables BEG to hold onto tenants as they progress
up the ladder. Size is another factor. Centres average around 60,000 sq ft –
reaching 100,000 sq ft in
The backing of conventional leases also produces stable cashflow. BEG was able to rejuvenate its Wembley centre with a £4m makeover out of internal resources. Hands-on control and a range of tenures is also proving a winning formula for Evans Easyspace, which won backing from Kodak Pension Plan via LaSalle Investment Management, for a joint venture which will make available up to £100m to triple the firm’s size over five years.
This will be mainly through new build, initially across the North, Scotland and Midlands, rather than taking on the problems of other landlords, although local authorities are being wooed over provision of workshop centres. “Over the years we’ve designed a style of building which we know to be very attractive in the marketplace,’ says MD Tom Stokes.
‘It’s a simple style containing small offices, workshops and fully serviced offices to let on flexible terms. All our sites are located within established business areas on the periphery of towns to ensure they’re close to good road networks and people.'