17 Sept 2018
Businesses of All Sizes Flock to Flexible Spaces
The rise of the market for flexible office space in the Asia-Pacific has been meteoric. Alex Barnes, Head of Markets at real-estate consultancy JLL, explains why, and where the sector is headed.
What scale of growth are we talking about?
JLL research indicates that major flexible office operators grew their footprint at an annualised rate of 35% over the 2014-2017 period, and that pace of growth has carried over into 2018. Among the 17 markets covered in our research, Shenzhen’s market share grew 83%, Bengaluru 98%; Shanghai 72%; Singapore 21%; and Sydney 18%. Growth has been steadier in most of the mature Asia-Pacific markets, such as Hong Kong and Tokyo (12% each), where vacancy is tighter and supply volumes lower.
What’s driving this growth?
The incredible growth in flexible space in some markets, such as Shanghai, has been driven in part by the large quantity of new supply built in recent years. Other drivers, for the co-working segment in particular, include the flexible terms offered to members, the plug-and-play ease of setting up, the sense of community and ready access to social and professional networks.
Who is after these flexible leases?
Initially, co-working appealed to start-ups who found it more affordable than opening a traditional office. But increasingly, large corporates have started including co-working in their real-estate strategy. And to accommodate corporates, operators have increased the size of their centres – our latest research indicates the average flexible space lease grew nearly 40% in 2016. That momentum has slowed somewhat but centres have continued to grow.
How does the bottom line work?
To date the most popular flexible space model has been rent arbitrage. Essentially, operators charge higher rents per unit basis to their members than the rent they pay to landlords. To achieve this, operators typically have seat densities much higher than a traditional office. However, as more operators have entered the market, competition has intensified and arbitrage margins have come under pressure.
And if not that?
Base or turnover rent, a popular retail lease structure, is one alternative. Tenants pay either a fixed base rent or a percentage of sales, whichever is greater. Such a model provides lower fixed rents than market but aligns the upside when centres perform well.
The management contract, popular in the hotel industry, is another alternative. Here, the operator charges a percentage of total revenues and/or gross operating profit for branding and operating the premises and typically there is no lease obligation for the operator. As with hotels, the primary upside and downside is with the owner of the property who is dependent on the operator to keep occupancy and profitability high. Operators have limited obligations compared to other models and yet they are still incentivised to maximise profitability.
What effect does flexible leasing have on the business environment in general?
Catering to corporates with larger centres enables operators to stabilise their rental income (providing much-needed comfort to landlords and investors), but it also means heavier rent obligations and larger expenditure on fit-out. As a result, operators have been chasing additional funding from investors and exploring alternative business models.
And while these alternatives offer operators a means to better withstand a market downturn, they will have a direct impact on how investors view the cash flows from a commercial asset. Going forward, the ability of the operator to demonstrate profitability above and beyond a traditional rental model will determine whether alternative models are adopted by landlords and how they are valued by investors.