Office Market Update – Is it the end of the world as we know it?

As we enter 2019 we are asking ourselves if this is the end of the world as we know it?

Well ok, perhaps that sounds overly dramatic, but as 2019 begins we are considering what the future holds in store for the office market and where the opportunities may lie.

Over the past two years we have seen a notable shift in the office sector with substantial growth in the flexible office market. A record proportion of office space take-up is now attributable to serviced office operators, with providers such as IWG (whose brands include Regus and Spaces) and new entrants from the US including WeWork, now dominating the market.

In the local area IWG has taken 25,000 sq. ft. in Hemel Hempstead, the town’s largest office transaction for 2018, accounting for more than 25% of the annual take-up. A similar picture was also seen in Watford last year with IWG appearing once again. This time as the second largest transaction amounting to 7.5% of the town’s annual take-up. This scenario is replicated in major centres throughout the UK and according to a BBC news article released in November 2018, “So far this year, flexible workspace operators have taken up one sixth of all new commercial property in the UK capital and last year their footprint outside the capital tripled with Manchester and Birmingham seeing the fastest growth”.

During the same period, we have seen major institutional landlords such as L&G introduce flexible leasing platforms to stay abreast of market developments (sometimes to the dismay of their existing serviced office operator clients).

We have also seen a greater willingness amongst major corporates to source quite significant amounts of office accommodation from the serviced sector and take advantage of their flexible terms. This is most prevalent amongst agile global brands.

It would seem a variety of factors could be considered as driving the demand for greater flexibility. Some are perhaps short term, but many look set to stay as the result of the manifestation of pressures that have been building for some time. Our team has taken a look at the major factors driving changes in the office market:

  1. The Political Turmoil in the UK
    The most obvious factor is the political and economic uncertainty which is wide spread in the developed world but is perhaps most obvious in the UK as Brexit approaches. A significant number of businesses are reluctant to tie into longer term lease commitments without a clear view of what lies ahead. Where a change is required to business premises this can sensibly be dealt with by the serviced sector pending the arrival of more settled conditions.
  2. IFRS 16
    From January 2019 IFRS 16 will require the vast majority of leases to be capitalised and declared ‘on balance sheet’. This significant accounting change will mean longer leases are less attractive from a financial reporting perspective. The full implications of this are as yet unknown but for many businesses as this changes the presentation of their accounts there will be a potential impact on the following: debt, credit rating and covenants, earnings, capital expenditure, distributable reserves, employee performance plans and tax liability. Lease agreements under 12 months have optional exemptions which may not be available to leases that are subject to options to extend or determine. This may provide increasing pressure for shorter leases until the effects of these changes are more widely understood.
  3. Efficiency & Employee Mobility
    Locational opacity, flexible working practices and increased employee mobility mean that many employees no longer have fixed or definable permanent workplaces. Consequently, the ability to offer overflow space at short notice in differing locations is important and serviced operations mean this is paid for only when and where required. This is likely to be a lasting and increasingly important factor as employee mobility continues to grow.
  4. Travel and Staff Morale
    Physical travel is becoming more problematic and being fixed to a physical location is both inefficient and has an adverse effect on employee morale. Homeworking does not appear to offer a solution that works for the majority of businesses but co-working, collaborative and drop in space may offer the solution particularly where software can now monitor and charge for use as it occurs.
  5. Footloose IT
    Technology is less physically fixed and is now easier to pick up and move from location to location and there is a tendency to refresh office environments with greater frequency as employee retention becomes more critical.
  6. Changing Workplace Priorities
    The serviced sector has embraced changing work practices and could be seen to be the only office option that delivers what the millennial workforce wants. Workplace wellness, breakout spaces, concierge services and open plan collaborative environments are all high on employee wish lists and those companies wishing to retain and attract talent may find flexible space provides a much more comprehensive and desirable service offering.

Whilst these drivers of market changes are not new, many of them have crept upon us and the confluence of factors has meant that the effects are now much more evident.

The workplace is becoming more casual in appearance and function, even in some traditionally conservative industries, which fits well with the trend towards serviced office providers and this is unlikely to be subject to a reversal.

Companies have never before had so much choice. Those involved in the property industry will need to understand the needs of employers and employees alike and adapt their offering to meet the office space needs of the modern market.