Serviced offices one would surmise, offer the ideal solution in a post-Covid world. Mainstream office investments are struggling in a world where a good proportion of most company’s office staff are working flexibly, either at home or on the move. Serviced offices, it would seem, offer many advantages.
The benefits of serviced offices include cost-effectiveness: they offer short-term leases so no long term commitments; all the useful facilities needed are provided on site; they are easy to move in and out of; they are usually well situated in business districts; they are maintenance free; they have fast internet access; and they easily facilitate networking.
Dispute all of this, many providers are experiencing the same difficulties as the general office market. The technology that’s enabling home and mobile working is having a similar impact on serviced offices.
The WeWork problem
The US listed company WeWork - a $47bn company with 44 million square feet of office space world wide - the so called world-changing office space provider - is evolving into a shaky entity that is casting a shadow over the whole flexible office sector. If you listen to the hype around this company, it can provide cheaper office space in a work-from-anywhere post-Covid-19 world with all the benefits listed above.
The reality, it seems, is something far different. Operating as the middleman is proving to be tough in the current environment. WeWork rents commercial office properties off landlords on long-term leases, it provides all the necessary facilities and services for a modern serviced office operation on site, and then it lets off piecemeal, offices and meeting rooms on short term (monthly or weekly) flexible leases and day rentals – something akin to a business hotel.
But WeWork announced in August that it had “substantial doubt about its ability to continue as a going concern” without a rapid turnaround in its business. Although there’s since been a share price bounce driven by speculative buyers who are keen to see the turn-around phenomenon seen with other struggling US companies, nothing can hide the fact that WeWork has lost 98 per cent of its value since its initial public offering (IPO) in late 2020.
Both WeWork and IWG (formerly UK based Regus) rely on generating their revenues by renting offices off office landlords and then subleasing them on flexible terms to their short-term tenants. Both have recorded years of losses, and Covid has driven these to a new level.
Covid drove down down the demand for office space, so both companies, tied in to long-term leases, found the cost of providing services to their customers was exceeding the amount of cash they were bringing in. The last time IWG posted a pre-tax profit was in 2019 and WeWork has never posted a pre-tax profit.
There is obviously an appetite for a more successful version of a large serviced office operation, says The Investor’s Chronicle. In the UK, IWG’s share price recovered 10 per cent of its value when the last results were announced and after management said it was considering a US listing. Perhaps its investors were pondering the potential positive impact for IWG of WeWork’s potential collapse. The development could also provide a growth opportunity for UK listed real estate investment trust (Reit) Workspace which specialises in providing serviced offices and workspace for London based tech start-ups.
A high debt base
According to The Investor’s Chronicle IWG’s latest results show that it is spending more than £500mn every six months on leases, while its net debt on the balance sheet, including lease liabilities, is £6.2bn, that’s 34 times larger than its shareholder equity.
While the company did manage record revenue and an operating profit for the six months to 30 June this year, by contrast, WeWork, which has even greater debt, negative shareholder equity* and billions more in lease payments to manage, posted an operating loss of $555mn (£436mn) for the same period.
* Accumulated losses over several periods or years often result in negative shareholders' equity, i.e, there are no retained earnings left over from profits, or net income, set aside to be used to pay dividends, reduce debt, or reinvest in the company. A company's management that borrows money to cover accumulated losses instead of issuing more shares through equity funding will cause the company's balance sheet to show negative shareholders' equity.
WeWork has warned investors that its survival depends on a new plan to improve liquidity and profitability over the coming 12 months. This will involve a cost-cutting programme, a drive to retain existing tenants and an effort to attract new tenants.
A deal with its major funder, Softbank, meant that its debt maturities have been pushed back and a $1bn cash injection provided. WeWork is obviously looking to better times, but for IWG, despite its own heavy debt loading, revenue growth and talk of a US listing, and WeWork’s troubles, could see the UK company “stealing a march”.
Landlords enter the fray
One headwind that both WeWork and IWG are coming up against in the business of serviced offices is landlords with vacant buildings. These traditional office landlords are becoming their competitors. The UK’s two biggest office Reits are Land Securities and British Land, both of which are growing their own flexible workspace brands, known as Myo and Storey.
London based Workspace PLC is another UK listed company that competes directly with WeWork and IWG, but their product is slightly different. Whereas Workspace has a model based on short-term leases, usually measured in months or years, WeWork and IWG generally let out space based on months, weeks or even days.
Most office landlords would prefer the traditional long-lease model, without the hassle of providing additional management and services. The traditional FRI lease offers “let it and forget it” “clear return” capabilities, but needs must: a building generating short-term income, albeit with additional services to be provided, is preferable to an empty building with no income and generation running costs.
According to real estate data provider CoStar, WeWork rents more office space in London than any other tenant, and with central London office occupancy still far below 2019 levels, its demise would be a terrible blow to their landlords.
Between a rock and hard place
It leaves these landlords in the unenviable position of having to decide between giving lease incentives to WEWork to keep the company going, or taking the opportunities that may arise to re-let their empty city centre buildings, at a time when the future of the office market is so uncertain.
As Mike Prew, property analyst at Jefferies, has said: “[WeWork’s] rental obligations have little or no landlord recourse”. These two companies, WeWork and IWG, currently cleverly maintain the “whip hand” with a model of leasing buildings using subsidiaries that they simply allow to collapse if they are unable to pay the rent.
IWG threatened to do this during Covid. It’s a nasty practice that upsets landlords, but it does offer these service companies protection, though given their precarious position right now, WeWork may be too far gone for that.
The future is flex
Meanwhile there are many hundreds of flexible office space and serviced office space providers running profitable small-scale businesses throughout the UK. These are on a much smaller scale that the large PLCs mentioned above, but they can offer exactly the facilities businesses need on a local level.
International property agents Savills says:
“Over the past couple of years we have seen a number of forward-thinking landlords recognising the benefits of flexible office space and become early adopters of including it within their overall office offer.
“As we move further into 2023, we expect this trend to continue as the need for agility that allows occupiers to scale up and down as required, becomes a vital requirement. This will either be through landlords offering flex space directly or through a serviced office operator.
“We also anticipate that significant service charge inflation will play a part in some businesses looking to reduce footprints by circa 10 per cent as they grapple with the conundrum of rising costs vs the need for quality.
“The provision of flexible space in the same building as conventional offices will not only provide an ability to flex up and down, but it will also act as insurance against businesses who may underestimate the desire and need of colleagues to be in the office.”
The jury is still out as to the true long-term impact of working from home (WFH) and flexible working. There is a distinct trend of a gradual drift back to the office as some of the downsides of scattered operations become apparent.
It is likely that some form of hybrid working will persist but it is unlikely to be on a scale we’ve seen during Covid or even in its immediate aftermath.