Whilst uncertainty lingers over the future of offices and serviced offices, there are some often-forgotten basics that shouldn’t be ignored by asset managers, fund managers and occupiers navigating this sector. Here is our short guide covering the key things you need to look out for to protect yourself, save money and stay ahead.
Dilapidations liabilities and associated capital expenditure
Landlords need to be proactive in preparing for a potential occupier ‘exodus’ and negotiation of leases, particularly with the impending rise in grey space. Our research is showing a 50% increase in office occupiers serving break options and seeking to exit leases during the last month alone. The timing of undertaking dilapidations to assess liabilities and the associated works and cost to put premises back into a lettable condition (whatever type of workspace configuration the future holds) is of greater importance than ever. Landlords now need to have these costs readily available to negotiate with tenants and determine their best-case position.
The reconfiguration of office space, particularly where landlords have adopted ‘flexible’ leasing with fully fitted out space to suit occupier needs, will be at risk. These typical refits, unless immediately re-lettable in their current state, often require further sub-division works and reconfiguration to air conditioning, ceilings, carpets and lighting which comes as an additional capital expenditure for owners. One only needs to remember the effects of flexible leasing models during the global financial crash to some listed companies who let their tenants off the hook with reinstatement covenants. Carrying out these works to reinstate offices might often cost more than reducing rent or negotiating terms to encourage occupiers to stay.
It’s not just owners who need to consider preparing for dilapidations early; this is something occupiers should consider too. Understanding your dilapidations liabilities and getting an assessment undertaken before you negotiate or serve your break option allows you to anticipate any costs that would fall due, and, ultimately, whether leaving would cost you more than staying. Documenting your liabilities and required works might also come in handy if any kind of dispute arises with your landlord around whether any tenant improvement works could be retained to assist future letting. It’s also a task occupiers should undertake carefully to comply with accounting standards, as too much of a provision may draw a query from HRMC, whilst too little will leave not much in the pot at lease end.
Converting serviced offices to multi-let – an option?
Predicated on a high-density headcount model and a fleet-of-foot customer base, serviced offices are facing significant challenges due to social distancing. With distancing measures around for considerable time, one option for serviced office owners or, of course, their landlords and lenders is the option to convert cellular space back into smaller multi-let offices, which may provide greater long-term security. Carrying out a feasibility exercise to assess whether this is a worthwhile option for you in terms of rental values and take-up, and getting your due diligence done to establish the viability and cost to converting the space may be prudent.
That said, take-up of serviced office space does of course have the potential to pick up in the short term: businesses may need a stop-gap if they’ve been caught out by construction/fit-out delays, or if they want more time to figure out their long-term office space requirements. But if we look across to Asia, the picture isn’t so positive; particularly with corporate businesses offering long term working from home options for staff.
The risks of mothballing and cutting maintenance costs
Before making the decision to exit a lease, occupiers should look closely at their lease and outgoings to see whether there are any areas of the tenancy they could be saving on or negotiating with their landlord. As the market is still uncertain, communication is key and landlords should remain open to looking at certain areas to help tenants stay – service charges reductions or monthly rents, for example.
Occupiers should also make sure they scrutinise their on-going costs such as insurance: check that any fit-out works haven’t been included by your landlord (which is an element often covered in your own business insurance). Landlords need to ensure that insurance premiums are accurate and based on elemental pricing instead of average pricing, so that you can confidently justify the premium if argued against in a dispute.
Owners, use the information you have about dilapidations liabilities and other costs associated with your tenant moving out to establish how much you can afford to negotiate (i.e. at what point would it cost you more for your tenant to stay than for you to find a new one).
Reducing void periods and getting the best out of new leases
Unfortunately, many office occupiers are being left with no choice but to terminate their tenancy. When this happens, the current climate presents owners with a very real threat of lengthy void periods – so you need to make sure your space gets snapped up as quickly as possible. Ensure you’ve got an accurate idea of timings too so you can react quickly. When exactly is your tenant moving out? How quickly can you return the office to a lettable space and get it back on the market?
Consider your workspace design, what occupiers are looking for right now and whether you need to adapt your space to suit new demands. For example, many occupiers are now wanting smaller spaces that will align in with an increase in flexible working practices – so perhaps you might look at installing partitions to divide your single office up into several smaller ones.
In terms of new leases, occupiers moving into office space will likely be seeking to introduce more flexibility into their leasing arrangements than before, so that they’re in a better position to deal with sudden crises like this in future. When securing a break option, for example, you might want to look at shortening the notice on it or introducing rolling dates to give you more exit options.
Correspondingly, landlords may consider offering more flexible terms to lure in new occupiers; but it’s well worth checking over any promises you’re making on the new lease and adapting them to protect your long-term interests. Offering fitted out offices, for example, might not be justifiable in a turbulent time when high tenant turnover is possible.
A buyer’s opportunity?
Whilst the pricing of offices hasn’t yet adjusted, there are likely to be companies with property assets who wish to put them to the market, or funds that may require cash for redemptions or want less office allocation within their portfolios. The era of sitting back to watch capital value growth in a rising market may be over, but that shouldn’t stop those buyers and asset managers who know about working assets hard.
Today’s world is very much about the asset. We are likely to see much better feasibility and technical due diligence carried out by buyers focusing on massing options; cost options; a proper understanding of the demise/areas; service charge recovery; change of use; and lease recovery costs (if buying a short WAULT). A joined-up approach for anyone purchasing offices will mean a greater focus on all angles, with sustainability also thankfully being a driving force behind all their plans.
Read our full pdf guide here.