London’s office ‘reset’ ignores rise of flex workspace

Investment in the central London office market was down 8% in the first half of 2022 and vacancy rates increased – but the falling market does not reflect strong demand for flex workspace, agents say.

BNP Paribas found vacancy rates for central London stood at 8.9% at the end of June, up on the long-term average (6.4%). The total value of investment deals fell sharply in the second quarter after a busy first three months of the year. In Q2 total investment deals transacted was less than half the 10-year pre-pandemic average.

BNP Paribas told the FT the market was going through a ‘reset’, and said the top of the market was late last year. But flex specialists point to the outdated RICS methodology for valuing office assets which ignores flexible space. If flex space was valued more highly, building values would be holding up better, they argue.

James Forster, director of MetricRE, which advises tech tenants on office requirements in London, said: “Capital values are decreasing, because the market has changed. The way buildings are valued has not.

“The flexible office market is thriving and occupiers find it attractive because of the shorter lease terms, hotelisation of space, range of amenities and activity-based interior designs. Demand for space as a service from occupiers has undoubtedly grown since the pandemic.”

Etienne Prongue, CEO, BNP Paribas Real Estate UK, said “The speed of the interest rate hike has caught the real estate market by surprise. As it stands, rising debt costs and the deteriorating economic outlook are impacting pricing discussions, causing some sellers to pause disposals and wait for improved sentiment. Yields are also beginning to soften in light of the challenging financial conditions, particularly for assets lacking in ESG credentials, or are noncompliant against shifting legislation.

“The market is now pausing for an adjustment in pricing –  when it does, there is still plenty of equity ready to deploy. What remains unclear is how the leasing market will adjust in response to changing market conditions over the next 18-months.”

The BNP Paribas data did not separate out the take-up for flex space, and figures for this part of the market are harder to find than for conventional office deals, done directly between landlord and occupier. A study published this month by Savills stated: “Take-up from [flex] operators has been gaining momentum gradually, and many operators are seeking new sites to expand in 2022 and beyond. The acceleration of demand for flexible office space, evidenced in the increase in enquiries, is expected to result in an uptick in leasing activity from flexible office operators that are predominantly seeking management agreements rather than conventional leases as we emerge out of the pandemic.”

Research by employee sentiment analyst Leesman points to the need for flexibility and hybrid practices in workplace strategies, yet this has not been reflected in investor appetite for buildings with large flex elements.

MetricRE’s James Forster continued: “Many occupiers no longer want to take long leases that involve high capex costs of fitting out, with little or no amenity spaces available. It’s about putting employees first and shaping the workspace around their behaviours and needs.

“We know of at least 10 operators seeking more space in London and a high number looking at acquiring space in UK regional towns and cities.”

Even in the face of the argument for flex space, many landlords of prime assets will not let their buildings to a flex operator because of the negative effect it has on the capital value compared with letting the space to a conventional occupier.

Historically, serviced operators would often leave a space in disrepair and put SPVs for individual spaces into insolvency when they walked away, leaving landlords out of pocket.

RICS held forums to develop the 2019 RICS insight report and continues to engage with market stakeholders informally.

In fact, the most recent edition of the Global Red Book effective from 31 January 2022, for the first time includes specific reference to flexible workspace within VPGA 4: “VPGA 4…A further subset of properties includes those where the adaptation in use or restraint on flexibility is less marked, but a valuation based on an income approach, including many aspects of this VPGA, may still be regarded as the best indicator of value. A non-exhaustive list of examples includes self-storage, flexible workspace and purpose-built investment student housing. The choice of method will be a matter for valuer judgement having regard to the specific type, form and use of the property and market circumstances prevailing, and evolving, at the time.”

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