OSiT champions new valuation model for flex space

Back in 2021 OSiT’s Chairman, Giles Fuchs, stated in no uncertain terms the flexible office workspace industry was going to be an area of continued growth and renewal post-pandemic, attracting attention from more and more traditional commercial real estate (CRE) landlords, looking to diversify their portfolios after the months of uncertainty which Covid-19 ushered in.

At the time we were also vocal about the need for an overhaul of the valuation methods used in relation to this growing sector of the property market so that a consistent and accurate valuation method is adopted, allowing landlords and investors to truly gauge the value of their assets.

Previous projections, based on growth of 31% between 2008 and 2016, suggested the UK flexible office market could reach a valuation of between £62 billion and £126 billion by 2025. However, there are also estimates that the sector could have been undervalued by as much as 20% due to the fact valuation methodology has not evolved in line with the industry.

Growth in the UK flexible workspace sector

Fast forward to 2024. Costar recently reported figures showing a slump in London’s property market, with pricing for large office buildings dipping below £100 million for the first time in 25 years. This highlights how traditional office spaces have been impacted by new remote and hybrid work models. Post-pandemic working practices are shifting the way London-based businesses use office space. This, combined with higher interest rates, has significantly depreciated property values.

However, the demand for flexible and serviced office space continues to grow. Workthere reported a 206% increase in UK enquiries for flex space compared to pre-Covid levels, with a 14% rise year-on-year in the first half of 2024. At OSiT we have seen strong demand and high occupancy levels of c90% this year and we anticipate this to continue into 2025. Indeed, a recent survey by NCG found that 76% of businesses polled were actively considering a change to their workspace over the next year, and 59% favoured flexible or coworking spaces compared to a private office.

This is a trend that has not gone unnoticed in the property sector. Existing players in flex space are already signalling their intentions, with InfinitSpace announcing that UK landlords plan to boost flexible workspace in their buildings by 50% by 20230 in order to meet the growing demand. Likewise, we at OSiT are actively looking to expand our London portfolio of service enhanced multi-occupancy buildings.

Meanwhile, more traditional CRE landlords such as Grosvenor, are as predicted also waking up to the benefits of the flex sector. In April 2024, the group announced its commitment to building a 300,000 sq ft flexible workspace portfolio, converting about 20% of its existing UK office portfolio into flexible or fitted, hospitality led, space. Joining the likes of GPE, British Land and Landsec who are already converting large chunks of their portfolios. As highlighted in a recent FM Business Daily article there are several benefits of converting to flex space – not least enhanced occupancy rates, higher rental yields and greater market trend adaptability.

However, with the increased attention on this sector of the property market, it is now more important than ever to resolve the ongoing issue of how to value flexible workspace. Managed, fully serviced, flexible and coworking spaces (unlike traditional offices) provide a service, not just square footage. At the most basic level this may include IT and reception facilities, and multiple business support functions, but can often encompass leisure and hospitality services too. Until a valuation framework takes account of these many and varied revenue streams, the real value of flexible offices will continue to be underestimated.

OSiT has previously proposed a valuation which recognises the inherent possibility of the serviced offerings found across the flexible office industry to generate more than standard office rent income and instead combines both contracted and variable income - typically 85-90% and 10-15%.

Splitting the annual income generated by a flexible workspace centre into multiple tranches, allows a market yield to be applied to the first (contracted) tranche up to estimated rental value (ERV) and then discounting the yields applied to income from other tranches, to take account of its variable nature. This approach incorporates and values the real operational income of a building. Unlike traditional commercial property landlords, flex spaces are home to multiple businesses, reducing the risk associated with any single client moving out and while average lease lengths are shorter but getting closer to traditional leases, post-pandemic it is this elasticity which is driving demand across the sector.

However, this method may also need revising, the high fees mean the contracted income within a flexible property will deliver a higher return than the ERV and therefore this income should not be discounted once it passes this mark.

As the flexible workspace market continues to grow, we want to highlight once again the pressing need for an accurate, fair and standardised valuation methodology to be adopted – so that this burgeoning sector of the UK property market is able to fully develop and reach its potential. Without it, landlords, investors and JV partners will continue to be hindered by uncertainty, confusion and slower growth.