Workspace's rerating potential underappreciated

Office landlords are arguably facing more uncertainty than those in any other corner of the real estate market. While the government’s roadmap set firm dates for the potential reopening of shops and hospitality venues, no firm guidance has been given for employees to come back to offices in great numbers. More unclear is just how many employers will even require their staff to make the return, and how many will embrace home or hybrid working.

Judging by some workplace surveys, the latter seems the mode of working favoured by many employees post-pandemic. With that in mind, flexible work space could prove popular with companies, particularly those uncertain about the strength of the economic recovery and unwilling to sign up to a long-term lease. For Workspace (WKP), which typically lets space on a year lease with a six month break clause, that could ensure a recovery in occupancy rates and rents.  

Pain before gain

Workspace lets co-working office space for small-and medium-sized businesses in Central and Greater London, managing 3.9m square feet (sq/ft) of business space across 59 properties that are let directly to clients. The very nature of flexible office space meant it was easier for tenants to hand the keys back to landlords in the face of lockdown and ensuing economic downturn last year. For Workspace that resulted in more severe declines in occupancy rates than traditional office landlords that let space for periods of several years. 

At the end of December the contracted occupancy rate had fallen to 82.1 per cent, driven by clients that had given notice earlier in the year to leave. That was down on 85.5 per cent at the end of September and 93.1 per cent at the end of March last year. The December level was the lowest since the aftermath of the financial crisis, when the occupancy rate stood at 81 per cent at the end of June 2009. While all the group’s offices remain open for business during the latest national lockdown, average customer utilisation of the buildings stood at just 10 per cent in January. 

It is not just rising vacancy rates that have weighed on rental income throughout the pandemic. Swiftly after the first lockdown was imposed last year, the group gave over 90 per cent of tenants a 50 per cent rent discount for three months until the end of June. Since then further incentives have been offered to some new and existing customers and that contributed to around half of the 5.3 per cent decline in average rent per sq/ft over the three months to December. However, management said the impact of that should unwind over the first six months of 2021. 

Lower demand for space among prospective tenants has also naturally led to weaker pricing as management attempted to maintain occupancy. Depending on the rate at which companies return to the office, rents could remain subdued. 

The January update sparked fresh downgrades in NAV and earnings forecasts among analysts. Panmure Gordon downgraded its NAV and EPS forecasts for the year to March by 2 per cent and 8 per cent, respectively. The consensus EPS forecast for the 2021 financial year stands at 20.6p, 13 per cent lower than the figure predicted in October, just prior to the group’s half-year results.   

Does reopening mean recovery?

The successful rollout of vaccines and anticipated removal of most social distancing rules in June could kick start the return of more workers to the office. Prior to the latest national lockdown, there was an indication that looser restrictions may give way to greater interest in leasing space among employers. During the summer months, the group said the number of enquiries and lettings to new customers had improved and reached near pre-Covid 19 levels by mid-September. With that in mind, analyst consensus earnings are forecast to return to growth during the 2022 financial year and reach pre-pandemic levels by 2024. 

For companies that are tentative about the pace of the economic recovery and still nursing the wounds of disrupted trading over the past year, the lower commitment required by flexible workspace could prove particularly appealing. A recent survey by Citibase found that flexible, short-term lettings contracts were the most important consideration for SMEs in choosing an office, with more than half expressing a preference for leases of less than three years in duration.

An increased shift to hybrid working could add to the attraction. Some larger companies, such as BP (BP.), have already announced plans to allow staff to work from home for part of the week. More broadly, a recent survey by the London Chamber of Commerce and Industry found that around half of employers will allow staff to continue working from home for part of the week once the pandemic is over. 

Overly pessimistic?

The group’s offices are either newly developed or refurbished premises, with good public transport links. That could give the premises the competitive edge over less modern offices in the capital. Unlike some other major, traditional office landlords listed in London, Workspace is without exposure to the retail space, which has benefited the overall value of its portfolio. That meant that while the underlying value of the portfolio declined by 4.9 per cent during the six months to September, that was a smaller reduction than the 6.6 per cent contraction reported by Great Portland Estates (GPOR), for example.

The board has deferred a decision over paying a dividend in respect of the 2021 financial year until the announcement of full-year results in May. However, analyst consensus forecasts are for a payment of 17.2p for 2021, rising to 24.8p the following year. At the current price, that gives the shares a respectable prospective yield of 3.1 per cent in 2022.  

The shares are trading at a 10 per cent discount to consensus forecast NAV of 897p a share at the end of March next year, when the shares are forecast to hit a trough. That is a valuation that could prove overly pessimistic given the group’s NAV is forecast to grow by 5 per cent to 942p the following year. 

Workspace has substantial financial headroom to withstand a period of subdued rental income and a fall in asset valuations. The loan-to-value ratio of the portfolio was just 23 per cent at the end of September and it had cash and undrawn debt facilities totalling £127m. That gives it the ability to withstand a 52 per cent fall in net rental income and 61 per cent fall in asset valuations. Even after offering most clients half-price rent for three months, the former metric fell 39 per cent during the first half of the financial year. 

Admittedly, recovery is expected to be slower than that for traditional office landlords, with Helical (HLCL), Derwent (DLN) and Great Portland forecast to report earnings at pre-pandemic levels either this year or next. Yet as the economy is set to reopen, there is reason to believe that Workspace’s occupancy rate and rental income could move back upwards and perhaps faster than brokers think. That could reinvigorate the shares’ re-rating even further. 

Last IC view: Hold, 723p, 11 Nov 2020