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Will landlords be undone by the WeWork effect?

The popularity of flexible office space has rocketed over the past three years, but under economic duress there are fears it could be the first to buckle
April 29, 2020 & Nilushi Karunaratne

When 155-year-old FTSE 100 banking giant HSBC (HSBA) last year agreed to lease more than 1,000 desks from WeWork, it signalled that the flexible working space model had firmly established its place within the London office market.

For the first time ever, flexible space accounted for the largest proportion of office take-up in the City of London last year at 23 per cent, according to data from real estate services group Savills (SVS), up from 12 per cent in 2018. 

Yet in the wake of the financial stress induced by the Covid-19 outbreak and warnings of a severe downturn in the economy this year and next, handing the keys back to the landlord also becomes easier for tenants not tied into multi-year leases. 

Less than a third of UK flexible workspace providers were optimistic about the prospects for the sector over the next three months, according to a survey by Workthere released this week, expecting average occupancy to fall to 76 per cent at the end of May from a pre-Covid level of 91 per cent. So far those surveyed said just over half of members had asked for rent relief and 15 per cent had not renewed contracts during the first two weeks of April.  

Businesses working out of shared office spaces are also excluded from applying for grants under the government's £12.3bn small business rescue package, according to a study by Colliers International. Under the programme, businesses operating out of premises with a rateable value of up to £15,000 can apply for a grant of up to £10,000 - but individual units operated by flexible workspace providers often do not have a rateable value assigned by the Valuation Office Agency. 

Some providers are already bracing for a loss in income. Workspace Group (WKP) collected half of rent due in respect of the second quarter by 7 April. The group has offered its tenants a rent reduction of 50 per cent during the lockdown period. 

Based on the group’s experience following the 2008 financial crisis, it is likely that some businesses will reduce the amount of space they rent, said chief executive Graham Clemett. “It’s fair to say that I expect the pricing/demand balance will probably mean that pricing will be flat or declining for a period of time as customers regroup,” said Mr Clemett. 

However, owning the property freehold means that the group is able to quickly make modifications to the spaces to adjust to tenants’ needs by, for example, putting in partition walls, and moving them internally at a month’s notice, which it hopes will retain customers. “I’d rather we do it by space than pricing,” Mr Clemett said. 

Meanwhile, IWG (IWG) has faced calls from some tenants to waive cancellation fees, freeze rents and memberships or provide substantial discounts via a petition that has gained more than 1,000 signatures. The group has made an undisclosed offer of support to tenants. 

Yet most providers such as IWG, which operates via the Regus and Spaces brands, The Office Group and US-headquartered industry titan WeWork, own only a proportion of the buildings in which they lease space to businesses. They also rent buildings from more established commercial landlords. Among the UK-listed office landlords, Helical (HLCL) earns the highest proportion of annual rental income from letting space to third-party providers, with WeWork accounting for 10.5 per cent of the annual rent roll last year. 

A drop in new enquiries and rise in lease terminations and defaults puts more stress on third-party providers and in turn threatens their ability to make rent payments to their own landlords. That is exacerbated by a mismatch: third-party providers sign leases for up to 20 years on space they sublet to businesses for a matter of months.   

For those that count WeWork as a tenant, that risk is increased by the company’s controversial creation of a multitude of special purpose vehicles to lease individual buildings from office landlords. Unless a separate guarantee is provided, the use of these shell companies means the landlord has no recourse back to WeWork as the parent company, in the event they fail to pay rent due on the building. 

A spate of bad news for WeWork, including last year’s failed IPO and more recently that Japanese investor Softbank had backed out of a $3bn share buyback, give extra cause for concern for the lossmaking group’s health as a tenant.  

“If WeWork was to disappear from London and all their office space came back to the market, it would only add one percentage point [to] the central London vacancy rate,” said Hunter Booth, co-head of the West End office agency team at Savills. 

Those with good quality, prime stock would have a better chance of re-letting the space once they have taken it back, he said. “The question then will be, I have been burnt once, do I want to risk getting burnt again?”, said Mr Booth. 

 

Race to compete

However, other commercial property groups have launched their own brands following the meteoric rise of providers such as WeWork, letting directly to businesses. Flexible workspace accounts for 11 per cent of Great Portland Estates’ (GPOR) portfolio, with the group letting fully-fitted space directly for an average three years, as well as via third-parties Knotel and Runway East on a shorter-term basis before the redevelopment of a building. 

Similarly, LandSec (LAND) launched Myo last year, aimed at businesses with up to 100 employees and offering leases of between one and three years. Unlike providers such as WeWork, Myo is not a co-working brand, given that businesses are required to take a private area within buildings, said head of Myo, Oliver Knight. “We can see there may be more uncertainty around co-working in future – knowing your neighbour and having more space around you may be more important in future,” he said.  

British Land (BLND) also operates flexible workspace brand Storey across four locations in London, targeting “scale-ups” with around 50 employees. Management hopes to grow the business to account for around 5 per cent of the its lettable space within five years. 

“There will be failures, but probably among the newer entrants to the market,” said Mr Booth, adding that flexible workspace providers that have the backing of large parent companies are better placed to withstand short-term losses in rental income. 

Relatively few letting agreements have fallen through so far, said Mr Booth. “There hasn’t typically been a change in terms; headline rent has very rarely been reduced, “ he said. However, some prospective tenants had asked for greater rent-free periods, either to allow them additional time to fit out the office or as an incentive for the deal to complete. 

Yet even beyond short-term letting agreements, landlords have suffered shortfalls in rent collections as tenants struggle to cope with the strain lockdown has placed on their cash flow. However, some landlords are bracing for further pain as the impact of lockdown on the economy becomes more clear. 

“I would expect the collection in the third quarter is going to be more challenging than the second quarter was,” said CLS (CLI) chief executive Frederik Widlund, whose office portfolio spans the UK, France and Germany. He said the group was in discussions with tenants about potential mitigating strategies such as switching to monthly rent payments. 

TIDMNameOfferEPSROE (%)Price to NAVLoan-to-value (%)Cash and undrawn facilities (£m)Second quarter rent collected (%)
BLNDBritish Land 407.8p34.93.80.4311,200*
CLICLS210p124.20.731.828584
DLNDerwent London3184p102.82.70.816.255473
GPORGreat Portland Estates697.4p19.42.30.814.141162.9
HLCLHelical369.5p-8.4-1.80.73512984
LANDLand Securities682.6p59.74.40.528.11,20065
WKPWorkspace756.5p40.33.90.72116650
*Deferred £40m in rent, equivalent to 15 per cent received over first-half of FY20 
Source: SharePad, companies