The Year WeWork And Co. Skewed The London Market
How good a year did the London office leasing market really have? It seems like there should be a straight answer to this question, but there is not.
The flexible office sector exploded in London this year — according to CoStar, once WeWork occupies the space for which it signed leases in 2017, it will be the biggest private occupier in London with 2.4M SF. Fellow flexible office firm IWG will be in second with 2M SF.
This marks a paradigm shift in the way people are working, but it could also be seen to paint a falsely positive picture of the overall health of the London office market.
Central London office leasing figures for 2017 are expected to come out at between 11M and 11.5M SF, according to an estimate by Savills. That would represent an uplift of around 10% to 15% on the 10.1M SF leased in 2016, in spite of a slowing U.K. economy and huge uncertainty around fractious Brexit negotiations.
But around 13% to 15% of that has been leased to flexible office operators, Savills said. And there is a debate about whether this space can truly be said to be leased, since operators like IWG, WeWork or The Office Group now have to fill it with members.
“When a flexible office company takes space we record that space as being off the market, but of course it’s not,” Savills Executive Director of Office Agency Jeremy Bates said. “That space still needs to be leased out by the operator itself, and there is very little data about occupancy rates from these companies themselves.”
It is hard to say how much of the 1.5M SF let to flexible office providers in 11 months to the end of November is occupied because the majority of flexible office companies are privately owned and do not provide detailed data. The only listed player in the sector, IWG, said earlier this year that it had an occupancy level of 75% globally but does not provide a figure for London, although it said membership growth in London had underperformed its expectations.
WeWork, which also made one of the biggest investment transactions in London this year, buying Devonshire Square for around £600M, told Bloomberg earlier this year that its London portfolio was 90% occupied.
Green Street estimates it takes around 12 months for flexible office space to become 90% occupied in Europe, based on its conversations with flexible office companies. So it seems fair to say that a significant proportion of the space taken by flexible firms this year remains unlet, putting a different complexion on leasing figures.
Some analysts argue that focusing on take-up figures has masked a weakening of the underlying London office market. Seaforth Land Director of Strategy, Research & Operations Simon Durkin said in the first half of 2017, while take-up figures were positive compared to 2016, an analysis of net absorption showed that occupiers vacated 800K SF more space than was occupied.
He estimates that on a net basis, 600K SF will be vacated between June 2017 and 2020 and that Brexit has cost London 6.2M SF of net new leasing.
Green Street said smaller leasing deals of 25K SF and below are most likely to be cannibalised by the flexible office sector, and that even bigger leases will be targeted by flexible office firms as they look to grow by eating the lunch of traditional office landlords and secure big corporate clients rather than just startups.
It estimates that by 2030 the growth of flexible offices will have reduced demand for traditional offices by 2% to 3%, but said their effect on existing landlords like REITs will be slightly negative but overall pretty neutral if REITs can improve their own offer to match that of the new breed of operators or partner with them successfully.
Not everyone buys into the idea that flexible workspace firms are skewing perceptions of the London market.
“There has been some concern that these transactions distort the take-up figures as the flexible office providers still have to source tenants to occupy the space,” JLL head of City agency Dan Burn said. “However many of these centres pre-sell the space and new centres are typically opening 65% pre-let and reach an occupancy level of between 80% and 90% within six months.”
Burn also pushed back on the idea increased demand for flexible offices is hurting traditional leasing, especially for tenants below 5K SF.
“Our figures demonstrate that take-up in this size bracket has remained consistent for the last three years,” Burn said.
The Instant Group said enquiries for flexible office space are growing 25% annually, which exceeds the 16% growth in new space.
In the long run, the bigger implication for London and real estate more generally could be the way in which, as they grow, the biggest flexible office providers will fundamentally alter the way office leasing works.
“Landlords will really have to change their mindset when these big co-working and serviced office firms seek to do hotel-style deals in main office blocks around the world,” Cain International Chief Executive Jonathan Goldstein told Bisnow’s London State of the Market event in November.
“Currently landlords like us are doing lease deals with them. But I am convinced that within two years they will turn around to people like us and say they want to do management deals, and because they will be such big occupiers they will be able to dictate the terms of the market. Landlords will have to think about whether they are willing to deal on that basis.”