Keeping control of your investment in the co-working boom
What is the co-working boom?
In recent years there has been a seismic shift in the office space market. Whilst traditional serviced offices have always been an option for occupiers wanting flexibility, we are now seeing the rapid rise of co-working space. “Users” or “members”, as opposed to tenants, are increasingly demanding the ability to work where they want, when they want, in modern spaces that are conducive to increased productivity and personal wellbeing.
Once the realm of start-ups, .coms and app designers, co-working space is now attracting the mainstream market. Major PLCs are taking space in co-working buildings, consolidating teams of employees and taking advantage of the flexibility that is on offer.
Advances in technology and connectivity, increases in workforce mobility and a desire for collaborative and communal space have all spurred on this new way of working. From the research we conducted when preparing The New Real Report we found that there is likely to be a reduction in the need for long leases of core space, as occupiers look for more dynamic and flexible options.
The activity level of one of the major players in the co-working provision market, WeWork, reflects this trend. In London alone, WeWork has over 2,000,000 sq ft of space either occupied or under construction, but this goes far beyond offering a “hot desk” to individuals. Users of co-working space are now offered dedicated desks, and private space to accommodate 100+ employees.
What does it mean for property owners and investors?
Owners and investors with interests in the office sector will have to adapt to this new way of working. This presents risks. The market is competitive meaning that any co-working offering must keep pace with the evolving market, generally including offering free coffee as part of the package! Valuation is another important consideration. If space is offered direct to users with no guaranteed rental income, it may be difficult for owners and investors to accurately calculate yields and projections.
Savvy owners and investors are using the traditional office lease model to facilitate and realise the potential of the co-working boom. 10 or 15 year leases of whole or substantial parts of office buildings are granted to providers to allow them to offer “membership” services to their users. Fixed rents over the lease term mean that owners and investors have certainty as to their returns.
Owners and investors will want to ensure that their buildings are attractive to the co-working space providers. Here connectivity and energy efficiency is paramount. Buildings will need to offer high-speed broadband and appeal to the desire of the users to work in carbon efficient green spaces.
Legal issues from a real estate perspective
The following are some of the points that owners and investors should consider when entering into agreements with co-working space providers:
- Rental Income Protection – whilst the market is currently booming, with the plethora of potential uncertainties, owners and investors may want to consider fixed rents supported by guarantees. Some of the main providers are based outside of the UK, giving rise to the need for foreign parent company guarantees and legal opinion letters in respect of the enforceability of their obligations.
- Underletting – the providers of co-working space enter into “membership agreements” with their users, which are stated not to create any form of tenancy or landlord and tenant arrangement. However, care must be taken to ensure that the terms of these membership agreements and what actually takes place in practice would not inadvertently go beyond what was intended. Owners and investors should review membership agreements periodically and ensure that any change in relation to how the use of the space is governed is subject to their prior approval.
- Sharing Occupation – Co-working space providers may outsource some of the facilities that they offer to their users and want the ability to share the space with ‘strategic partners’. Owners and investors must maintain checks and balances on these arrangements and a sufficient degree of control over who is actually in occupation of the premises.
- Security of Tenure –underletting arrangements must be managed carefully. Whilst an underletting of the whole or permitted part is likely to require that the security of tenure provisions contained in the Landlord & Tenant Act 1954 are excluded, the extent and degree of exclusive occupation of the premises has to be considered. With larger companies taking more and more private space in co-working buildings, the lines between permission to use a space and exclusive possession of it could become blurred. The membership agreement may state that no tenancy is created, but this may not be sufficient protection if, in practice, the occupier has exclusive possession. Again, the lease to the provider and the arrangements between the providers and their users will need to be reviewed. Owners and investors will not want a third party claiming security of tenure in respect of the space that they occupy.
What next?
It is clear that owners and investors can benefit from the burgeoning co-working market but that appropriate scrutiny and adaption of existing lease models is required.
Owners and investors should ensure that they are properly advised on the co-working model and the opportunities it presents to them. Most importantly, owners and investors should ensure that their agreements with co-working space providers balance the fundamental issue of the degree of control they need to protect their asset against the flexible arrangements that the market demands.
This article was written by Stephen Fallon, associate. For more information please contact Stephen on +44 (0)1242 246373 or stephen.fallon@crsblaw.