The last 20 years have seen a significant increase in the flexibility of real estate occupiers: shorter lease lengths, increasing use of break clauses, and lower levels of renewal at lease expiry.
An analysis on short leases and their investment performance would give investors all reasons to stay out of flexible contracts. Regardless of this risk/reward mismatch, Tom Grounds researched the real trends supporting this change in demand.
There is 4 trends clearly showing as underlying drivers of demand for more flexible space.
#1 Flexible workspace as an overflow solution
Businesses, even large ones, have come to recognise that their business turnover (and implicitly employment base and space requirement) does not remain unchanged for 5, 10, 20 years. Thus fixed real estate over that period no longer aligns with business strategies. This does not mean the fixed-term lease is dead; far from it. What we are increasingly seeing is medium- to-large sized companies taking serviced office space as an over overflow solution, satellite or project space.
#2 Employment growth with small companies
Small and medium-sized enterprises – typically defined as any business with fewer than 250 employees – have been the dominant drivers of employment growth. This does not mean that this trend will continue unabated, however, the data does suggest that the number of people employed by smaller organisations is on the increase, with smaller firms inevitably needing more flexible and shorter-let space.
#3 International lease accounting standards
We expect occupiers’ drive towards more flexible leasing to be given further impetus by the introduction of the new leases standard - IFRS 16 Leases – by the International Accounting Standards Board from 2019. This will mean that the rent due on operating leases will appear on balance sheets as both a liability and asset (reflecting the right to use), with the rent no longer recognised as a rent expense, but rather appear as interest and depreciation expenses.
Interesting to note is that leasing commitments with a maximum term of 12 months or less are not considered by the new standards.
#4 Mobile technology has freed tenants from ‘sunk costs’
A fundamental, and sometimes overlooked, part of tenants’ growing flexibility is the growth of new technologies that enable them to lower the costs of moving in and out of property. The removal of these ‘sunk costs’, a cost that has already been incurred and cannot be recovered, is fantastic from an economic efficiency point of view, even if for landlords the benefits are not immediately obvious. See figure below based on the UK Lease Events Review suggests that, over time, tenants have becoming increasingly willing to leave their premises at the end of leases instead of renewing them.
In a response to these drives, it's well-established amongst some of the investor community that they will inevitably become more customer focused. We continue on this topic here: investor solutions