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Flexible offices are no longer seen as the letting of last resort or a stop gap solution for start-up businesses. They increasingly appeal to a wide range of organisations attracted by flexibility, quality of buildings and unique collaborative working environments. However, as the recent WeWork cancelled initial public offering (IPO) highlights, in this fast-evolving industry which many landlords are keen to be involved in, there are potential risks that need to be considered and managed when exploring the many opportunities that flexible offices can provide.
For landlords wishing to enter the market directly, a robust strategy is needed to ensure that after considerable initial expenditure on the building and brand, and the laborious direct marketing and management of short-term tenancies, their venture will be profitable. Safeguards such as requesting deposits and/or guarantors from tenants will help mitigate risk. Requesting up front rental payments for an agreed period may be considered and, if the landlord is operating the business as a subscription-based membership club, fees paid up front for the relevant period will be expected and help mitigate risk. The landlord approval and legal process will need to be speedy to be attractive but the process needs to be robust. Standardised tenancy and membership agreements will assist, but the landlord needs vigorous internal measures to undertake financial checks and references, to mitigate potential financial loss.
The most straightforward way to enter the market with limited up-front costs, is to sublet the whole of a building to a serviced office provider. Traditional safeguards such as obtaining a rent deposit and/or guarantee, and enforcing lease covenants directly, are available. This helps mitigate potential risk but, as the recent WeWork situation has shown, well established operators may also face financial uncertainty. Before letting a building on a long-term basis to a single operator, the landlord should undertake detailed due diligence on its proposed tenant and consider requesting a more robust security package. To safeguard the landlord's reversionary interest and avoid potentially inheriting unwanted occupiers, alienation provisions in the lease should prohibit security of tenure to be granted to any occupiers, and the form of tenancy agreement should be pre-approved by the landlord. Before considering either of the above, if the landlord has a leasehold property, headlease restrictions on such forms of underletting and sub-letting should be checked.
If the landlord decides to enter into the market as a joint venture (JV) with a serviced office operator, the most critical safeguard is finding a partner with an aligned vision and business model. Significant due diligence on any proposed partner(s) is needed, and then adequate safeguards need to be put in place in the JV agreement to protect the landlord's income fee split on the agreed profit share arrangement, which should take into account the capital expenditure input made. Safeguards should include rachet clauses so that the percentages of equity in the JV alter based on the performance of the business, and contain change of control and assignment restrictions, so that the landlord retains control on who it is in partnership with.
Flexible offices provide landlords with a great opportunity to diversify their offerings from traditional leases to serviced offices, incentivising them to modernise buildings in more fringe locations and re-position their own brand, either directly or via collaboration, to meet market needs. There are a number of options open to landlords and a number of legal safeguards available to help mitigate potential risks. However the secret to long-term success lies in landlords ensuring that they only enter into collaborations with entities that they have properly considered, and which have a vision that is line with their own.
This article was originally published by CoStar News on 11 December 2019.