Flexible leases take over 18th May 2017

Business is changing and so is the working environment. There’s an increasing need for more flexible offices and flexible leasing alternatives. So is there a new norm for lease lengths, or will long leases remain? asks Toby Chapman, Associate Director, London Office Agency, Lambert Smith Hampton.

Large companies are often contracting out to small specialist firms instead of keeping everything in-house, so sometimes no longer require larger premises. Small, dynamic companies often want short flexible leases. Location and quality of property remain key.

Changing lease priorities

The growth of serviced offices and co-working is well documented. Companies no longer want long leases, which is causing landlords to look differently at offices. Typical lease lengths are now between 5 and 10 years for most floor plate sizes between 5,000 and 20,000 sq ft. Occupiers that have uncertain growth projections or are fast-growing, require additional flexibility. Tenants with conventional direct leases increasingly want third year break options on spaces of less than 5,000 sq ft.

Generally tenants taking larger floor plates, of 20,000 sq ft and above will not require as much flexibility but this depends on the companies’ development stage, maturity and long-term head count projections. With the current market uncertainty linked to Brexit and other geo-political matters, the future is harder to predict, making flexibility important even for the larger take-up volumes.

Finding the right environment, at the right cost

Footloose companies are increasingly willing to agree to higher total occupancy rates that factor in the additional costs associated with flexibility if it means they are provided with the right environment and location on flexible terms. They also appreciate the ability to pay monthly rather than quarterly in advance, which is a boon to cash flow in serviced office centres. With the current rate of technological change, many TMT companies and organisations within other sectors cannot risk the fixed, long term costs associated with a 10 – 15 year lease.

Within conventional leasing, there is always a balancing act between additional flexibility and maintaining incentives/rent free. Many landlords look to reduce the rent-free incentive if a break is included, covering the potential future void and remarketing costs. The landlord’s bargaining position is obviously dependent on the particular sub market, property and micro market supply and demand balance. In markets with very tight supply and consistent, strong demand, landlords will generally be more bullish and can resist flexibility, holding firm on the requirement for a 5 – 10 year minimum term. However if availability edges higher, this trend may wane even in the tighter sub markets.

Growth of the grey market

Added to the above, grey space now accounts for over 50% of total availability in Central London. This helps tenants requiring flexibility, as these opportunities are typically “tail end” leases with fewer term years remaining, and are often fitted out and furnished allowing tenants to move in quickly.

Serviced offices take centre stage

Another example of a flexible mindset is the rising tendency for agents to run serviced and conventional searches side-by-side to provide clarity on the cost-benefit analysis between a serviced, semi-serviced or conventional option and running cash flows across various terms for all options.

Often it is the hidden and additional costs, such as meeting room hire, that inflate the total cost. Typically when the head count reaches 20-30, the serviced model becomes uneconomical. Then the company may seek its own space which can be branded and fitted out to suit the particular culture, values and configuration requirements.

Lease terms have already changed to meet the evolving needs of office occupiers, so shorter leases with break clauses are the new norm. To an extent, landlords have had to respond to changing requirements to maximise the income from their investments, and this has been to tenants’ advantage. The Brexit referendum has caused uncertainty for some businesses but this seems to have mostly affected larger corporates and multinationals in certain sectors. Once the upcoming election is out of the way, some uncertainty will hopefully dissipate, however the spectre of a hard Brexit looms large. Whilst there are no guarantees what effect the impending political, economic and cultural changes have on the office market demand over the next few years, what is certain is that the long lease’s days are numbered.