Daniel Whebell, Associate, Fladgate LLP (email@example.com)
Maddy McAra, Trainee Solicitor, Fladgate LLP (firstname.lastname@example.org)
The serviced office sector is evolving as businesses are increasingly demanding flexible, short-term office leases. Serviced offices are particularly attractive to SMEs and start-up businesses as they avoid a long-term commitment in terms of costs as well as allowing companies to increase or decrease their office space as required. This trend is set to continue as the political and economic uncertainty surrounding Brexit means companies are less willing to enter into long term commitments and will accept premiums in order to avoid doing so.
While there has been an uptake in companies willing to provide such serviced offices, lenders have been less enthusiastic to fund them due to adherence to traditional deal structures which prevent competitive debt pricing being available to borrowers. The increased risk of vacant buildings inherent in the serviced office business model casts doubt over landlords’ income streams and financial feasibility. This risk is exaggerated by increased business rates and an increase in company voluntary arrangements (CVAs). However, the increased popularity of serviced offices offers a chance for lenders to diversify their portfolios providing they can obtain an accurate valuation.
Valuations are more complex for serviced office portfolios as traditional financial covenants are unable to accurately measure the financial performance of the borrower throughout the term of the transaction. Alternative methods may include the approach utilised by the hotels sector of looking at the business as a whole. While a lender may be more comfortable assessing the borrower on a vacant property valuation basis, this would be resisted by borrowers as not being representative. Data such as the standard occupancy percentage could help provide an informed and feasible starting point for discussions and lenders may also demand an interest shortfall guarantee to circumvent the risk of lower occupancy rates.
Borrowers can improve their attraction to lenders if they focus on establishing a brand that can attract larger clients which can be considered more stable. While serviced offices are typically utilised by SME businesses, large companies are increasingly seeking to expand quickly but cannot commit to a specific uptake. This cannot be accommodated for by long-term leases, so flexibility is a key advantage of serviced offices. The inclusion of a large company within the customer composition can help signify the financial feasibility of the borrower.
While there is an inherent risk in financing companies focused on signing long term leases and renting out on a monthly basis, consideration should be taken of the wider portfolio of the company as diversification reduces risk and enables efficient utilisation of current market conditions. Furthermore, focus on companies with a freehold serviced office model, rather than leaseholds, will improve financial viability.
As the uncertainty of Brexit continues and companies seek to reduce a key fixed operating cost, serviced offices will remain popular as an alternative to traditional office leases. Lenders should utilise this opportunity to capitalise on the political and financial uncertainty that is set to remain by carefully considering the borrower business model and understanding its risks. Landlords, too, should focus on refining their brand and maintaining longer, more stable tenants in order to become more attractive to lenders and take advantage of the current market.