"Overwhelmingly office spaces must be appealing – almost a hospitality offer – to their occupants; otherwise workers just vote with their slippers and insist on working remotely"
Publishing a paper titled Only the Paranoid Survive, Founding Partner, Michael Kovacs, says the traditional business model associated with long-leased offices is ‘broken’.
The company’s analysis shows that the average length of stay in an office space has plummeted in the last two decades from 14 years to just 7 years today, a trend that preceded COVID-19 and the rise of remote working. This means that the lifetime value of a typical office customer has been cut in half.
Technological developments have seen ‘switching costs’ reduce dramatically, with office tenants able to pack up and move almost as easily as a traveller moving between hotels due to cloud computing and mobile internet adoption.
According to the firm's research, cap rates for traditional multi-tenanted offices have become a poor measure of those properties’ annual cash flow yields due to the rising costs of tenant turnover. The report shows that returns to traditional office investors are well below the stated cap rate.
Castleforge predicts that only two categories of office space will deliver a good yield for investors in the coming years:
- flexible workspaces generating higher stabilised income yields through reduced customer acquisition costs, with appealing buy-and-hold returns
- ‘best-of-the-best’ spaces for large multinational companies, with traditional 15-year leases, offering investors a high-quality, long-term income stream without the regular turnover of lower-quality spaces.
Michael Kovacs, Founding Partner of Castleforge, said: “The average value of an office tenant has essentially been cut in half these last two decades because they simply don’t stay put for long enough. That means the old model of reliable leases and predictable income just isn’t there anymore and that a ‘cap rate’ doesn’t mean what it used to.
“The future of offices is increasingly in flexible workspaces, which cater to shorter lengths of stay and generate a leasing pipeline more cost-effectively through direct marketing efforts. They also minimise turnover costs by creating a high-quality, flexible offer targeting smaller tenants.
“Overwhelmingly office spaces must be appealing – almost a hospitality offer – to their occupants; otherwise workers just vote with their slippers and insist on working remotely. That means a hotel-like model: managing high-amenity spaces in a manner that takes into account all costs of maintaining these spaces to a high standard.
He concludes: “Only the biggest multinational companies will now look for serious, permanent HQ space, and we’re investing selectively in buildings which can accommodate them.
“But for everyone else flexible workspaces are the best answer, and that’s where the smart office investors will need to put their capital to work.”
