What are the property value implications of flexible office space for today’s U.S. market? A recent report has revealed several key insights regarding today’s dynamic marketplace, where corporate and niche spaces are claiming an increasing proportion of the country’s real estate industry.
The latest report from CBRE, dubbed US Property Value Implications of Flexible Space, states: “The niche flexible space segment should continue to mature and expand, potentially boosting its share of Class A office space nationally to as much as 10% by 2028.”
However, there is still a level of risk associated with integrating a flex space into your building. As such, landlords and investors need to tread carefully and the report offers the following advice:
- Don’t forget the real estate fundamentals: consider your market, submarket, and asset when deciding how much, if any, flex space to include in your asset. The report reveals Class A buildings with lower proportions of coworking space perform better as investments than Class B assets.
- Understand and help your tenants: corporate tenants increasingly want to integrate a flexible space strategy into their buildings and will turn to landlords to help them with their flexible space strategies, according to the report.
- Engage with quality flex operators: this will help you increase your income stream and mitigate some of the risks associated with the flexible space sector.
The research analyzed building sales between July 2016 and August 2018 where at least 10% of rentable space was dedicated to flex space at the time of sale. More than 30 flexible space sales were included across 13 U.S. markets and five national coworking operators were represented in the sample. More than 100 transactions with no flex tenants were also included.
Here are the key insights extracted from the CBRE report:
Flex spaces have lower cap rates
Most flex transactions–meaning sales where the property contained more than 10% of flexible space–had cap rates that were lower than the national and market averages.
For example, for Class A CBD office buildings, 81% of the flex transactions had lower cap rates than the national average over the past five years. For Class AA buildings, the figure was 58%.
The report states this is probably “because flex operators typically locate in active investment markets and in high-quality buildings.”
However, the flex transaction cap rate performance relative to peers was not uniform with differences maximized when flex tenants represented more than 60% of the total building area.
Higher cap rates also appeared to correlate with higher proportions of flex occupancy in a building, but factors such as building size, class and location also played a significant role. For example, 77% of Class A flex transactions had cap rates that were essentially equal to their peers and 57% of Class B flex transactions had higher cap rates than their peers.
The report also highlighted three transactions with lower cap rates than their traditional peers, all of which were Class B buildings. Two of these transactions had significant coworking occupancy rates–75% and 100% of the total rentable space. “These outliers suggest that, given sound real estate fundamentals, there are investors who value the tenancy of coworking operators,” the report reveals.
High coworking concentrations have the maximum impact on the value
The increase in cap rates was more pronounced with high concentrations of coworking. Some 64% of buildings with more than 40% coworking space had higher cap rates compared to their peers. Two-thirds (67%) of buildings with 40% coworking traded on par with their peers.
However, there was a pronounced divergence in cap rate performance when the flex transactions were split by building class. More than 75% of Class A flex transactions had cap rates that were on par with their peers, but none outperformed their peers. However, 57% of Class B flex transactions had a higher cap rate and only 21% had a lower cap rate than their peers.
The report concludes that if a building is in a good location, modernized and in a strong business area, then a moderate amount of flexible space does not impact asset values in either direction.
Few implications of flexible space on price per square foot
Flex space concentrations also do not tend to impact value from a price per square foot perspective either. Relative to their peers, Class A flex transactions generally performed better than Class B.
The report also notes that flexible space operators tend to invest heavily in their build-outs and focus on desirable locations, which can contribute to higher sales prices. Some 43% of flexible spaces had a higher price per square foot, 33% were on par and only 23% had a lower price.
While the report acknowledges that many questions still exist concerning the longevity of the flexible space model, it concludes that growth in the segment “likely won’t be deterred even if there are short term dips in demand.”