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Covid-19 puts flexible space markets under strain

Long-term future of flexible space remains bright says JLL, but the global Covid-19 outbreak has had serious negative effects on commercial real estate, including flexible space.

Daniel Lorenzzo

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Despite varied market conditions and end-user demand across the region, the Covid-19 outbreak has put some operators under financial strain

The global Covid-19 outbreak has had serious negative effects on commercial real estate, including flexible space. Of late, many operators have experienced the flexible nature of the business working against them, as many occupiers have opted to surrender desks and implement work-from-home plans.

This is particularly true of freelancers, start-ups and SMEs. Demand from corporate occupiers has been more mixed. Generally, flexible space with open plan and dense centre layouts is viewed as a higher risk. But in some markets, corporates have taken additional flexible space to satisfy business continuity and disaster recovery requirements.

As corporates return to the workplace, we expect to see them continue to leverage flexible space for these purposes, as well as for split teams and de-densification requirements. Thus, companies enable their employees to work remotely in better connected and more productive workspaces compared to home.

Landlords re-think flexible space strategy

Despite varied market conditions and end-user demand across the region, the Covid-19 outbreak has put some operators under financial strain, and we expect the consolidation of a heavily fragmented sector to accelerate as a result.

This is particularly true of operators on a straight lease, rent arbitrage model who are paying top of market rents. In the wake of operator defaults, landlords will be forced to re-evaluate the role of flexible space in their portfolios.

But we do expect them to continue using flexible space as a tool to attract and retain traditional occupiers in their buildings.

Greater China may offer some insight

Greater China may offer some insight into how landlords will respond to centre closures as operators there were making strategic adjustments to their portfolios well before the outbreak. Surrendered space can be re-purposed and leased as fully fitted-out, turnkey space to traditional tenants.

However, given current market conditions, corporates’ wait-and-see attitude and desire to avoid capex, landlords may find it difficult to backfill vacancies with traditional occupiers. Some landlords may attempt to operate centres themselves.

But landlords should be aware of potential pitfalls – flexible space is a high-touch, high-service level business which most landlords are not set up to operate.

However, a few have experienced some success although it has been difficult to compete with the professionalism and service levels of experienced operators. A third option is to bring in a new operator.

When choosing this path, landlords should be mindful of the operator’s reputation – even before the outbreak, corporate end users exhibited a clear preference for operators with a stable and profitable track record.

Long-term future of flexible space remains bright

The same fundamental demand drivers that brought about the recent structural shift in occupier markets remain intact, if not reinforced, and we believe the sector will resume growing.

However, we do expect to see landlord-operator agreements evolve with more sustainable revenue share and management contract models becoming more commonplace.

Reports suggest that during the Covid-19 downturn, operators and landlords on management contracts are cooperating and strategising in a far more symbiotic fashion.

These models align the interests of both parties, and they are more sustainable through property cycles. They reduce the risk of operator defaults whilst providing landlords with the added benefit of sharing in the upside of the centre’s profitability. Covid-19 puts flexible space markets under strain | JLL

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