The growing appeal of space as a service

The service-based business model is here to stay. In fact, its reach today is staggering. If we can now think of a pet as a service – there are apps available that allow you to rent a puppy for a walk – why should real estate not be seen as a service, rather than just space?

The appeal of the ‘space-as-a-service’ strategy to create value, particularly through lease acceleration and potentially even higher rents, has led property managers to increasingly adopt this model over the last decade.

In 2015, for instance, Brookfield Properties put a ‘placemaking’ strategy in place to renovate its Brookfield Place complex – comprising around eight million square feet of office space and 350,000 square feet of retail in lower Manhattan – and lease over 3.5 million square feet that was becoming vacant. Through architecture, it aimed to create a welcoming space and a mix of retail and events programs to offer convenience and wellness. The strategy helped the Canadian investment giant to lease its vacant space in just 18 months – an “incredibly fast” achievement, despite competition from the brand-new construction of the World Trade Center site at that time, recalls Callie Haines, head of the New York region for the firm.

The model has been proven to yield positive results even in challenging times like these, marked by the pandemic. In mid-March last year, FORE Partnership signed up CBRE’s co-working arm Hana to Windmill Green in the UK, which claims to be Manchester’s most sustainable office building. The flexible workspace provider took 26,000 square feet of the redeveloped office building just a few days before the UK went through its first lockdown. The building’s green credentials, flexible space offer and amenities – including a communal pavilion space with a large terrace – attracted two more tenants during the national lockdown, taking Windmill Green to 75 percent occupancy. “We let two floors, 50 percent of the space, during the pandemic at £34-£36 ($47-$50; €39-€41) per square foot,” says Basil Demeroutis, FORE’s managing partner. “This is top-rent levels – even higher than we got in 2019.”

The pandemic has highlighted the need for landlords to identify the needs of their tenants, helping them to optimize their businesses through the buildings. This is particularly evident in offices, which are no longer seen as places where people come to work in an isolated way in front of their computers, but rather as spaces for communities to interact and increase productivity.

“There’s a need to change the real estate model,” says Sandrine Lafon-Ceyral, head of asset management and SRI Policy at Amundi Real Estate, which has implemented the strategy in flagship buildings such as the Coeur Défense office complex in Paris’s La Défense business district. “We used to be in an ownership situation where we monetize spaces. Now, we have to include more and more services and flexibility in the space we can offer. We really need to push our boundaries, our mindset, to innovate and find solutions to maximize and optimize the use of our space.”

Jonathan Bayfield, head of UK real estate research at Aviva Investors, agrees: “Real estate has become a lot more operationally intensive over a number of years, with property owners like us effectively having to work harder to sustain income, because lease lengths are falling across sectors and, more importantly, because occupiers want more flexibility – a trend that covid has accelerated.”

This change of mentality from being a ‘provider of space’ to a ‘provider of a service’ has led Aviva Investors to rethink its location strategy in recent years. The asset manager now focuses on owning assets in a much smaller number of locations, which enables it to get closer to the users of the buildings from a specific city or town and meet their needs. That, ultimately, puts it in a better place to sustain and grow income from the occupiers.

“Historically, an institution like ours might have focused on tenant covenants or lease credentials,” Bayfield explains. “But because of our confidence in the sort of cities we’ve chosen for the long term – like Copenhagen, Manchester and Paris – we’re then able to offer more flexible leases to our tenants and be more service-orientated, because we know we’re in the strongest locations in Europe and there’ll be another tenant coming on board behind them if they act on their flexibility.”

Benefits

Managers usually see a reduction of the void period and lease acceleration through the ‘space-as-a-service’ strategy. Sometimes, they can also increase rents for offering greater levels of service and flexibility. In turn, these comforts contribute to the development of the tenants’ businesses. It’s “a win-win situation” for both property owners and occupiers, says Amundi’s Lafon-Ceyral. “When tenants find these solutions, they are able to pay higher rents, because these services actually add a value that helps develop their business and enhance workers’ satisfaction. Meanwhile, landlords not only create value in rents, enhancing thus the value of their assets, but also make tenants stay for longer, which helps to have more resilient cashflows.”

For Guillaume Delattre, chief investment officer at BNP Paribas REIM France, the ‘space-as-a-service’ model, which the French manager is planning to implement progressively across Europe, mainly in office space, also contributes to tenant retention, which increases rent liquidity and, in some cases, even rent value. “The rent a tenant is ready to pay is closely linked to its perception of the ‘use value’ of the building – something intangible, but that increases thanks to this strategy, for example through the availability of common spaces that can offer multiple uses throughout the day.”

Additional revenue streams, meanwhile, can be sourced through service charges for further services requested by tenants, Delattre notes: “Asset managers suggest service options, but tenants make the decision and pay for exactly what they need, no more. It’s a change of paradigm, compared to the previous typical investor approach of, ‘This is the service offer we decided for you with this building.’ It’s really a change of mindset, and I think it’s quite successful because the tenants are very comfortable to make that choice and to decide the level of service charges they will have.”

Other benefits, such as tenant diversification, are highlighted by real estate landlords. Brookfield’s Haines uses the example of Brookfield Place to illustrate how its renovation, and enhanced retail and amenity offer, helped to attract new occupiers beyond financial services firms. “The placemaking strategy that we put together really diversified our tenant base, everything from media to tech to fashion,” she says.

“I would rather have a multi-let building to a bunch of growth companies. Maybe each individual one is a bit higher risk, but at least they’re the future; at least they’re the companies I know are growing”

Basil Demeroutis
FORE

FORE’s Demeroutis puts it this way: “Would you rent a building to, say, an HSBC that turns around and says, ‘I’m cutting 40 percent of my staff’? Or would you rather rent your building to a start-up, or a fast-growing company, in a dynamic sector of the new economy? These companies value something different. They don’t value 20-year leases to the whole building; they value authenticity, agility, flexibility, creativity.

“I would rather have a multi-let building to a bunch of growth companies. Maybe each individual one is a bit higher risk, but at least they’re the future; at least they’re the companies I know are growing. And if one goes bust or moves, or whatever may happen, I know I’ve got 10 sitting in the background that would want to come into the building.”

Challenges

Adapting to the needs of tenants through an active management strategy requires landlords to make upfront capex commitments and deal with monthly operating costs, however. The main risk of the ‘space-as-a-service’ strategy is that these extra expenses could erode returns if not planned adequately.

With that in mind, Gilles Cordon, head of workplace and design at BNP Paribas REIM, says it is crucial to invest promptly to avoid losing tenants and prevent void periods impacting rental income. Cordon previously designed a service strategy to meet local market expectations with “not more but not less” of an offer than what is needed. “The capex must be adjusted in line with the rent level – you are not going to spend the same amount of money in Paris suburbs compared to Paris’s central area. We must adapt the service offer to the local market and clients’ requirements.”

Market sources agree that rapidly changing tenant demand requires landlords to be close to their occupiers and have a local presence in different markets to fine-tune their servicing strategy.

Assuming capex and operating costs are planned for adequately, then, can a ‘space-as-a-service’ strategy actually boost returns and add value?

Industry sources say it is difficult to quantify the strategy’s impact when it comes to returns. Brookfield’s Haines, for instance, says the strategy does not always translate into increased return rates across the firm’s office portfolio, though sometimes it does. “Certainly, it does accelerate the lease of our space, which to us is incredibly valuable,” she points out.

As for creating value, most managers agree the strategy effectively adds value to assets. FORE’s Demeroutis, however, gives a more nuanced answer: “This strategy can create value in the right hands – if it’s part of a wider strategy and vision for building that reinforces the brand of the asset.”