This article argues that serviced offices don't get the investment attention they deserve.

The following article is by Giles Fuchs, co-founder and chief executive of Office Space In Town, the UK property business. This article examines the investment case for serviced offices. Recent data for office investments as a whole is certainly attractive in the UK. Figures from Investment Property Databank, an organisation tracking real estate returns in residential and commercial sectors, said that in the three months to 30 June, annualised total returns for UK office properties over one year were 20.7 per cent, ahead of all other categories, and ahead of the total property result of 15.6 per cent. In the latest three-month period, total returns on office investments were 4.9 per cent, made up of an income return of 1.0 per cent and capital growth of 3.8 per cent from the previous quarter. Whether those returns can continue in the same vein is, of course, another matter. Serviced offices are just one part of the office sector as a whole. We hope readers finds the comments here useful and if they have views they wish to share, please contact the editor at tom.burroughes@wealthbriefing.com

Demand for serviced offices is growing at a striking pace. In central London – the sector’s global capital – serviced offices’ share of floorspace surged by 67 per cent from 2004-2014. Over the coming decade the City of London Corporation expects the market to at least double in size.

With commercial real estate currently among the UK’s best performing asset classes, there is strong appetite for investments which provide multiple stable streams of income. But while investors have in recent years flocked towards newly defined real estate classes such as hotels and student accommodation, serviced offices remain overlooked and undervalued.

There are compelling reasons why this needs to be reconsidered. The serviced office industry is mature but still evolving, driven by the transformation in the way we work and the way companies operate. One is the growth of self-employment and new start-ups. 

Deloitte’s research found that the average number of employees for a customer taking serviced office space is 10 to 12 people, meaning the growth of SMEs is likely to fuel further demand for the sector. Another is the preference of the millennial generation for the types of flexible, co-working spaces that serviced offices tend to accommodate more naturally than more traditional alternatives. Demand is also rising as a result of the squeeze on the broader office market, with Central London experiencing the lowest level of office availability since 2009, fuelled by trends such as office to residential conversions. 

Changing customer requirements are driving a move away from the conventional one-size-fits-all serviced office model to a much more bespoke offering, tiered at different price levels – in the same way hotel offerings range from basic rooms to luxury five-star suites.

The comparison with hotels is a revealing one. Hotel valuations correctly account for both rental revenues and for variable income, generated from conference rooms, restaurants and bars, gym and leisure facilities, and so forth. Yet a chief reason serviced offices have been long undervalued is that the additional income they derive from their contracted and variable services is poorly understood. Yields from facilities such as IT and reception services, secretarial functions, clerking, and bookable meeting rooms are often significantly higher than yields from standard rental revenues – a factor rarely taken into account during valuations.

Another widespread misunderstanding is about the stability of income that they generate. Serviced office clients have an average tenure of two and a half years, which is only a little lower than the average commercial lease of just less than four years. What’s more, income from conventional offices can be vulnerable to disruption when a lease ends. Serviced office centres – whose occupants are often SMEs with a dozen or fewer employees – tend to have multiple clients at any one time, which reduces the impact of the loss of a single client. And although it is true that serviced offices’ variable income can fluctuate with economic conditions, much more stable contractual services contribute to the vast majority – typically between 85 and 90 per cent – of their total revenues. 

As investors search for yield, serviced offices offer both stable returns and, with demand showing no sign of easing, the prospect of strong capital gains. In addition, some analysts predict mergers and acquisitions in the sector, likely being driven by overseas investors and operators acquiring existing players in the UK with offices in favourable locations or attractive client lists. 

With the multiplicity of changes the sector is undergoing, the time is ripe for wealth managers to reconsider serviced offices as a defined asset class of its own.