The impact of flexible workspace tenancy on capitalisation rates

Flexible workspace providers are substantial occupiers of commercial real estate in the UK that usually lease large proportions of a building over a significant period. The covenant strength of these tenants is not as straightforward as blue-chip companies. While providers offer diversity to a building and an additional amenity to other existing tenants, their covenant strength might not be as compelling as their peers given that they depend on volatile revenue streams obtained from subletting the space through a membership scheme. The covenant strength impacts default probabilities during the lease and is a dynamic that is factored into the risk premium component of the capitalisation rate. In the grey literature, there is some evidence that the share flexible workspace providers occupy in a building can drive capitalisation rates up or down, reflecting the risk of this tenancy. Therefore, the valuation of a freehold that houses flexible workspace providers as tenants is not uncomplicated and the yields applied to capitalise the rental income need to be properly considered. This research analyses transaction information from CoStar to investigate the impact of flexible workspace tenancy on capitalisation rates in the London market. Preliminary findings suggest that office buildings with less than 40% of their total net internal area occupied by flexible workspace providers produce little to no loss in value.