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COMMERCIAL PROPERTY – The fourth law of property: renovation

Putting a corporate roof over your head is more difficult than ever before. If you want to refurbish your existing offices, you face months of dirt and disruption. If you want to relocate you could soon be caught in a nasty accounting standards trap that makes it financially painful. And you haven’t even heard the bad news yet.

No matter how desperate you are to move to new offices, the chances are you will have difficulty finding something suitable. This is particularly true if you seek grade A-style accommodation, want to locate in London or the southeast and need more than 20,000 square feet.

In just five years the commercial property scene has been transformed. Back in the depths of the recession of 1990-92, spanking new empty office blocks towered over even small provincial towns. “To let” signs peered hopefully from windows in empty offices from London to Glasgow. If you were a FTSE-100 company looking for a major office site you could get landlords to walk over broken glass to win you as a tenant.

How it has all changed in five years. Now it is the landlords with the smug grins on their faces. Those empty offices now hum with purposeful activity. Too many tenants are chasing not enough space.

To understand just how the situation has changed, consider this one statistic.

Over the past six months, 16% of companies have decreased their property holdings while 31% have increased.

These figures come from the latest six-monthly CBI/Grimley property trend survey. And even though the survey shows that a shortage of suitable property is now the third most important constraint, this is not because it is declining in real terms but because other factors – inadequate returns and cost of accommodation – are accelerating in difficulty faster.

What’s all gone wrong (from the tenants’ point of view, that is, because the landlords are laughing their socks off)? And what can the company that wants to strike a balance between cost and providing modern and pleasant working space for its staff do about it all?

The first problem is that the property development cycle is out of sync with the economic cycle. During those heady boom years of the late 1980s, developers rushed to build new offices, spurred by a shortage of space in 1985-86. But office blocks generally take at least two years to plan and build.

By the time all this new space hit the market at the start of the 1990s, the recession had set in and many companies were paring down their existing office portfolio rather than taking on new space. So new development dried up.

Now with a new boom, there is hardly any space to cope with the demand. And by the time new space comes onto the market we will be into the projected downturn of 1999-2001.

So the first thing that needs to change is that developers need to use their brains and get property development in sync with the economic cycle. But the second thing that needs to change is that the tenants need to have a clearer picture of the options available and the consequences of each. The first point to consider, argues Carolyn Tobin, director of corporate real estate services at DTZ Debenham Thorpe, is whether or not it is really worth paying for extra quality.

“Will your company perform better?” She asks. Much of this debate revolves round the quality of staff you need to attract and retain. “If you are trying to employ inexpensive people and are not employee-friendly, you may choose a hole somewhere,” says Tobin. “But, these days, I think most bigger companies will go for the grade-A building as part of the image they want to project to their customers and staff.”

“With unemployment dropping rapidly, a key factor in retaining staff is quality of the working environment,” says Howard Woollaston, partner responsible for the business space team and commercial regional offices at Knight Frank. “Very few companies these days want to have something that is overly extravagant. The general feeling is that they want to be in a building that looks efficient.”

Fine, but if your building fails to meet these criteria, just what can you do about it? Relocating is an increasingly thin option, largely because of the paucity of new property, especially in major towns and cities. In any event, as Tobin points out, the ability to relocate partly depends on whether you are locked into a long lease.

Moving to new premises and hoping to find sub-tenants to occupy the old building for the remainder of the lease was always a risky matter. To often, the kind of companies looking for sub-tenancies are corporate problem cases. And, in any event, sub-tenancy rents rarely cover the cost of exiting from an unwanted lease.

Now it looks as though there may be even more financial penalties. A new draft regulation from the Accounting Standards Board – FRED 14 – would have the practical effect of making a company account for the whole liability on an unexpired lease in the year in which it quit the building.

Although the change would bring UK accounting more in line with current US practice in this area, there are critics in the property business who think it might encourage “uneconomic behaviour”. “It might not be economic for a company to relocate to a better building and then carry the liability of its old lease if it knows the liability will take a big bite out of one year’s P&L,” says Tobin.

She reckons the change could especially affect smaller companies and those in the service sector which have a lot of staff and, thus, a lot of buildings. It will also have a disproportionate impact on companies in the southeast who took on new property in the mid-1980s boom when rents were higher than now.

Some of these companies are still suffering from a kind of corporate “negative equity” – or “over-renting” as the property specialists prefer to call it. The market rents they agreed to pay back in the 1980s are now below the current asking price.

“If this regulation comes in, I am sure we will get companies playing all kinds of games, such as leaving a couple of boxes behind in order to claim the offices are still occupied,” predicts Tobin. Indeed, the regulation would, in some ways, replicate the problems that exist with tax planning. For example, it is more tax efficient to buy out of a lease while still in occupation.

These issues may seem somewhat removed from the usual property worries of calling round the builders or ordering up the removal vans. But because they have a potentially significant financial impact, they should certainly be on the FD’s agenda. But, of course, these are not the only property issues that knock a nasty hole in the bottom line.

Whether you refurbish or relocate, there are costs. Start with refurbishment. It is difficult to give precise costs, because it depends on the type of building you start with and the quality of refurbishment you want.

Tobin estimates that refurbishment costs could be anything from #25 to #50 a square foot for a basic building with walls, floors and wiring – what the property people call a “base build” building. To furnish the building you can add on anything from #1,250 to #1,750 a head, again depending on the quality you want.

Relocation may add even more expense. Unless you are moving to purpose-built premises, you could find yourself paying out a large refurbishment bill as well as the costs of moving. Tobin puts the typical “moving day” costs for an office staff at around #150 a head, but obviously much depends on the amount of furniture and equipment to be moved and the distance.

Relocating is not only difficult because of lack of accommodation. Moving any substantial distance creates a pack of other troubles, especially retaining key staff and recruiting new people to replace those who inevitably don’t follow the caravan. Yet, in one respect, some specialised forms of relocation are taking place – often of backoffice-type functions. Call centres are a good example. Most of these are being set up in the north or Scotland, where property is cheaper and the lucky ones pick up regional grants.

So what about refurbishment? It is a nightmare time of dirt and dust for everybody trying to work in the building at the same time as the builders, all the property experts agree. And, again, there are financial implications.

First, you want to avoid refurbishing towards the end of the lease where, if you then move, some other company will reap the benefits of the cash you’ve lashed out.

Besides this, refurbishing might involve the tenant playing a subtle political game with the landlord. “If you plan to refurbish, you have to consider whether you will end up paying a higher rent merely for improving the landlord’s premises,” warns Tony Fisher, head of provincial offices at Chesterton.

One way round this problem, suggests Fisher, is to persuade the landlord to refurbish the offices and “rentalise” it back to you over the remaining period of the lease. But whether you can pull that stroke depends on the period left in your lease and the desirability of your office location. “Faced with an opportunity to refurbish, some landlords might want to let the premises on the open market.”

So does this mean that refurbishment is out, too? “If you have a good building which can be refurbished reasonably, stick with it,” advises Fisher. Other property specialists reckon the balance lies with refurbishing rather than relocating at the present time.

But, in the property game, there is a season for everything and the balance of advantage may change. In the meantime, it is the landlords who hold, if not a monopoly, certainly the upper hand. Do not pass Go and do not collect #200.

Peter Bartram is a freelance journalist.


To see just how dramatically the balance of power has swung from tenant to landlord, just consider the ring of small towns that circle London round the M25 corridor like a giant doughnut. For tenants, there is very little jam left in the doughnut.

The bald figures are these. Three years ago, around 15% of the property around the M25, in towns such as Bromley, Crawley, Guildford, Slough, St Albans, Waltham Cross and Brentwood, was vacant. There were landlords who would have sold their grandmothers for the sake of a tenant.

Today, vacancies are down to 4% of property. That might not sound too bad, but Howard Woollaston, a partner at Knight Frank, points out the implications. “In broad terms, there are about 110 million square feet of offices around the M25 so the 4% represents slightly over four million square feet.

“But of that four million, over half is what we would categorise as poor quality space with little demand for it. To make the position worse, new supply is down to about 400,000 square feet. If you put that in the context of annual take-up running at around 3.5 million square feet, you begin to see what the problem is.”

Put simply, there are around two or more tenants scrabbling for a very good quality property.

No wonder that rents are moving up and some companies are considering the previously unthinkable – buying their own place. For example, accounting software company SAP bought the 10,475 sq ft Clockhouse Place, near Heathrow, from property company Rutland and Hanover Group.

But buying is not an option for every company. Only an estimated 10% of companies own their own offices. Buying the building ties up capital that could be deployed more profitably elsewhere. And it might make the company a prisoner in the future – when the building no longer really suits its needs.

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