In this article we consider the market trend for new businesses to enter into flexible office arrangements with organisations such as WeWork or Regus and we look at the advantages and disadvantages in such arrangements.
What is meant by a Commercial Lease? A Commercial Lease is an agreement between a commercial property owner (Landlord) that permits a third party (Tenant) to exclusively occupy a defined property (Premises) for an agreed length of time (Term) in return for the payment of rent to the Landlord.
What is meant by a Flexible Office Service Agreement Licence? A Service Agreement Licence (SAL) is an agreement made between a commercial property owner (Service Provider) and an occupier (Serviced Occupier) which allows the Serviced Occupier to use office space on flexible terms in return for the payment of a Licence fee.
These arrangements may sound similar, but there are critical differences that, if not considered carefully from the outset, may have an adverse impact both on the success and value of a business. On more careful examination, the perceived benefit of one arrangement over the other may be questioned. Any business should carefully consider these differences (and potential traps) to ensure that the type of arrangement they are seeking and that they commit to will be suitable for their existing and future business needs.
Security or Flexibility?
For a business start-up, the ability to be able to scale up or down office space quickly as business needs change is relevant. A SAL appears to offer the flexibility of limiting the cost of a fixed-term lease by facilitating a short-term licence to occupy at an agreed licence fee. Under the SAL, the occupier can agree to occupy on a short-term basis with an anticipated ability to move to smaller or larger premises as the needs of the business change and become
However, a SAL does not give the occupier ownership rights or security in the space. By its nature, it can be terminated on short notice. There is limited or no ability to carry out alterations or install personalised signage advertising the presence of the occupier. Thus, the Serviced Occupier could find itself homeless on short notice or be presented with onerous renewal terms in the face of limited alternative options! On closer examination, a SAL will very likely include re-location charges and inflation proofed licence fees together with service charges which when added to any further fees that may be charged on renewal or for alternative premises may make the SAL less attractive to a business over time.
The longer-term security that a Commercial Lease offers is attractive to established businesses, particularly those whose location is linked to their success. Commercial Leases are usually granted for 5 to 10 years. The ownership rights in the space means they can tailor their fit-out and design to enhance and establish their business and brand by referencing their location, property and accessible product. This can be contrasted with the SAL where an occupier can be removed on short notice with the resultant business disruption.
In the SAL arrangement, meeting rooms are often presented as impersonal cubicles and /or shared communal areas which do not always create the professional and confidential business ambience that an occupier needs to develop and grow its customer or client-facing business.
A Commercial Lease through exclusive possession and ownership enables the Tenant to create more secure and professional meeting rooms for interfacing with customers and clients. This creates a heightened sense of professionalism and generates confidence in the service provision.
Some SALs will add the cost of outgoings, such as electricity and internet together with business rates, service charges and insurance and will include reviews linked to inflation from time to time. This may not be apparent to an occupier at the date the SAL is agreed as outgoings very often only accrue as the occupancy moves forward. In some cases, the outgoings can exceed the licence fee.
Service Providers often retain the right to change the cost of outgoings through the incorporation of “House Rules” or “Service Rules” which may not be apparent to an occupier at the outset.
The Serviced Occupier cannot predict with accuracy what its future outgoings will be and indeed on expiry of the SAL it may also incur “relocation charges” which can be increased over the length of the SAL. This can come as a complete surprise to Serviced Occupiers who enter into these arrangements on what they understood to be pre-agreed licence fees for the short-term. In reality, a Serviced Occupier may be induced to enter a SAL and later be presented with short notice to quit. The occupier then finds itself with no option but to agree to a more onerous agreement to retain possession. This
can result in a spiral of increasing costs, decreasing service provision and diminishing flexibility.
For most businesses, the upfront cost of entering into a Commercial Lease and the security it provides appears more
expensive when compared to a SAL.
For example, a commercial tenant may be exposed to the following costs:
- Stamp Duty Land Tax
- Fit Out Costs
- Yield up or Dilapidations Costs when the lease expires
However, Landlords are often willing to offer incentives. The more lettings a Landlord completes, the more secure is their long-term commercial property income stream. Landlords know that it is necessary to compete to get tenants invested in their properties. Incentives offered to tenants may include substantial rent-free periods or discounts which in the current market can range from 15 to 18 months at zero rent upfront. If a tenant business can negotiate to offset some of the expense incurred in respect of their fit-out cost against a rent-free period, this can offer a more stable investment over
the longer term for the Landlord and Tenant.
In the case of a SAL, non-ownership of the space, practicalities of the shared workspace, restrictions on advertising and corporate signage and the lack of security in this type of agreement will limit or remove any opportunity in a rising market to convert any increase in value in the property investment to an asset on the balance sheet of the company.
With a traditional Commercial Lease, the business owns its interest in the property and can market its services by reference to its location (including affixing signs and displaying marketing materials) over the term of its lease. This allows it to build up its brand in a location e.g. City of London and establish its market credentials by association with that market both nationally and internationally. A leased property may also increase in value over time and a tenant may have the right to sell its lease to third parties or charge the same to a bank or finance provider thus raising capital.
By fixing the physical location of the business the Lease will provide more stability to the business and enhance public confidence in the brand and its market profile - it has invested its presence in a market. This may increase the value of the business and is known as “goodwill”.
The choice between a fixed lease and a short-term licence requires careful consideration informed by the needs and financial strength of a business and the need to assess its position and ambition in the marketplace both on commencement and over the longer term. Typically smaller and start-up businesses have favoured the SAL, as this offers greater flexibility to its risk of boom or bust, whereas established businesses will cement their physical position in the marketplace through a fixed-term arrangement.
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