Office Space…If you could just finance it that would be great.
By Duke Dennis
As real estate product types change and evolve it takes time for the financial markets to learn/understand and adopt new underwriting standards as it relates to capital providers continue, in maturing product loans & investments. However, the beginning is always the toughest part. With the recent developments in creative office & co-working spaces, I will highlight differences in these sub-categories of the product type and how those impact your ability to obtain capital for your project.
First off, what is Creative Office & Co-Working?
- Creative Office is a modern office building that offers tenants dedicated office suites/space with an “open” style floor plan tied to a defined lease. A building where tenants have shared floor amenities/facilities such as: kitchens, lounge areas, courtyard, restrooms, that historically were found in each office suite.
- Co-working is where tenants/individuals are interspersed throughout a single, open working space and share communal printers/copiers, Wi-Fi, conference rooms and where tenants typically pay to occupy based on a membership fee/subscription basis.
Lease Terms & Flexibility
Typical office tenants are also looking for stability with their space, as are building owners. Given this mutual desire, Tenants and Landlords come to agreeable terms on leases usually ranging between 3 – 10 years. Once the lease is signed you are in there until it ends.
Co-Working operators will sign the long-term lease but, then offer various levels of monthly memberships to small businesses, satellite offices & entrepreneurs who do not need an entire office to themselves. These memberships are monthly, meaning in 30-days you can leave if you want. On the flip side, you can sign-up at any time. This gives smaller businesses the opportunity to grow/scale like never before. It also makes consolidating different locations/offices much easier as the Co-Working space can serve as a permanent new home or bridge between your old offices and the new office.
Space Finish Out
Typically, given the long-term nature of the lease for a traditional office tenant, the Landlord is usually expected to provide tenant improvements for the space in conjunction with the new lease, which can be a large capital expenditure for the landlord. Also, at the end of the tenants lease all the now 10-year old furniture and equipment must be taken into consideration with whether or not the tenant should move.
The Overall Value: Why are tenants/businesses embracing the change in types of office space they can lease?
Creative office & Co-working space is giving tenants a new amenity that millennials are demanding…social interaction. Walls, doors and separation are going away leading to more interaction not just within a specific office suite but, also within the building. This is creating a social environment and sense of “community” within the building which can in-turn lead to longer tenancy given the end-users connection with the building and other users in the building.
In terms of Co-working by offering smaller spaces, shorter lease terms & high amenity levels, businesses & entrepreneurial firms have greater flexibility and affordability without sacrificing amenities or, breaking the bank.
Credit Behind the Lease & Resulting Financing
Traditional office space caters to larger businesses & tenants who typically want to occupy larger swaths of dedicated space. These larger tenants are viewed as more stable and often have stronger “credit” behind their business that can be underwritten to give a lender comfort that they will have the ability to pay their rent, which will, in turn, be used to pay the debt service by the building owner. Given the security provided by long term leases, and credit-worthiness that can be assessed of larger operating business, financing for more traditional office tends to be easier. You will see more leverage, lower interest rates and varying levels of recourse.
Co-Working operators often take large spaces, sometimes whole buildings, under what is essentially a master lease and then offer “memberships” on a month-to-month basis to small businesses and entrepreneurs who will pay the operator for the right to occupy the space. Co-Working operators essentially sub-lease the space. The idea is that due to the lack of a “long-term commitment” from the underlying membership-tenants, lenders will purely look to the financial strength of master lessor (i.e. Co-Working concept/tenant) in their underwriting for a loan. Lenders will not afford property owners the same metrics for a loan on traditional office building occupied by long-term credit tenants as they will Co-Working operators as a result.
Lucky for you, working with a commercial real estate professional who understands these differences and the challenges that result can lead to a smooth acquisition, development or redevelopment with confidence that your capital will be in place when the time calls for it. Having just concluded successful marketing for both Debt & Equity on a recent creative office / co-working transaction I can speak first hand to these data points and how we helped to navigate them with capital sources.
For more information on arranging capital & financing for your project, please contact Senior Director Duke Dennis at 979-777-9910 or by email at [email protected].
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