The new international standard for the accounting of lease liabilities has been published.
The full implications will emerge over time, but it is already clear that landlords and tenants will have to reconsider their traditional operating models. With the new rules stating that leases will now have to be accounted for on balance sheets, landlords and tenants need to be agile and react quickly. The future winners in the property industry will grab this opportunity to refresh some established thinking.
The traditional management approach saw building owners seek long-term contracts and strong covenants in order to drive valuation. This was fine in an ‘analogue economy’. However, this is no longer synchronised with the increasing desire for flexibility from occupiers of the ‘new economy’, who will now demand yet even more, due to the change in accounting standards.
Although long-term leases will be increasingly difficult to secure, the new environment creates opportunities as well as threats. How many times has a long-term occupier actually decreased the potential future value of a building by preventing its owner from exercising optionality when a chance of development arises? How many tenants have moved into serviced offices because the building they wanted to occupy did not offer flexible leases? In most industries, preserving optionality for both the buyer and supplier of products and services is regarded as fundamental to wealth creation, and with the inevitable move to flexibility, the commercial office sector will be no different.
Epitomised by the likes of Airbnb and Uber, success lies in connecting customers with what they want, when they want it, and there is no reason why commercial property should be any different. The occupiers of the new economy, the SMEs and start-ups, want flexibility as opposed to long-term tie-ins. Providing optionality for both buyer and supplier in a commercial office occupier transaction will move to the forefront of its valuation model. As with any product, adaptability and flexibility are the important assets needed to answer the ever-changing requirements of customers and businesses alike.
With the world of work now changed forever, long-term contracts are harder to come by. A solution is needed, one that capitalises on this new world of business and that keeps buildings occupied without the need for long-term contracts on either side. This will only be found if more building owners start thinking outside the box and approach the issue with an understanding of the power of optionality. One obvious solution could be to offer ‘pop-up’ management, filling office buildings with short-term flexible contracts. The pop-up retail sector significantly contributed £2.3bn to the UK economy last year, according to a report by CEBR and EE, showing the potential value for the commercial sector.
A wealth of smart entrepreneurs are setting up new businesses every day. These myriad small businesses will be extremely reluctant to take long-term leases, but will need office space. The challenge for building owners will be to provide products and services that attract flexible occupiers while increasing both cashflow and valuation.
Now is the time for building owners to start thinking unconventionally and for a move away from traditional management styles. The world of work has changed, with businesses wanting more from less space, and on their own terms. The onus is on landlords to position their product in such a way that they can benefit from this dynamic working environment rather than be harmed by it, before the new economy looks elsewhere for value. The future winners in the commercial sector will be those who adapt to the new regulatory and economic environment.
Steve Jude is chief executive of Citibase