The providers of flexible office space have previously been satisfied with taking a traditional lease and then providing short term occupation to their clients. The market is shifting, such that the traditional lease route is no longer the only option.
Flexible office space deals are increasingly being structured in a similar way to those of the hotel operating companies who provide a branded stay to guests despite rarely owning the bricks and mortar. Operating the space on behalf of a building owner in this way creates a very different risk profile from leasing the space.
The negotiations between a building owner and an operator will focus on the allocation of the risks that, under a leased model, typically fall upon tenants. These could include fit-out cost, maintenance of the building, fixtures and fittings, rates liability and payment default by occupiers. In order to ensure the property remains widely acceptable to institutional funders, lender protections will also need to be considered carefully.
No rent is paid to the building owner by the operator under an operating structure. Instead, the operator is paid a fee for running the serviced office business, with the income from the flexible office space occupiers being the income of the building owner (although the process of payment is managed by the operator who will make deductions such as its fees and reserves for the upkeep of fixtures and fittings). The method of calculation and collection of fees, operation of bank accounts and selection of occupiers all need consideration, negotiation and documenting.
A particularly complex issue is that many serviced office operators run their business as a “club” whereby membership entitles the occupier or “member” access to a number of serviced locations. If multiple building owners are involved with the same operator or brand (which will be the case for many concepts), careful consideration needs to be given to how monies are allocated as between building owners.
An operating structure brings some other advantages over a traditional lease. Without a lease, no stamp duty land tax will be payable (provided that the transaction is carefully structured – and we can help with this). Deals structured in this way enable operators to develop their business and brands more quickly as deals utilising an operating structure do not clog up the operator’s balance sheets with property assets and liabilities and will typically call upon the landlord to fund fit-outs and to take construction risk.
The legal process for concluding such deals is different to a typical property deal, and although land registration may not be required, it will often be the case that the rights of the operator will be protected by registration over the building owner’s title. Appropriate legal due diligence remains necessary but the emphasis will have regard to the allocation of risks as between owner and operator.
Our hotels and corporate occupiers practice, recently ranked tier one by the Legal 500 UK 2018, benefits from a wealth of experience in navigating, negotiating and structuring operating agreements, which could shape the future of this rapidly expanding sector of the market.
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