Does connectivity add value to commercial real estate? The case of managed and conventional offices A preliminary study funded by The British Property Federation
September 2005
Authors: Dr Tim Dixon, Director of Research Bob Thompson, Senior Research Associate (and RETRI)
Funded by: Produced through:
Published September 2005 by the College of Estate Management, Whiteknights, Reading, RG6 6AW
No responsibility for any loss occasioned to any person acting or refraining from action as a result of any material included in this publication can be accepted by the authors or the publishers.
ISBN 1-904388-48-5
© College of Estate Management 2005
Executive Summary
Overview
This research is a preliminary study which examines the impact of connectivity on value in the managed office and conventional office sectors. The research is based on an extensive literature review, online survey and case studies carried out during 2005. The research shows, for the first time in the UK, how connectivity can increase value in office buildings, and how technology is priced in the market place.
Main findings
The majority of stakeholders see that connectivity adds value. Some 56% of the respondents agreed with the proposition that it commands a rental premium, while 35% agreed that it adds to capital value. An average premium of 3% on rent was proposed by the respondents. Those venturing an opinion on yields saw an average of around half a percent discount to be a reasonable expectation. Location is still vital but connectivity was ranked alongside design and proximity to services as a factor affecting office values. As far as features of connected buildings were concerned, there were significant differences between stakeholder groups:
o Owners and managers placed reduced voids as the most important feature of connected buildings; o Occupiers saw tenant retention as unimportant, raising questions about the premise that better facilities help to retain customers; o Occupiers also saw customer service as important, whereas other groups saw it as fairly unimportant; o Occupiers were joined by managers in seeing service availability as important. Building owners saw it as neutral and agents as fairly unimportant. o Potential liabilities on sale were seen as fairly important by owners and occupiers but neutral by agents and managers. The case studies showed that location and security were also key issues alongside technology choice in buildings. The managed office sector is moving towards a total occupancy cost model which offers a good degree of transparency in costing. DCF analyses show the real benefits of connectivity in offices.
1 About the research
The online survey comprised 162 responses, equivalent to a 4.7% response rate from owners/occupiers; agents and their advisors; occupiers and property managers. However, there is a substantial non-response component to the survey of some 95.3%, and this should be borne in mind in interpreting the results. The managed office case studies comprise Davidson House, Reading (Stonemartin), and 7 Soho Square London (Landflex). The conventional office case studies comprise Portman House (Land Securities), Spinningfields (Allied London) and Broadgate (British Land).
Acknowledgments
We would like to thank all those who responded to the online survey and to our interviewees. Our thanks are also owed to the British Property Federation for funding this research. The report is produced through the PIREC consortium (Partners in Real Estate Connectivity). For further details see www.pirec.co.uk
Further information For further information on this research please contact: Professor Tim Dixon Department of Real Estate and Construction School of Built Environment Oxford Brookes University Gipsy Lane Headington Oxford, OX3 0BP UK Tel: 01865 484202 Email: [email protected]
2 Contents
Executive Summary………………………………………………………………………….1 Contents………………………………………………………………………………………3 1 Introduction ...... 5 1.1 Context of study...... 5 1.2 Aims and objectives...... 5 1.3 Methodology ...... 5 1.4 Format of report ...... 6 2 Background and Context ...... 7 2.1 Introduction...... 7 2.2 Technological change: alternative perspectives ...... 8 2.3 An example of a socio-technical framework ...... 10 2.4 What is connectivity and why is it important? ...... 12 2.4.1 First order effects...... 13 2.4.2 Second order impacts...... 19 2.5 Methodologies for unlocking connectivity value impact ...... 24 3 Online Survey Results ...... 26 3.1 Introduction...... 26 3.2 Main Findings ...... 27 3.2.1 Rental impact...... 27 3.2.2 Yield impact ...... 29 3.2.3 Nature of the agreement...... 30 3.2.4 Factors affecting office values ...... 31 3.2.5 Relative importance of features...... 32 3.2.6 Experience...... 33 3.2.7 Owner/Investor questions...... 34 3.2.8 Occupier questions...... 36 3.2.9 Manager questions ...... 36 3.3 Summary ...... 37 4 Case Studies...... 39 4.1 Introduction...... 39 4.2 Managed offices: case studies ...... 40 4.2.1 7 Soho Square, London...... 40 4.2.2 Davidson House, Reading...... 44 4.3 Conventional offices ...... 49 4.3.1 Broadgate, London EC2 – the manager’s view ...... 49 4.3.2 Portman House, London W1 – The occupier’s view...... 52 4.3.3 Spinningfields – developer’s and advisor’s views...... 54 4.4 Summary ...... 55 4.4.1 Managed Offices ...... 55 4.4.2 Conventional offices ...... 55 5 Managed Office Pricing and DCF models - Towards Added Value ...... 57 5.1 Introduction...... 57 5.2 Managed office pricing model...... 57 5.3 Hard components of value...... 58 5.4 Fuzzy components of value ...... 59 5.5 Typical examples ...... 59 5.6 Conclusions ...... 60 6 Conclusions ...... 61 6.1 Does connectivity add value? ...... 61 6.2 What other factors are important? ...... 61
3 6.3 Is the pricing of connectivity transparent? ...... 62 6.4 Limitations of research...... 62 6.5 Need for further research...... 62 References…………………………………………………………………………………. 63
Tables Table 2.1 Conceptions of ICT in organisations/society (adapted from Kling, 2000) ..11 Table 2.2 Centripetal and centrifugal drivers in City of London offices (after Dixon et al, 2002d)...... 12 Table 2.3 Floorspace per worker ratios and new working practices (net floorspace (sq m) per worker) (from Gerald Eve, 2001) ...... 14 Table 2.4 New working practices (adapted from DTZ Pieda, 2004) ...... 17 Table 2.5 Messages, transactions and location of standardised and specialised products (adapted from Leamer and Storper, 2001)...... 18 Table 2.6 Summary of real estate services transformation (adapted from Dixon et al, 2005)...... 21 Table 3.1 Structure of responses...... 27 Table 3.2 Relative importance for owners (factors attracting tenants)...... 35 Table 4.1 Case studies ...... 39
Figures Figure 2.1Key new economy drivers in property/real estate (‘socio-technical model’) (adapted from Dixon et al, 2005) ...... 10 Figure 2.2 ICT and real estate impacts ...... 13 Figure 2.3 Changing paradigm of work (adapted from ECATT, 2000)...... 17 Figure 2.4 Impact of ICT on office rents (adapted from Tien Foo, 2002) ...... 20 Figure 2.5 CORENET findings (adapted from CORENET, 2004d)...... 23 Figure 2.6 Enhancing rent and building value and tenant attraction/attention (adapted from BOMA, 2000) ...... 24 Figure 3.1 Response by stakeholder group ...... 26 Figure 3.2 Rental premiums in connected buildings ...... 28 Figure 3.3 Rental impact of connectivity ...... 29 Figure 3.4 Yield impact of connectivity...... 30 Figure 3.5 Telecommunications agreement...... 31 Figure 3.6 Relative importance of connectivity ...... 32 Figure 3.7 Connected features – relative importance ...... 33 Figure 3.8 Experience of connected buildings ...... 34 Figure 3.9 Tenant requests...... 35 Figure 3.10 Impact on space and productivity ...... 36 Figure 5.1 Total office cost split – conventional and flexible office space (source: Actium, 2005)...... 57 Figure 6.1 The connectivity model ...... 62
4 1 Introduction
1.1 Context of study From the perspective of the occupier, a building represents, amongst other things, economic capacity for the business. The cost efficient use of that capacity is a key determinant of profitability. Traditionally, the provision of utilities like telecommunications to a building has been facilitated by the property owner through the granting of access, usually within a regulated framework. However, in an increasing number of cases the property owner has a stake in the provision of connectivity to his clients in the building – those same occupiers. For the occupier such an arrangement holds the prospect of cheaper telecommunications, richer services and a higher level of service. For the property owner the value of connectivity needs to be demonstrable in conventional measures of property performance. In theoretical terms, a broadband-enabled building would be expected to command a premium with lower yield, faster letting and few voids, higher rent and with occupation charges reflected in the cashflows. New research is needed to test the addition of such value for both occupiers and owners in practice.
1.2 Aims and objectives The focus of this preliminary study of connectivity in commercial property is the office sector. The study examines both conventional offices and the managed office sector. The objectives of this research are: To define the mechanisms through which value to the landlord and the occupier may be expressed; To quantify the impact of connectivity upon value using those mechanisms as a framework; To identify future trends in value through the use of DCF-based models; and To highlight best practice examples of connectivity management and occupier relationship management through case study examples.
1.3 Methodology This preliminary study scopes and examines existing literature to highlight the context and background to the research and to examine a range of appropriate measures, including ‘network effects’ and cashflow-based methodologies. The research also scopes the future research agenda that needs to be developed in the field. The study uses an online sample of occupiers and landlords to test the hypothesis that connectivity adds value. Five in-depth case studies of specific ‘connected’ buildings are also highlighted from London and other major regional cities. Finally, the research also seeks to establish appropriate metrics for benchmarking the impact of connectivity on property performance using valuation and cashflow scenarios. This enables preliminary testing in cases where the landlord provides
5 connectivity services, making comparisons with similar, conventionally connected buildings in each market.
1.4 Format of report The report is structured as follows: Section 2 Background and context to the study. This section covers the nature of connectivity and its importance in commercial real estate. A full literature review is included and the section also examines the ‘socio-technical’ framework in the context of alternative perspectives of technological change, and the changing role of offices through a critical review of the impact of ICT. Section 3 Online survey results. This section examines the results from the online survey Section 4 Case studies. This section examines the five case studies from the research. The managed office case studies comprise Davidson House, Reading (Stonemartin), and 7 Soho Square London (Landflex). The conventional office case studies comprise Portman House (Land Securities), Spinningfields (Allied London) and Broadgate (British Land). Section 5 Managed Office Pricing and DCF models – Towards Added Value. This section examines the ways in which the managed office sector and conventional offices are priced in terms of technology and connectivity. Section 6 Conclusions. This section provides conclusions to the research.
6 2 Background and context
2.1 Introduction During the late 1990s there was increasing debate over the emergence of a ‘new economy’, built on major structural changes driven by globalisation and Information and Communications Technology (ICT). At the same time, many commentators were starting to forecast the demise of physical assets in the new economy (Boulton et al, 2000). The trend was away from tangible physical assets (such as real estate) towards intangible goods such as knowledge and information (Coyle and Quah, 2002). The argument was that if ICT pervaded, productivity would increase and space requirements would reduce, thereby reducing the demand for real estate (see, for example, Borsuk, 1999). This thesis was strengthened by the view that real estate outsourcing could increase shareholder value, as property was taken off the balance sheet through financial instruments such as sale and leaseback or synthetic leases (Dixon et al, 2000). However, sceptics questioned the hype and the demise of dot.coms, and falls in stock markets strengthened such views. Some (see for example Gordon, 2000) challenged the very nature of ICT and its ability to increase productivity. Nonetheless, although the ‘irrational exuberance’ (Shiller, 2000) from this period is now clear-cut, it can be argued that the sceptical view of technological impact itself remains a flawed one. ICT has not disappeared, and new evidence now emerging from OECD (2003) research suggests that productivity impact is proven by a number of statistical studies. It can also be argued that the ‘new economy’1 is a very real phenomenon, and that increasingly technology is impacting alongside other factors (such as social and economic forces and organisational change) to affect the intensity of use of real estate; its configuration/layout and location; and the amount procured and the duration over which commercial office real estate is procured. This section of the report will therefore argue2 that: 1. A variety of perspectives have been adopted to conceptualise the impact of ICT at an economy level, firm level and real estate level. Frequently, however, such frameworks have suffered from a deterministic structure. Instead, we favour what we describe as a ‘socio-technical framework’ to examine ICT impact. Therefore, ICT is a fundamentally important part of the ‘new economy’, but must be seen in the context of a number of other social and economic factors.
2. There is a growing body of evidence to suggest that commercial office property is being, and will increasingly be, affected by ICT impact, but unravelling ICT impact from other factors is a taxing research issue. Statements such as the ‘death of real estate’ and ‘increased productivity means less jobs’ are important to deconstruct.
1 In this paper we use the following definition which we believe captures the main components of the new economy: ‘a knowledge and idea-based economy where the keys to job creation and higher standards of living are innovative ideas and technology embedded in services and manufactured products’ (Progressive Policy Institute, 1998). This seems to us to capture both the potential impact of ICT and the transformational power of knowledge and information- based industries. 2 A number of the concepts explored here are discussed in further detail in Dixon et al (2005). For book website see: www.cem.ac.uk/neweconomy
7 3. ICT has a variety of impacts on commercial offices through the characteristic of ‘connectivity’. This impact can be summarised as ‘first order’ impacts: Space intensity; Design and construction; Productivity; Location; and Organisational design/culture.
These can lead to ‘second order’ impacts: Value; Lease provision; and Service provision.
4. Future research in real estate and facilities management (FM) must recognise the growing importance of ICT in real estate markets and real estate service provision. The rest of this paper is therefore divided into the following sections: Technological change: alternative perspectives; An example of the ‘socio-technical’ framework; The changing role of offices: a critical review of the impact of ICT; What is ‘connectivity’ and why is important? The section is based on a literature review (see also Dixon et al, 2005) and the authors’ continuing research programme in the field3. In what follows we focus on commercial offices.
2.2 Technological change: alternative perspectives Many doubt whether the new economy really is a new phenomenon. For example, Rowlatt et al (2002) suggest there have always been new economies and that the concept is not tied to time or technology. Over hundreds of years, periods have occurred when technological change has brought about radical changes to market boundaries, increasing the scope to exploit intellectual capital. Examples include printing, steam, power (including electricity), canals and railways, mass media, and more recently ICT (see also Perez, 2002, and Gordon, 2000)4. But the new economy of the 21st century is different from any other new economy. Rowlatt et al (2002) highlight three main aspects: Infrastructure to assemble, analyse, communicate and manage information within ‘computer mediated networks’; Transactions to purchase goods and services carried out through EDI or over the Internet; Interactions transferring information between enterprises or individuals which add to value.
3 See website at: www.pirec.org.uk 4 That is not to argue that such changes occur in a linear, sequential fashion (i.e. television did not replace radio and ICT has not replaced books).
8 It is the sheer scale of information processing power that has provided the driving force for the new economy. A key reason is technological advances based around the microprocessor (i.e. Moore’s Law)5. There is also growing evidence to suggest that a new economy is developing, driven by technological change in alliance with other forces. An obvious indicator is the trend towards services away from manufacturing, for example, which has occurred more quickly in the UK than in other economies (Coyle and Quah, 2002, and Pohjola, 2002). Frequently the conceptual frameworks to assess these impacts of ICT have pursued a deterministic slant, arguing that ICT acts in a linear fashion and imputing its direct benefits (DTI, 2001). Others adopt what may be termed a ‘non-spatial perspective’6, and do not explicitly consider the spatial aspects of technology (i.e. locational and space demand/supply dynamics at a meso/micro level), but nonetheless offer valuable insights. Examples from the ‘economy level’ include Schumpeter (1939) and Perez (2002), and at a ‘firm level’ Scarbrough and Corbett (1992). What we can learn from these models is that technology can only be understood within the context of social, political and economic structures and institutions, and that technological determinism (i.e. a simple linear trajectory and cause and effect relationship between technology and desired outcome) is an oversimplification. Similarly, ‘spatial perspectives’ have been developed on the impact of technological change on the shape and form of our towns and cities (see for example Berry, 1973, and Castells, 1996) and on the real estate occupied and owned by organisations (see for example Gibson and Lizieri, 2001, and Vandell and Green, 2001). Castells (1996) suggests that in fact ICT can lead to both dispersal and concentration, and this view has been taken forward by other authors such as Christie and Hepworth (2001) and Gillespie et al (2001)7. Castells (1996) builds on this fundamental concept and refers to the new economy as the informational economy, in which information generation, processing and transmission become the fundamental sources of productivity and power. A ‘space of places’ has been joined by a ‘space of flows’. The latter refers to the technological and organisational possibility of orchestrating social and work practices simultaneously without physical proximity. In other words technological impact can lead to both ‘clustering’ and ‘dispersion’ of activities. At the ‘real estate level’, some argue (see for example Lizieri, 2003) that the impact of business reorganisation and new working practices on corporate office real estate is less dramatic than often supposed, because of the importance of ‘institutional’ barriers. However, recent research (see for example Dixon and Marston, 2002a, and Dixon et al, 2002b), has found a growing impact of ICT in both the retail and office sectors. Moreover, the issue is not one of lack of impact of ICT; rather, part of the problem with much of the research in this field is that it is cross-sectional in nature, preferring to take snapshots in time rather than tracking trends longitudinally. This suggests we may therefore be missing changes caused by ICT, because in organisational management and business process, the changes are much harder to map. It is inherently more difficult to identify ‘step changes’ in process if you have only recently become part of the ‘revolution’ in technology, and part of the issue may
5 In the 1960s Gordon Moore (1965), co-founder of Intel Corporation, projected that the density (and hence power) of transistors on a silicon chip would double every 18 months. The principles of Moore’s law have held fast, and today’s processors have 256 times the density of those manufactured in 1987 and 65,000 times the density of those manufactured in 1987. 6 For a full discussion see Dixon et al (2005). 7 It was in fact more than 100 years ago that Alfred Marshall (1890) drew attention to the battle between centrifugal forces and centripetal forces in the spatial organisation of the new economy: ‘Every cheapening of the means of communication alters the action of forces that tend to localise industries’.
9 also be connected with who is surveyed in these studies, what their role is in the organisation, and how they see technological change as altering their business models. Focusing too narrowly on the institutional barriers to ICT could therefore compound the problems we must resolve in order to measure and identify the precise nature and impact of technological change. New frameworks are therefore needed.
2.3 An example of a socio-technical framework If we accept that ICT operates within the context of other factors, and that a deterministic view is too simplistic, then it is possible to learn from the existing conceptual frameworks outlined above to develop what we term the ‘socio-technical’ framework (Dixon et al, 2005). This, shown in Figure 2.1, is based on the research programme already undertaken by the authors and is a starting point for developing further research in the field.
Figure 2.1Key new economy drivers in property/real estate (‘socio-technical model’) (adapted from Dixon et al, 2005)
Stakeholders Real Estate
Business ICT, Information Social, Society Product / Economic, Asset Political Consumers and Services Organisational / New Business Economy Factors Government
It can be argued that the socio-technical framework offers a number of advantages over those based either purely on a deterministic view of technology or on a purely supply and demand led model. In particular, the framework is able to link the economy, firm and urban/regional level impacts more closely to the real estate level and sets technology in context. Institutional barriers and market barriers can still be examined but must be seen in the context of broader political, social and economic factors governing the transformation of technology. These ideas bear a degree of synergy with the work of Kling (2000) who was at the forefront of the development of the field of ‘social informatics’, which examines the design, uses and consequences of ICT in ways that take into account their interaction with institutional and cultural contexts. Arguing that ICT is socially shaped, Kling differentiated between standard (tool) models and socio-technical models (Table 2.1) to explain ICT impact.
10 Table 2.1 Conceptions of ICT in organisations/society (adapted from Kling, 2000) Standard (tool) models Socio-technical models ICT is a tool ICT is a socio-technical network A business model is sufficient An ecological view is also needed One-shot ICT implementations are made ICT implementations are an ongoing social process Technology effects are direct and Technological effects are indirect and immediate involve different timescales Politics are bad or irrelevant Politics are central and even enabling Incentives to change are unproblematic Incentives may require restructuring (and be in conflict) Relationships are easily reformed Relationships are complex, negotiated, multivalent (including trust) Social effects of ICT are big but isolated Potentially enormous social and benign repercussions of ICT Contexts are simple Contexts are complex Knowledge and expertise are easily Knowledge and expertise are inherently made explicit tacit/explicit ICT infrastructures are fully supportive Additional skill and work are needed to make ICT work
This theoretical framework enables us to take a critical view of technology’s impact on real estate because it combines technical and social elements within an integrated framework. Much of the real estate literature in the field seems to ignore social, political and economic context, and fails to make the link between economy, firm level and property level impacts. However, there is a growing awareness that technological change can only be interpreted in the context of other socio-economic forces. Recent research by CORENET (2004a) highlights that five forces in particular are driving the nature of work and the workplace and therefore the demand for commercial real estate both now and in the future. These comprise: Demographics, through declining birth rates and increased longevity; Technology, through the emergence of the networked enterprise; Globalization, through intense competition. Sustainability, through the increased emphasis on a ‘triple bottom line’ model; Public policy, through influence on firms’ decisions. This has also been highlighted by recent research from DTZ Pieda (2004) on Working Practices in South East England, where technology is highlighted as a key driver but operating in the context of other factors which include demographics, globalisation and changing management and organisational cultures. As an example, the impact of ICT on office markets should consider ICT alongside other factors. Research by Dixon et al (2002d)8 on eBusiness and its impact on City of London offices suggests that there are factors in addition to ICT which are driving business change and the demand for real estate in offices (Table 2.2). These can be categorised according to whether they are ‘centripetal’ or ‘centrifugal’. In practice, ICT may also partly act as a centripetal force if technology maps itself on to existing economic activity and continues to promote ‘clustering’. If home working and other
8 See also a paper based on the same research in Dixon et al (2002b).
11 ICT-based activities grow, then ICT will tend to promote ‘dispersion’. Similarly, there is also an argument for saying that sustainable development could be promoted by encouraging living and working in the City. Therefore our previous empirical work suggests that adopting a framework based around the factors in Table 2.2 provides a sound basis for explaining and understanding the importance of technological change alongside other factors in impacting on real estate markets and services.
Table 2.2 Centripetal and centrifugal drivers in City of London offices (after Dixon et al, 2002d)
Centripetal (agglomeration) Centrifugal (dispersion) Face-to-face contact ICT Location Transport Clients Sustainable development Clustering Human resources
2.4 What is connectivity and why is it important? ICT is clearly important in transforming real estate (Dixon et al, 2005). The nature of ICT is also such that it can affect real estate and the services that are provided for owners and occupiers. The physical nature of buildings means they can also act as conduits or objects within which the transforming power of ICT is offered by landlords for tenants or ‘customers’. Increasingly therefore buildings are referred to as ‘intelligent’, ‘smart’ ‘or ‘wired’. In this sense they possess a key characteristic which refers to the extent to which they are networked or provide the cabling and infrastructure for businesses to use ICT. This characteristic is referred to as ‘connectivity’. This should be compared with CORENET’s more general use of the term (CORENET, 2004b), which refers to how a computer connects to a network. If we accept that technology interacts with other factors to shape real estate and related services, we can also hypothesise that ICT (and therefore the ‘connectivity’ of an office building) interacts with these forces to produce particular outcomes. These outcomes fall into two broad categories, first order and second order effects, which are now discussed (Figure 2.2).
12 Figure 2.2 ICT and real estate impacts
First order effect Second order effect
Productivity Space intensity Design & construction Value Organisational Lease provision design Services Location
2.4.1 First order effects
2.4.1.1 Productivity and space intensity There is an element of ‘fallacy’9 in productivity arguments (Bean, 2003, and Bootle, 2003) and the way in which they are often posited in terms of real estate impact. Technological advance does not automatically reduce jobs. Although technology may lead to job losses in some firms and some sectors by enabling the same output with less labour, it need not necessarily do so, because the lower cost of production may allow a firm to lower prices and so boost demand for its product. Whether employment rises or falls therefore depends on how much the demand for the product is affected by price (Landmann (2002)). This means that it is simplistic to extend the logic and argue that improved productivity created by ICT automatically leads to job loss and reduced space demand. For example, although teleworking is widespread, it does not necessarily reduce the demand for office space, and may increase the demand for residential office space (Greater London Authority, 2002). Also, although research (Gerald Eve, 2001) has shown that net densities have increased over time and that new working practices (NWP) increase densities (see Table 2.3), the picture is by no means straightforward, and firm size, length of occupation, and whether a property is leasehold are also important factors to consider.
9 This is often referred to by economists as the ‘lump of labour fallacy’. For example, in France in 2001 the Government courted controversy by introducing a 35-hour week, not only to promote a better work-life balance, but also to share work effectively, because, the argument went, if people did not work so long there would be more work to go around. However, this assumes a fixed ‘lump’ of work, which is not the case, because the level of jobs is dependent on aggregate demand: if one person gets a job it does not necessarily mean another loses one.
13 Table 2.3 Floorspace per worker ratios and new working practices (net floorspace (sq m) per worker) (from Gerald Eve, 2001)
Function Offices without NWP Offices with NWP Head office 16.8 15.2 Admin centre 17.2 15.6 Branch office 17.1 14.8 Sales office 17.6 14.8 Sole office 16.8 15.1
What we are likely to see more of is a growing trend towards separation of front and back office operations: back office operations are extremely cost-driven, and, with recent call centre outsourcing from the UK to India and China, we may be seeing a downsizing shift in back office operations with consequences for real estate demand in that particular sector. As London Property Research/EGi (2003) point out, Bombay can beat London by a factor of at least five on labour and property costs10. However, although the emphasis is shifting in office sub-sectors, and although outsourcing of key operations such as the management and maintenance of real estate may seem to be an inevitable consequence of the shift towards intangible assets, real estate has not ‘disappeared’, and will not do so. Indeed, what we are also seeing is the mapping of new growth and technological infrastructure on to areas of existing economic activity (Local Futures Group, 2001) in the UK because of the benefits of clustering (Trends Business Research, 2001). Similar findings have emerged from a regional study of South East England (DTZ Pieda, 2004). This research found that although ICT was a major driver for change in changing work practices and business space, other regional factors – such as economic restructuring through the growth of the service sector and knowledge economy, changing business practices and operations, and internal human resource management and organisational factors – were very important. In particular, restructuring and rationalisation had led in some instances to an increase rather than a decrease in floorspace per worker (e.g. in growth sectors such as business services, leisure, retail, restaurants and hotels). In the same study, other barriers were found to be preventing substantive ICT impact on space use. These included: Costs of implementation; Time and resources; Environmental considerations; Organisational culture; and Social relationships. However, in some sectors with intensive ICT use, floorspace per worker requirements had declined. Finally, an interesting perspective on the link between workplace design and productivity was highlighted in recent research from CABE/BCO (2005). Technology as part of the workplace design can impact on the quality of the physical value of a
10 More than 2.8% of the British workforce is in call centre operation which currently is the fastest growing employment sector. The UK has 4,300 call centres (ContactBabel, 2003), and when jobs disappear overseas it may be difficult to replace them.
14 building and its business value rather than simply its asset value. Indeed, wireless technology (or WiFi)11 is seen as an important part of this process (BCO, 2005).
2.4.1.2 Design and construction One of the key driving forces influencing office space has been the managerial changes that occurred at the end of the 19th century, as greater control became exerted over manufacturing and distribution through the accumulation and synthesis of information (Duffy, 1997). Paper-based tasks became more common, and greater numbers of workers were needed to process the information. ‘Taylorism’, or the scientific management of people as units of production, operated first in the factory and then in the office. It encouraged an ordered, hierarchical, supervisory approach to office space that is still seen in the legacy of buildings of the last two centuries, and was also strongly underscored by a general decline in manufacturing and a flight to the service economy (Dixon et al, 2005). Partly as a result of the changes brought about by ICT and allied social and economic forces, there has, however, been an increasingly blurring of the term ‘office use’. New kinds of space have emerged which offer greater flexibility and comfort to users and occupiers. Duffy (1997) in fact recognised this in the 1990s with his seminal work, The New Office. Duffy suggested that, historically, the dominant mode of the conventional office was the ‘office as factory’, where individuals processed work under supervision at their own desks. In some instances such work has been outsourced overseas, but in general he characterised such processes as giving rise to ‘hives’. ‘Cells’, on the other hand, were characterised by independence and concentrated study (for example, professional and research tasks). In contrast, where group processes were involved, this led to more team-working and interaction, and Duffy therefore termed this type of space ‘dens’. There is also a cyclical dimension to Duffy’s typology, because as group processes and concerted study are transformed through organisational and technological change, they may in some instances converge into ‘clubs’ or spaces for transactional knowledge. This typology can apply to parts of a business or a whole business, and Duffy also suggests that differences in work patterns, space layout, and ICT requirements are all closely related to these types of space. A similar, yet distinct, typology of office space has also been developed by Myerson and Ross (2003) who identify four themes in 21st century office development, again largely driven by organisational and technological change: Narrative office – here design and layout are used to develop brand differentiation (examples include Toyota’s UK headquarters at Epsom Downs and Reebok’s Canton, Mass, US headquarters). Nodal office – here design is used to encourage new ways of working such as hot desking and hotelling so that fixed points for networking, coaching, training and knowledge sharing are promoted to complement the more mobile work methods (examples include IBM’s Santa Monica HQ in USA, and McKinsey and Co’s Amsterdam Harbour complex in the Netherlands, employing ‘lounges’ and ‘cocoons’). Neighbourly office – this runs against the grain of the ‘Taylorist’ model and uses design and layout to promote social interaction (examples include the Cellular Operations centre in Swindon in the UK).
11 WiFi hotspots are growing in number. A prime example of their use and the way in which building design is linked with ICT is the British Library. WiFi is also common in coffee shops, hotels and airports. GNER, BA and Lufthansa all provide such facilities (Unwired, 2005).
15 Nomadic office – this is characterised by a series of geographically distributed spaces for work (examples include Workspace, operated by Granada and BT, and the Institute of Directors building in London). On the face of it, the two typologies of office space above perhaps support the view that ‘processing space’ is a more appropriate term than ‘office space’. Flexibility, efficiency and effectiveness in design and use are therefore increasingly powerful mantras, and ICT has played a major role in transforming the shape and form of traditional office use, as business models themselves have changed and adapted to technology and socio-economic factors.
2.4.1.3 Organisational design and location Research by CORENET (2004c) has identified that new business models are evolving as a result of the interaction of ICT and other forces. These ‘networked enterprises’ are (CORENET, 2004c): ‘…flat, fast, flexible, process-driven, globally dispersed, highly interdependent and networked’. One example of how work paradigms are changing office space requirements alongside technology is shown in Figure 2.3. Moreover, from a broader perspective, the development of ‘telework’ can be seen as one of a number of developments in the way in which paid work is organised. The extent to which this flexibility benefits the employer or employee is subject to negotiation. The traditional, post-war work paradigm (ECATT, 2000) is changing from a model which consisted of: Permanent employment with a contract of employment; ‘Life-time’ employment; Standardised working hours (‘9 to 5’); Full-time employment; State-provided social security provisions; Workplaces co-located in centralised buildings; and Strong intra-organisational co-operation based on face-to-face meetings, with external contacts limited to certain gateways. Changes in the economic environment, together with shifts in social attitude and the impact of ICT, have led to a 21st century work paradigm, characterised by: Spatial dislocation; Self-employment; Greater diversity and flexibility in working time patterns; and Stronger external boundary co-operation. This paradigm shift is shown in Figure 2.3. The new paradigm is broader than the post-war paradigm, as it covers a much wider spectrum of ways of working. Traditional work practices continue to exist and remain at the core of the labour market, but they are likely to be just one of a number of work patterns that exist in the future.
16 Figure 2.3 Changing paradigm of work (adapted from ECATT, 2000)
Flexible
Time
9 to 5
Post war Co- Place work operation
paradigm Intra Trans Dislocation Co-location Organisational Organisational
Employed
Contract
Self- employed
DTZ Pieda (2004) provide a useful classification of new working practices (Table 2.4).
Table 2.4 New working practices (adapted from DTZ Pieda, 2004)
Type Summary Flexicontracts Contractual arrangements including agency workers; temporary or fixed term contracts and casual labour/self-employed Flexi-time Part-time working; job shares; compressed working weeks Flexi-location/workplace Working from home or from telecentres/satellite offices. Includes homeworking, hot-desking and virtual office Team working Small number of team members using shared space Outsourcing Outsourcing of support functions
Finally, location dynamics are also being impacted. This is, however, contingent on the type of process and its information content (Dixon and Marston, 2004). This theme has also been explored by Leamer and Storper (2001) in a spatial context. They categorise processes according to the character of the information needed to use them (Table 2.5).
17 Table 2.5 Messages, transactions and location of standardised and specialised products (adapted from Leamer and Storper, 2001)
Mass-produced, Specialised, customised standardised products and innovative products Messages Codified, transparent Tacit Degree of intermediate Low (high scope High (low scope transacting economies) economies, high ‘roundaboutness’) Degree of agglomeration Remote/low aggregation Market- of supply chain centred/agglomerated Location of Remote Indeterminate production/distribution in relation to markets Examples Dispersal: consumer Agglomeration: design- banking and finance driven retail
For example, mass-produced, standardised products can be codified and shipped separately from the product in the form of specifications, blueprints, standards and so on. This therefore allows geographical distance between buyer and seller. However, if the product is non-standardised it cannot be so easily expressed in a codifiable form: the principal way of verifying the product’s qualities is then by touching, feeling or knowing the product. This leads to a much more market-centred focus to the product and thus geographic proximity is important. The Internet has the power to shift these relationships and can lead to both increased ‘clustering’ and increased ‘dispersion’ through: Increases in product variety; Increases in the fineness of division of labour, or ‘roundaboutness’, which is the number of intermediate steps to produce a final output; and the automation of intermediation/coordination tasks (disintermediation). Leamer and Storper (2001) suggest that the ways in which a new ICT such as the Internet interacts with production and its geography will be many and varied, and there will be no single business model that is created but, rather, complex feedbacks to specialisation and divisions of labour in different sectors will occur. The exact geographies of new mass variety sectors such as designer retail, consumer-driven manufacturing and parts, new consumer services (customised take-out food, Internet-ordered home repair), and knowledge inputs to production, will be determined by whether the input-output relations are ‘conversations’ or ‘handshakes’. Sectorally, we would therefore expect to see greater changes in businesses associated with the greatest level of ICT adoption, in terms of business/process change, or in terms of the type of product sold (for example, travel, financial services, the ICT sector itself, and some retail trades (books, CDs). The implications of these first order impacts are now explored in terms of second order impacts.
18 2.4.2 Second order impacts
2.4.2.1 Value We can hypothesise that ICT could, through first order impacts, also lead to secondary value impacts. Such impacts could feed through into the rent agreed where ICT was part of the service provision through the landlord’s offer, or indeed through a premium value over and above comparable rents passing in the market. From the perspective of the occupier, a building represents, amongst other things, economic capacity for the business. The cost-efficient use of that capacity is a key determinant of profitability. Traditionally, the provision of utilities like telecommunications to a building has been facilitated by the property owner through the granting of access, usually within a regulated framework. However, in an increasing number of cases the property owner has a stake in the provision of connectivity to his clients in the building – those same occupiers. For the occupier, such an arrangement holds the prospect of cheaper telecommunications, richer services and a higher level of service. For the property owner the value of connectivity needs to be demonstrable in conventional measures of property performance. In theoretical terms, a broadband-enabled building would be expected to command a premium with lower yield, faster letting and few voids, higher rent, and with occupation charges reflected in the cashflows. Early research by BOMA (2000) found that tenants were not generally prepared to pay a premium for a connected building. However, more recent research is showing a different picture. For example, in a study of the Singapore office market, Tien Foo (2002) provides an interesting economic analysis of ICT to highlight the impact on the demand function for office space in two main ways: firstly by the expansion and creation of new firms offering ICT services to other firms; and secondly by the new working practices and business reorganisation that may arise leading to structural change. ICT-enabled operations can achieve improvement of efficiency gains in three main areas: business function and configuration, staffing and organisation structure, and locational flexibility. If ICT-induced change therefore impacts on firms occupying larger office space, then aggregate demand for space is also likely to be affected by the increase in ICT investment. This is shown diagrammatically in Figure 2.4. Assuming perfectly elastic supply, new ICT firms would push equilibrium demand from A to B on the new demand curve D1 leading to a rent rise to R2. But when new office supply is increased, rent is adjusted downwards to R3 with a new equilibrium point of C. Moreover, if ICT-induced effects take place, more firms may give up space by downsizing, and a new equilibrium point is reached at R4 with a lower amount of occupied space, Q4 (point D). The Singapore survey also showed that those occupying firms that tended to be more positive towards ICT generally also tended to perceive that ICT adoption would lead to a reduction in floorspace per worker.
19 Figure 2.4 Impact of ICT on office rents (adapted from Tien Foo, 2002)
B
R2 b a C R3
A
R1 c D D1 R4 S
S1 D
Q1 Q4 Q2 Q3 Quantity of space Point A= Original market clearing position a=derived demand from ICT firms b= demand shift from rental increase c=structural shift from ICT
Clearing mechanisms in the market will also affect the rental value of office property, and it would logically be expected that ‘wired buildings’ would carry a rental premium over and above other buildings. Further work by Tien Foo et al (2004) focused on the developer’s perceptions of ICT and broadband in office buildings in Singapore, and also attempted to measure the value impact of ICT. Building on work by Thompson and Hills (1999), Almond (2001), and Spurge (2002), they studied Suntec City in Singapore and found that in their survey of 24 developers, 71% expected upgrading of buildings to increase marketability and would also be able to attract tenants who were willing to pay a premium for ICT and broadband services. The majority of developers also felt that ICT would impact positively on occupancy rate, rent and running/maintenance costs.
20 2.4.2.2 Lease provision and services Real estate service provision has also been transformed through the provision of online listing services, bundled service provision and shorter leases, again driven by technology acting with other forces (Dixon et al, 2005). This has had implications for the way in which real estate managers manage buildings and client relations, and the way in which appraisers, FM specialists and brokers all offer services. Arthur Andersen (2000), for example, suggest eight possible future business models to unlock the value chain for real estate service provision: Advertising: through owned channel on behalf of product or service suppliers; Direct commerce: supply of product directly to customers, bypassing other channel intermediaries; Transaction facilitation: facilitates the matching of buyers or sellers in any market; Service provision: provision of a general or specialist service to the customer, often on ad-hoc basis; Utility provision: provision of product/service which can be paid for as it is used; Online community: provision of community of common interest; Information trading: provision of information about markets, products, services and/or market traders; and Market aggregation: aggregation of demand or supply through a digital marketplace providing products and services. Table 2.6 summarises some of these important impacts.
Table 2.6 Summary of real estate services transformation (adapted from Dixon et al, 2005)
Service function Forces for change Transformation by ICT (with ICT) Owners/ Corporate finance Additional revenue streams Owners’ managers Unbundled assets Flexi-leases Outsourcing New products Lease structures Occupiers/ Corporate finance Growth of FM services Occupiers’ managers Unbundled assets Intelligent buildings Outsourcing Lease management Lease structures Asset management Appraisers Corporate finance Changing skills Unbundled assets Flexi-leases Outsourcing New products Lease structures Brokers Increased Disintermediation and transparency Reintermediation Competition
Serviced offices are an interesting and important example of increased flexibility in space provision. The last decade has seen the growth of demand for more flexible space and leasing requirements by occupiers. This has been focused very much on
21 ‘peripheral’ space demands which has driven the demand for ‘serviced offices’, or what is frequently referred to as ‘managed offices’, at the higher end of the market. Although the serviced office concept has been established in the UK for a number of decades, until the late 1980s the sector was characterised by fragmentation and diversity of ownership and nature of operation. Specialist serviced office providers such as Regus, HQ and MWB offer a combination of flexibility and services to their occupiers and have been the main suppliers (Dixon et al, 2005). Typically, they provide a full range of business support to their occupiers in terms of facilities management, equipment, IT, catering, secretarial/reception and so on, in addition to flexibility of exit from operational properties. In relation to type of occupier, a survey of the UK serviced office sector found that 41% of occupiers were IT companies (split fairly equally between business service firms and financial service firms), and a corresponding US survey by ESA (2000) found that technology firms comprised 29% of occupiers, followed by business service firms (17.8%), and financial service firms (12.5%). The increasing expansion of the technology sector has therefore also fuelled the growth in the serviced office sector. Clearly, occupiers of serviced offices require flexible space and lease arrangements, and research by Jones Lang LaSalle (2000) has shown that dot.com companies have been successful in securing a significant degree of flexibility in their property arrangements, ranging from shorter leases (an average of 5.2 years, compared with 15 years typical length in the London office market) to more extensive use of serviced space on a 24/7 basis. The rent package in this sector also differs from ‘conventional’ office suites: executive suites or serviced offices offer ‘virtual space’ and firms can use the centre for telephone or mail answering, hiring meeting rooms, and so on, and the rent chargeable reflects the bundle of services available (Gibson and Lizieri, 2000). As Stirling (2005) points out, the UK serviced office sector has grown threefold since 2000. In 2000 they accounted for 1% of UK office space, but now account for 3%, in comparison with 10% in the USA. Technological change has also been mirrored by changes to lease structures and the provision of serviced office space, although it is difficult to unravel the true impact of ICT (Dixon et al, 2005). Research by CORENET (2004d) also showed that corporations would, at least by 2010, be willing to pay for flexibility in the workplace. As Figure 2.5 shows, 47% of respondents would be willing to pay 5% or more for flexible workplace design and 41%, 5% or more for flexible contract terms.
22 Figure 2.5 CORENET findings (adapted from CORENET, 2004d)
50
45 Flexible workplace Flexible Contract 40 design Terms
35
30 Now 25 By 2010 20 % respondents
15
10
5
0 No premium <5% =>5% No premium <5% =>5%
Finally, the linkage between ICT, organisational design and potential impact on rent is revealed by recent research from Actium Consult (2005), which shows that flexible working shifts the cost balance from property (65%) and IT (35%) of total infrastructure costs in a traditionally operated building to 55% for property and 44% for IT. ‘Connectivity’ in a building therefore offers landlords the opportunity to provide value- added services which can be focused on the customer’s business. This requires the partnership with a technology service provider to provide ICT services and support. In the USA, the benefits of such provision for both landlord and customer have been highlighted by BOMA (2000) (Figure 2.6). In practice, however, there were severe teething problems with some of the early adopters in the USA (Mattson-Tieg, 2002).
23 Figure 2.6 Enhancing rent and building value and tenant attraction/attention (adapted from BOMA, 2000)
Building Value Enhancement Tenant satisfaction & Retention
Connectivity
Potential New Revenue Streams
Clearly there is a mixed picture emerging in relation to connectivity in the UK and overseas, and new research is needed to test the addition of such value for both occupiers and owners in practice in the UK. The research on which this paper is based therefore seeks to: Define the mechanisms through which value to the landlord and the occupier may be expressed; Quantify the impact of connectivity upon value using those mechanisms as a framework; Identify future trends in value; and Highlight best practice examples of connectivity management and occupier relationship management.
2.5 Methodologies for unlocking connectivity value impact The methodologies for unravelling the impact of ICT have been explored in previous research. The majority of research has tried to unravel ICT impact through a cashflow approach, but, as Dixon et al (2005) suggest, three main effects need to be analysed: ‘Blurring’, where it may be difficult to deconstruct the charge for rent and other services; ‘Substitution’: where some services are high margin, a lower rent may be agreed; and ‘Enhancement’: where high quality services are provided, an increased or premium rent may be payable. As Tien Foo et al (2003) point out, compared to an unconnected building, a broadband-ready office commands a potential premium through a lower yield, faster
24 leasing and fewer voids, with a higher rent and an occupation charge for the broadband services in the cashflow streams. Thompson and Hill (1999) used a hypothetical business model to illustrate the case of a new 150,000 sq ft central London office building with an installed 2Mb leased line (one of the fastest services available at that time) that could pay back within four years. Almond (2001) also used DCF analysis on a 100,000 sq ft multi-tenanted building to show the payback period and breakeven point for the investment. Finally, Tien Foo et al (2004) used a combination of cashflow-based analysis and network analysis (after Katz and Shairo, 2001) to show how connected property can produce a premium rental value. Network externality benefits can arise also where the utility of a user increases as a result of growth in the network (Katz and Shapiro, 2001), and Tien Foo et al (2004) incorporated a measure of this (based on size of office building as a proxy) in an incremental net present value model to estimate the economic gain of investing in ICT and broadband. Excluding intangible economic benefits such as enhanced landlord-tenant relationships, lower leasing risks, higher market branding and so on, their research showed that ICT/broadband connectivity produced a premium of 3.86% of unit rental value12.
12 When probabilistic uncertainties are introduced the premium increases to 5.27%.
25 3 Online Survey Results
3.1 Introduction Between May and July 2005 a survey of property owners, occupiers, managers and advisors was undertaken. Using a structured, online questionnaire, the objective of the survey was to obtain expert opinion from within the property stakeholder community on the impact, and relative importance, of connectivity provision in buildings. The first phase involved emailing a list of 2,967 verified individuals at their workplace soliciting completion of the questionnaire. In order to get a sample more representative of UK industry as a whole, a further 486 individuals at manufacturing companies were also emailed to complete the same questionnaire. There was no duplication between the lists.
Figure 3.1 Response by stakeholder group
Agents/ Advisors 9%
Property Managers 36% Occupiers 25%
Owners/ Investors 30%
Although the net result of the second survey was to increase the number of responses from manufacturing industry, the responses still bear a heavy bias towards construction and real estate. Company size is also skewed, with too few small and micro-sized responses to make cross-tabulation by size worthwhile. The overall response rate of 4.7% is reasonable for a survey of this nature. The anonymity afforded to respondents ruled out any intensive follow-up to investigate potential non-response bias. Given that, hitherto, connectivity has been perceived as an issue for the office sector and that responsibility for property matters is often outsourced to the real estate industry, these shortcomings are not felt to invalidate the results of the survey. However, having noted these structural issues, care should be taken in the interpretation of these results in isolation.
26
Table 3.1 Structure of responses Micro Small Medium Large Total Manufacturing 6 18 3 27 Construction 8 15 8 31 Business or financial services 3 11 9 15 38 Real estate 31088 29 Public sector 2 6 15 5 28 Other 162 9 8 42 71 41 162
In total, 162 responses were received from the combined surveys. Property managers were the biggest stakeholder group with 60 responses, followed by owners/investors at 48, occupiers at 40 and agents/advisors at 14 (see Figure 3.1 and Table 3.1)
3.2 Main Findings
3.2.1 Rental impact One of the main objectives of this survey was to examine the issue of the potential impact of connectivity on rents and values. Each of the stakeholder groups13 were asked whether, in their opinion, a connected building commanded a higher rent than a conventional building and, if so, what that premium might be. Overall, 56% of respondents felt that connectivity had a positive impact on rents, but there were significant differences between the stakeholder groups. The 56% comprised 19% from property managers, 17% from owners or investors, 15% from occupiers and only 4% from agents or advisors (Figure 3.2).
13 Investor/owners of property; property managers; agents/advisors; and occupiers.
27 Figure 3.2 Rental premiums in connected buildings
Ad visors Occu piers 4% 15%
Positive im pa ct on r ents 56 %
Owners/ Investors 17% No impact on rents 44%
property managers 19 %
When asked to quantify this impact further, those respondents that felt that connectivity commanded a rental premium proved much more reluctant to commit to an estimate, and occupiers frequently failed to answer. Overall the likely impact of connectivity was expected to raise rents by an average of 3% (Figure 3.3).
28 Figure 3.3 Rental impact of connectivity
No response circa 1% circa 2% circa 3% circa 4% circa 5%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0% Agents/ Advisors Managers Owners/ Investors Occupiers Average 3.1% Average 3.4% Average 2.6% Average 3%
3.2.2 Yield impact A similar question was asked with respect to value rather than rent. In this case only 35% felt that connectivity would have a positive impact on value (Figure 3.4).
29 Figure 3.4 Yield impact of connectivity
No response Less than .25% 0.25% to .5% 0.5% to .75% 0.75% to 1% Other
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0% Agent Manager Investor Occupier
Property managers provided the biggest contribution to the positive response with 17%. Owners and investors comprised 9% with the remainder split between agents (4%) and occupiers (6%). The disparity between rent and value impacts seems inconsistent. It may be that the ownership of the connectivity itself may be an issue here. In some business models the building owner never owns the infrastructure, instead just taking a volume-based slice of income. It could be that this is colouring opinion here.
3.2.3 Nature of the agreement All respondents were asked how connectivity should best be reflected in an agreement between landlord and tenant. Some 30% felt that connectivity should be the tenant’s responsibility; 30% saw it as an item in the service charge; 33% saw another kind of (unspecified) agreement; while 6% thought it would be best included in the rent paid (Figure 3.5).
30 Figure 3.5 Telecommunications agreement
Included in rent 6%
Tenants responsibility 30%
Different agreement 34%
Service charge item 30%
3.2.4 Factors affecting office values In addition to issues of rent and value, the survey solicited opinion on the relative importance of connectivity compared to other factors and the importance of different aspects of connectivity. Connectivity was expected to be less important than location for the value of a building, but perhaps on a par with design issues and even proximity to local services. Broadly, the data bears this view out, but with significant differences between stakeholder groups (Figure 3.6). As would be expected, location was scored most highly by all the groups, although occupiers gave it slightly less importance than did the other groups. Design and layout was felt to be fairly important by agents and property managers, but fairly unimportant by owners and occupiers. Proximity to local services was felt by all groups to be a broadly neutral factor in the attractiveness of a building. None of the groups scored connectivity as important in this frame of reference. However, once the importance of location is discounted, there is little difference between connectivity and the other issues, save for the view of agents and advisors, who see connectivity as significantly less important as an influencer of value.
31 Figure 3.6 Relative importance of connectivity
No response Unimportant Fairly unimportant Neutral Fairly important Important
Proximity to local services
Connectivity
Design & Layout
Location
0% 20% 40% 60% 80% 100%
3.2.5 Relative importance of features The importance of different aspects of a connected building was also explored. This question sought the relative importance of: Reduced voids – anecdotally, connected buildings let more quickly; Higher retention rates – customers are tied in more effectively in a connected building; Customer service – connected buildings provide a wider range of customer services; Service availability – the importance of resilience in the connectivity itself; Potential obsolescence – fast-moving technologies go obsolete quickly; and Potential liability – onerous contracts affecting the sale of a building, for example. Figure 3.7 shows the overall results. As would be expected, there were significant differences between stakeholder groups as to the importance of each feature. Owners and managers placed reduced voids as the most important feature of connected buildings. As far as owners were concerned, the quicker a building started to produce income, the better. Agents were broadly neutral on the subject, but occupiers saw it as fairly unimportant. Tenant retention was seen as broadly neutral by all the groups save occupiers, who saw this as unimportant, raising questions about the premise that better facilities help to retain customers.
32 Occupiers were much more convinced of the customer service category, rating it as fairly important. Other groups saw it as neutral to fairly unimportant. Service availability was the most important feature as far as occupiers were concerned. Managers also saw it as fairly important. Building owners saw it as neutral and agents as fairly unimportant. Potential obsolescence was seen as broadly neutral save for owners, who thought it more important. Potential liabilities on sale were seen as fairly important by owners and occupiers but neutral by agents and managers.
Figure 3.7 Connected features – relative importance
No response Unimportant Fairly unimportant Neutral Fairly important Important
Potential liability
Potential obsolescence
Service availability
Better customer service
Higher retention rates
Reduced Voids
0% 20% 40% 60% 80% 100%
3.2.6 Experience Owner/investors, managers and occupiers were asked about their experience of connected buildings, specifically whether they owned, managed or occupied such stock (Figure 3.8). Some 42% failed to respond, perhaps not recognising the term ‘connected building’, although this was clearly defined by the survey. About 26% responded negatively and 32% positively, demonstrating the penetration of connectivity into buildings.
33 Figure 3.8 Experience of connected buildings
Do not own, manage or occupy connected buildings 26%
No response 42%
Own, manage or occupy connected buildings 32%
3.2.7 Owner/ Investor questions Owners and Investors were asked about requests from their tenants for facilities: Broadband, ADSL, Internet access, VOIP, ISDN, email services, and wireless connections. Around half of owner/investors had seen requests for each of these features, with no one feature taking any precedence (Figure 3.9).
34 Figure 3.9 Tenant requests
Wireless connections
Email services
Internet access
Voice Over IP (VOIP)
ISDN
AD SL
Broadband
0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% %
Owners and Investors were also asked to rank factors in order of importance as far as tenants or prospective tenants were concerned: Quality of finish; Level of service charge; Flexibility of terms; Provision of connectivity services; and Building Security (Table 3.2).
Table 3.2 Relative importance for owners (factors attracting tenants) Weighted ranking First places Last places Building security 1st 9 7 Provision of connectivity services 2nd 7 7 Flexible terms Joint 3rd 7 9 Level of service charge Joint 3rd 6 12 Quality of finish 5th 5 17
Building security proved to be the most important factor by a narrow margin. Provision of connectivity services was second, with flexible terms on a par with the level of service charge.
35 3.2.8 Occupier questions Occupiers were asked about the impact of connectivity upon their space needs and their productivity (Figure 3.10).
Figure 3.10 Impact on space and productivity
space productivity
Significant increase (>10%)
Small increase (<10%)
No effect
Small decrease (<10%)
Significant decrease (>10%)
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% %
In terms of space, 35% of respondents felt that connectivity has had no impact, with those identifying a decrease matched by those seeing an increase in space required. As far as productivity was concerned, however, 40% of respondents identified an increase, with only 13% seeing a decrease.
3.2.9 Manager questions Additionally, managers were asked whether they had experienced any problems with connectivity. Here, failures of customer service were the biggest factor, with 68% of the 60 managers responding experiencing the problem. Non-availability of the service was the next largest group, with 37%, the failure of the provider and the installation of obsolete equipment being seen in a few cases (Figure 3.11).
36 Figure 3.11 Management problems with connectivity
Installation of obsolete equipment
Inadequate customer service
Service unavailability
Failure of the provider
0.00% 20.00% 40.00% 60.00% 80.00% %
3.3 Summary The most important finding of this survey is that the majority of stakeholders see that connectivity adds value. 56% of the respondents agreed with the proposition that it commands a rental premium, while 35% agreed that it adds to capital value. However, there is a substantial non-response component to the survey of some 95.3%, and this should be borne in mind in interpreting the results. While quantification of that position attracted fewer responses, an average premium of 3% on rent was proposed by the respondents. Those venturing an opinion on yields saw an average of around half a percent discount to be a reasonable expectation. In both cases there were significant differences between the stakeholder groups, with occupiers much more reluctant to quantify impact. As a factor affecting office values, connectivity was ranked alongside design and proximity to services, all being placed some way behind location, which indicates the continued importance of place. As far as features of connected buildings were concerned, there were significant differences between stakeholder groups: Owners and managers placed reduced voids as the most important feature of connected buildings; Occupiers saw tenant retention as unimportant, raising questions about the premise that better facilities help to retain customers; Occupiers also saw customer service as important whereas other groups saw it as fairly unimportant; Occupiers were joined by managers in seeing service availability as important, whereas building owners saw it as neutral and agents as fairly unimportant;
37 Potential liabilities on sale were seen as fairly important by owners and occupiers but neutral by agents and managers. In questioning the individual stakeholder groups, some important points were drawn out: Owners and investors are asked about the provision of specific connectivity services by their tenants; Occupiers saw the impact of connectivity upon space as broadly neutral, but a substantial majority saw an increase in productivity from this source; When asked about any problems with connectivity, 68% of managers identified failures in customer service.
38 4 Case Studies
4.1 Introduction This part of the report covers the five case studies, which were examined as part of the research. Table 4.1 shows the case studies and the stakeholders who were interviewed for each case study. For reasons of confidentiality individuals are not named.
Table 4.1 Case studies
Group Developer Interviewees Managed offices 7 Soho Square, London Landflex Sales Director Davidson House, Reading Stonemartin Director IT services manager Conventional offices Spinningfields, Allied London Developer & advisors Manchester Portland House, London Land Securities Occupier W1 Broadgate Estate British Land (owner) Manager
39 4.2 Managed offices: case studies
4.2.1 7 Soho Square, London
7 Soho Square is located in London’s West End and is one of a number of properties offered as managed offices by Landflex. Other properties include Empress State, 140 Aldersgate Street and 40 Eastbourne Terrace, also in London.
Description: Based in the heart of London’s West End, 7 Soho Square offers a range of units for occupiers. The property is newly refurbished and is a high specification office building. The total floorspace is 4,195 sq m. Current occupiers include Expedia and Metropolitan Police.
Services/Infrastructure: Fully air-conditioned; two lifts (8 and 13 persons); shower facilities on each floor; large footplates; raised access flooring; pre-installed cabling (floor-wired CAT cabling); broadband connectivity; managed server room; 24-hour security; and Business Club facilities.
Key characteristics: Flexible leasing with inclusive core accommodation services and additional business/meeting and conference facilities.
40 4.2.1.1 Interview findings
The Landflex package Landflex emerged from Land Securities Trillium subsidiary and is a separate business unit. The first two buildings offered under this new venture were Empress State (subsequently let to the Metropolitan Police as a single unit) and 7 Soho Square. The package, which can offer leases from 1 to 10 years, and on which customers can take options to cancel or extend with prices fixed for the term and no upward-only rent reviews, was designed to conform to the Code of Practice for Commercial Leases. Customers can also take a range of different leases in the same building and also reserve space for future expansion. A key area of differentiation is the drive to produce fixed cost certainty for the occupier. As our interviewee stated: ‘Choice of lease lengths, choice of additional services and choice of location, obviously that’s something that needs to evolve when you start with anything … so we call it choice and certainty and service. These are the three sort of watch words of our Holy Trinity of Landflex.’ For Landflex this also offers the company flexibility in pricing: ‘Not everybody is on a 10-year lease, you have not got one tenant with one break (i.e. the probabilities of the building becoming empty are reduced) … but also if you really understand the customers’ needs you could, in your own business model, assess the risk and you can price the risk as well.’ Landflex see themselves as being positioned between traditional and fully serviced offices, with approximately 500 sq m as their minimum offering. They also see themselves as distinct from others in the serviced office sector: ‘[Number] 1 is we don’t do anything less than a year. 2 is we do leases not licences. 3 is we don’t offer, as our standard core service, furniture; we don’t offer, as our standard core service, IT; and we don’t offer, as our standard core service, fit-out. Those three parts, furniture, IT and fit-out are additional services. Companies can procure those from us or they can go to the market place and benchmark our pricing against their own, and if they’ve found a supplier that will do it better or cheaper for them – whatever reason, they are at liberty to do that. In the service sector they control those three elements fairly well.’
Pricing model Instead of paying rent and other bills separately, customers pay a single accommodation charge reviewed annually in line with RPI both upwards and downwards. The accommodation charge (see below) includes rent (per unit floor area), buildings insurance, maintenance, repair, operation and cleaning of all building systems, structures and finishes, security and utilities. There are no end-of-term dilapidations. For Landflex, the analysis lies in a cashflow model rather than an investment model, in other words, to generate income throughout the year and year on year. Cost items are broken down according to whether they are core or additional, and these are added to rent. For example, core costs include: Building maintenance; Life cycle replacement; Facilities management;
41 Cleaning; Fit-out (i.e. CAT 6 voice and data cabling and small power. Floor boxes can be moved and carpeting/decoration is included in the price); Security; Mail and post room; Reception and visitor management; Building insurance; and Utilities. Additional or optional services include: IT infrastructure; Telephony; Furniture; Additional fit-out; Reprographics; and Health and safety training.
IT services and value impact IT is an additional service offered by Landflex because it is bespoke. As described above although cabling is fitted as standard within the core costs, broadband can be added at an additional cost. As the interviewee stated: ‘With the IT, yes we are broadband enabled in our buildings. We put the phone lines in, so it’s enabled, but the route through which a tenant subscribes to it is down to them and we find that’s a major selling factor because it gives them control. But also it means that they feel as if it’s got to be good value for money because they can go and benchmark somewhere else, and if it’s not good value for money then they will just do something else all together, so we had to be competitive and we have to maintain it.’ Telephony is also offered as an additional service in terms of handsets and telephone services: ‘The telephone take-up has been almost exclusively to those companies who have had space between 0 and 2 years. Over 2 years it is difficult to come up with a robust pricing that makes it competitive to them buying a system effectively.’ On the other hand, there may be related elements of IT which are not priced as core/additional costs, but which are reflected implicitly within the rent. As the interviewee stated: ‘My take on it is that people view certain elements such as IT, such as a business club environment [i.e. meeting and conference facilities] that we’ve got here as a value add-on. It’s a reason to come to the space over someone else’s space. They don’t always necessarily factor it into the price they are prepared to pay, but if you think about it they should be and subconsciously they probably are (i.e. in negotiation it will have a part to play although it’s never separated out).’ However it is also vital to understand the occupier’s business and needs: ‘But it’s as much to do with understanding their needs as being able to get and extract that premium value. If you don’t understand the needs or you don’t understand the IT requirements, then sometimes it’s difficult to extract that because
42 essentially you’re not sure whether they themselves have attached any value to it. So therefore it’s as essential at the front end to have a conversation with them about IT as it is about furniture, as it is about all these other services that they could procure from us which saves them time.’ In terms of value impact there is a perceived yield shift as far as the managed office sector is concerned. As the interviewee stated: ‘There is probably a 0.5% shift out between Landflex and non-Landflex but that has been difficult to quantify … because again you can’t compare it to another property and therefore it is about assessing risk.… It’s gone through 2 years of Landflex trading. We are now comfortable and happy with the fact that Landflex is an income model. We are so close to our customer base that we know when the voids are coming up, we manage the voids, we have sufficient notice of the voids. We have gone through churn where we have demonstrated that we have increased income and minimised voids, particularly in this building, and because of that they [the valuers] are not worried about yield, they don’t see any detrimental impact.’ Indeed, the income growth from the property has compensated any possible yield shift, given that accommodation costs are tied to the RPI.
Security issues 7 Soho Square also has basement space converted to a communications room. This has deep floor voids, enhanced air-conditioning, a gas suppression system, CCTV monitoring and a robust alarm system. This raises the issue of security and whether companies are prepared to effectively place their servers in ‘third party’ space. This has created issues for some companies: ‘Security doesn’t seem to be an area of compromise when it comes to cost for companies. You would think that it would be reasonable to expect a company to say, yes, we see that as a logical cost saving in the same way as another value asset. In most cases I have experienced, they refer the decision to the IT department/director. The IT director/department will not comprise security over cost and therefore will say, yes, we understand what Landflex are offering, we understand it will do exactly what they say on the [inaudible], but we want our own comms room in our own space, we do not want third party access to it, we don’t want third party control to it.’ Because of this issue it has been difficult to recover the cost of the communications room and Landflex have no plans to provide similar space in other buildings. Rather, space will be provided on each floor for companies to install their own communications facilities.
Is location still important? The property is in a prime location and so location is still a vital factor for occupiers, but offering flexibility is also critical: ‘All I’m saying is that location will always be there, but in our world, in Landflex modelling, it is reduced … and it’s been replaced by flexibility, so … the degree to which you are able to sort of align your leasing structure to their business is, I think, one of the most important factors. Location is still going to be 2 or 3.’ Technology enablement was less important: ‘…Technology enablement I think should be about number 3 or 4, but again if you are taking short-term flexible spaces it should be up there at about number 3. If you are taking a long-term lease where you can essentially adapt the building to your technology requirements because you have a longer term to do it, then it’s maybe a bit lower down.’
43
4.2.2 Davidson House, Reading
Davidson House is located in central Reading and is one of a number of properties offered as managed offices by Stonemartin. Other properties are based in Birmingham, Manchester and London.
Description: Based in central Reading, Davidson House offers a range of units for occupiers with units available for up to 250 people. The property is newly built and is a high specification office building. The total floorspace is 11,148 sq m on six floors.
Services/Infrastructure: Fully air-conditioned; large footplates; option to split flooring; pre-installed cabling (floor-wired CAT cabling); broadband connectivity; managed server rooms; and Institute of Directors facilities.
Key characteristics: Flexible leasing with total occupancy cost basis.
44 Interview findings
The Stonemartin package14 Stonemartin plc (‘the Company’), whose shares are traded on AIM, was founded in April 1999. In conjunction with the Institute of Directors, the Company is developing a series of offices. Stonemartin has already opened three buildings: Peter House (Manchester), One Victoria Square (Birmingham), and Castlemead (Bristol), and plans to open more across the UK. Two further buildings are being launched in June and July 2005 respectively – Davidson House (Reading) and New Broad Street House (London). The London building is the first of three proposed sites in the City. The Company provides Grade A, high quality, serviced and managed offices in city centre locations. A Limited Partnership was established in 2001 to fund the acquisition and fit-out of these properties, and investors include Norwich Union and Britel Fund Trustees Limited, with funds managed by Morley and Hermes. In terms of funding structure, Stonemartin and the Limited Partnership split all the income, operating costs and capital costs in a 20:80 ratio, except for Birmingham, where the ratio is 15:85. A key feature of this arrangement is that Stonemartin does not have to purchase or lease buildings and no rent is payable. The interests of Stonemartin and the Limited Partnership are therefore completely aligned. The Company has further shareholder backing, and its shareholders include Hammerson plc, Warner Estates Holding plc, Interior Services Group plc, MEPC Limited and the Institute of Directors. The Company differentiates itself from traditional serviced office operators by: The size of the buildings – between 75,000 and 125,000 sq ft; The extent of its offering – up to 20,000 sq ft per customer; The degree of material modifications it will undertake to fulfil its clients’ needs; The scope and flexibility of its IT infrastructures to apply to clients’ existing systems; and The Institute of Directors’ lounge, for IoD members. As an interviewee from the company put it: ‘We are delivering something that is quite unique, a proposition that sits neatly between the conventional and the serviced office market … somebody once described Stonemartin as being extremely proactive asset managers within an environment more akin to a hotel than an office, which is a good description of our offer.’ Furthermore, the offer aims to balance serviced and managed space: ‘Our model is geared towards approx. one third of the total workstations being offered on a fully serviced basis, namely for deals up to 20 workstations, on terms of up to a year. The other two-thirds are offered on a managed basis, which is typically for larger deals of 20 workstations plus on terms of anything from 1 to 5 years, or more by arrangement.’
14 Some of the information in these sections is based on material at http://www.stonemartin.co.uk/company/
45 This offers flexibility to Stonemartin and the customer: ‘So we can cut the deal according to what is required because quite often clients require the security of the longer term lease whilst retaining the flexibility to terminate their contract at short notice as business needs dictate – this delivers a win/win scenario for our clients.’ This also applied to future expansion of client companies: ‘Because of the size and scale of our buildings we have the luxury of being able to work with clients and structure deals that guarantee expansion options going forward. It’s a real winning formula, especially when you offer this within a non-branded environment whereby clients can choose from a shopping basket of optional services. This allows the client to define the level they wish to outsource non-core functions’. Each centre is approximately 10,500 sq m, with conferencing, catering and IT all on- site. They are to be located in prime city centre sites, close to public transport and will be a focal point for the local business community. The centres are intended to provide organisations with a flexible working environment in which to help expand, without the need to relocate. An exclusive partnership agreement with the Institute of Directors (IoD) provides Stonemartin exposure to the IoD’s membership, which now stands in excess of 55,000, as well as all future members. Clients are typically SMEs or regional divisional branches of major corporations, and Stonemartin aim to keep at least 15% of each building vacant for the purposes of occupiers’ growth.
Pricing model Stonemartin calculate the total cost of occupancy over the term based on the actual workspace need (i.e the total number of workstations; meeting rooms and other non- office areas such as communications room etc, if not out-sourced; IT and telecoms; and car parking). Unless required within the work environment, there is no charge for the amenities of a staffed reception, communications (‘comms’) rooms, management offices, kitchens, and print rooms. Public areas and walkways are also eliminated from the work environment. Stonemartin suggest that by paying for the space required, clients can achieve a 20-30% efficiency factor compared with conventional space. As a company interviewee put it: ‘We price our deals based on the term offered, i.e. the longer the deal, the lower the risk for us, and therefore we are prepared to take a lower margin – it’s as simple as that. So the rate for a 5-year deal is going to be lower than the rate for a 3-month deal. We’ve got a clear price matrix which sets out our pricing policy. We can also offer rate-free terms, which is something different to our competitors in the service sector, but again we want to follow the sentiment of the market, so if you are taking a 5-year deal we might agree a ‘rate-free’ period to deliver a lower effective rate. It is important to understand that, by ‘rate-free’, we mean a total occupancy cost-free period, something very different to the conventional approach of just rent-free.’ Stonemartin also take into account other parts of the business overhead, such as internal computer network, high speed web access and IT management along with the current level of staffing. Car parking is also available subject to availability. Finally, density is important to consider: ‘We base our density of operation on 75 sq ft per person, whilst most of our competitors base their density on 65 sq ft per person, a difference of about 13%. In consultation with potential clients we define and agree their need, pointing out the
46 impact a high density might have on the Mechanical and Electrical design loads, with the ability to offer a lower price point if they decide to increase their density of operation. We feel that ultimately it should be the client’s choice.’
IT services and value impact IT is seen as critical to the business offer of Stonemartin, and this, alongside other factors, impacts on the premium value charged. However, Stonemartin aim to make all costs transparent: ‘What we do is we sell the workstation rate, which includes telephony. It includes the desk and filing/storage. We then separately bundle the IT, offering the client the option of taking our broadband, LAN, and any additional IT support through an IT Services menu. Where clients analyse priced alternatives between conventional and a Stonemartin offer, we always underline the need to be honest with themselves and to consider a true like-for-like approach, and not just ‘cherry pick’ for the purpose of negotiation.’ The interviewee continued: ‘We believe genuinely that if clients try and build up a rate per sq ft comparison and they assume there is no space saving through outsourcing non-core functions, then the Stonemartin offer would appear expensive. Our argument is that if the client is looking to take two similar grade buildings in the same city, and they accept the principle that there is a space saving due to the fact that they are happy to outsource a proportion of their meeting rooms, and are happy to share racking space within our comms room, as well as taking a communal approach to areas such as the kitchen and reception/holding zones, then the resultant financial saving can be significant over the term of their contract. This saving can be enhanced tremendously when companies adopt a 'just in time” philosophy for any future expansion need.’ Stonemartin have developed a cost comparison model (www.stonemartin.co.uk/costcalculator) to articulate the impact a total occupancy cost analysis can have on a company’s P&L or balance sheet. A range of telephony and IT options are available with the initial costs included in the workstation price. For telephony this includes: DDI; Handset; Connection; Lie rental; Call screening; and Fax analogue. For IT, this includes: Initial set up; Cable management to floor-port; and Secure comms room. Racking and floor-box installation or moving are also available at additional costs.
47 Security issues Secure comms rooms were a particular feature in Davidson House. These are provided on each floor and provide full air-conditioning, fire suppression and secure faciltities15. This has been a key issue for clients: ‘One of the things we do offer is racked space for the clients for servers, for switches, routers etc within a common area.’ Stonemartin do not provide individual comms rooms unless through separate agreement with the client, in which case the client would be asked to fund this facility: ‘Certain clients, often those within the financial sector, insist on providing their own IT solution which sometimes entails them funding and constructing their own comms romm facility.’ IT cabling is provided as standard, and future expansion for companies is well catered for. As our interviewee put it: ‘We have got 2Mb in place which is being been used by the phone system and email. We have the facility to increase this to 10Mb or more dependent on occupancy and client need.’
Is location still important? Location and individual branding were seen as being very important alongside IT provision, which itself was ‘critical’. All buildings are city centre offers with good transportation links. As our interviewee put it: ‘Our brand is Peter House, 1 Victoria Square. Davidson House, New Broad Street.… Most companies want to deliver a permanent solution that presents the best image for both their staff and clients. We like to think that we are no different to any conventional offer in terms of our positioning in this regard as you walk through the threshold of our buildings. We want clients to think, “Wow, this is different and better than that offered elsewhere”, both in terms of the level of service, the design of the interior environment, and security.’ It was also felt that costs savings add to the bottom line through an impact on employees’ performance: ‘We work on the premise that by creating the right environment, our clients’ staff selection and retention will improve, which will have a very positive impact on the “bottom line”. This clearly requires a controlled environment that works and functions correctly – we achieve this through active hands-on management of the mechanical and electrical services. We also want our clients to benefit from an environment that has natural corporate warmth – this is achieved through careful design and use of interior colour, landscaping and staffing. The buildings finally have to be located in the right part of the city which staff and clients can easily access via public transport, nearby gyms, bars, and restaurants.’
15 Stonemartin has considered the provision of ‘cold sites’ in disaster recovery plans, but this is not provided, as it was felt clients needed to tailor this to their own requirements.
48 4.3 Conventional offices
4.3.1 Broadgate, London EC2 – the manager’s view
Background Broadgate Estates Ltd was set up in 1980 and manages prime real estate in central London for British Land and other third-party landlords. They are a wholly-owned subsidiary of British Land. The company has grown out of the original management company for the Broadgate development to manage many of the landmark buildings and developments across London, including 1 Poultry, Chiswick Park, Plantation Place, Paternoster Square and More London, as well as Broadgate itself. Broadgate was undertaken by Rosehaugh Stanhope Developments Plc in partnership with British Rail Property Board. The project comprises 3.5 million square feet of office and retail space and has a working population of around 20,000 people. The first two phases, totalling 725,000 square feet gross, all of which was pre-let, were completed in June 1986, predating by some margin the effective liberalization of telecommunications. The entire scheme was completed in 1990.
The initial concept for the estate envisaged large single building occupiers, a The Broadgate Estate is a 3.5 million square feet mixed development, primarily offices, on the edge of situation that has changed over time to the extent that the majority of buildings on the the City of London. It was developed between 1986 and 1990 as Grade A space. estate are now multi-tenanted. Nevertheless, these are still large tenancies and broadband access is universal throughout the estate. Description: Broadgate consists of twenty keynote buildings designed originally for single Britishoffice occupLand,a thetion. owners Over t ime,of the some est aote,f the are space also hassharehold becomeers multi-let. in HSO, Currentlya broadband there are service40–50 provider.occupiers. Mo Theves timingare bein ofg themade development to make thepredates HSO servicethe liberalization available of throughouttelecommun theications. estate, but, given the size and purchasing power of the occupiers, it is not felt to be a priority. Services/Infrastructure: Fully air-conditioned; large floorplates However, Broadgate Estates have taken advantage of the broadband provision to add a software layer of functionality for their tenants through the implementation of Key characteristics: Building and Portfolio area networks the Vicinitee product.
Vicinitee Vicinitee is a building-focused web portal that supports building management. It works at two levels: V2B focuses on the building. The V2B webtools have been designed for building managers, and use the internet to drive through operational efficiencies and service enhancements in property management. V2C focuses on the community in which the building is situated. The V2C webtools bring a wealth of information, interaction and timesaving webtools direct to the desktop. The service also provides local businesses and organisations with an easy way to communicate with the building’s occupants, encouraging them to contribute fully to the social and commercial development of the local community.
V2B V2B webtools include the following: Tenant Handbook enables the storage of essential building management information (e.g. health & safety, fire instructions, medical emergencies, security protocols etc) in a format that is easy to view and easy to update, and replaces the customary paper manuals, which are difficult to collate, update, distribute, and locate.
49 Helpdesk provides a window between occupiers’ desktops and specialist ‘computer- aided facilities management’ (CAFM) systems. The enhanced real-time communication means users can log calls and track progress without interrupting the service teams, who in turn can manage their workloads more efficiently. Visitor Security. Designed by a team managing the front desk for a large, busy, multi-tenanted City office, this is a fast, user-friendly visitor management system which enables the management and monitoring of both corporate guests or contractors, print visitor passes, increase front desk efficiency, reduce costs, and enhance security. Building Diary enables a building manager to create and maintain a schedule of all activities affecting their building (e.g. planned maintenance, repairs, fire drills etc), thus enabling the team to plan actions and manage the buildings to optimal efficiency. Building News. Central alerts from emergency services (e.g. police) and local sources (e.g. Corporation of London) are received and posted in real-time to the building manager, who then has the option to share this with their occupiers via email-alert and home-page posting. Building Contacts stores contact information for internal and external building team members including photographs, contact details and one-click email access. Building Documents is an open-storage area enabling the storage of a wide range of documents in an area that is easy to access and easy to update.
V2C V2C Webtools include: Webcams ‘Liverpool Street Live’ is a service that gives a live view of the main line station’s departure boards and taxi ranks. Tube Updates are delivered, specific to each station, in partnership with Transport for London. Bus Movie Maps are one of the most popular features of the site; the animated maps make it easy to identify routes and connections. Local to You is a comprehensive directory of the local shops and services ‘within a 10-minute walk’ of the office. E-shopping is a handy directory of tried and tested retail websites. Special Deals are negotiated on behalf of Vicinitee members, and include both one- off specials and long-term partnerships, examples being Concierge services from TenUK Restaurant bookings with TopTable New car deals with SytnerUK. Classifieds. Selling or searching, this service offers individual users a powerful way to advertise to a large ‘local’ audience. I Saw You is a message board, which enables people to make contact with new people in the neighbourhood. Event Finder enables searching across the What’s On listing for events in a range of categories, taking place at lunchtime, evenings or even at the weekend.
50 Added value Vicinitee is provided by Broadgate Estates as a free service designed to differentiate their buildings and add quality to the offer. Clearly, however, the V2B tools are able to reduce the logistical costs of management principally through the management of the tenants handbook and the issuing of permits. In the ten major buildings using the system, the number of passes issued in those buildings in July was just under 50,000; the largest attendance in one building in the month was approx. 8,500. One single tenant had 6,500 visitors alone – this represents significant cost savings from the old paper systems The cost savings achieved through efficiency and better, more accessible information are much less easy to quantify, but, logically, are manifest. The system is used extensively in the marketing of space by British Land, to the extent that any new building has a Vicinitee established long before the building is let. Broadgate Estates are convinced that the system adds value through differentiation of the management product and through tenant retention. However, they recognise that provision of efficient communication and cost-effective services will not be the main reason for locating at a property.
51 4.3.2 Portman House, London W1 – The Occupier’s view
The former Gulf House, redeveloped in 2001 to provide 100,428 square feet of office space arranged over the upper seven floors and 18,729 square feet of ground floor retail space at 480-504 Oxford Street.
Description: Portman House is an example of a refurbishment designed for multiple letting. Currently there are nine occupiers arranged over eight floors. The timing of the refurbishment would have allowed the developer full flexibility over telecommunications provision.
Services/Infrastructure: Fully air-conditioned; underground parking; 4 passenger lifts, atrium; broadband provision post refurbishment.
Key characteristics: Occupier demand for connectivity unmet by landlord.
Background The refurbishment of Portman House was completed in 2002. The occupier interviewed is a leading data provider to the property industry with a substantial on- line product which is hosted at Portman House. The occupier has some 110 full-time and contract staff of which 85% are based in the London office. They also have small numbers of staff in Manchester and Glasgow. They are a subsidiary of a large US corporation. Most product support is done through the London office. The workforce is largely static – ie deskbound most of the time. Occupation of the space was taken up in 2003. At the time the landlord did not provide any connectivity in the building – it was entirely tenant-led. Ironically, on the day of the interview, Land Securities started marketing high-speed internet access to the building via Intellispace.
52 From the standpoint of telecommunications, the lack of information was the ‘signal’ feature of the move being undertaken. As one interviewee put it: ‘The interesting thing there was that no-one knew. On the agents’ particulars it didn’t appear and even asking the agents no-one knew anything about it. All the buildings I visited – probably five – on every single occasion not one of the agents knew anything about how the building was lit16.’ This is seen as a significant shortcoming of the acquisition process. Telecommunications is a mission-critical utility for almost all businesses of any size, yet it can take up to 90 days to get connected. As the interviewee said: ‘It is probably the most critical thing in a move but the one that is least appreciated by the operators of the business and the landlord. Forget the installation cost and the management cost, if the landlord did provide a proper service at a proper price then we would definitely have gone with it.’ Having dealt with a number of connectivity providers, one common thread runs through them all: whenever there are problems ‘they always blame it on BT’. The occupier now uses a third party telecommunications provider independent of the landlord. The most important criteria are performance and reliability: ‘Yes, we get a good price, but I would say that price is not as important as working technology and support.’ On the question of risk to the landlord’s reputation inherent in the provision of non- building services such as telecommunications, this was not felt to be relevant. It was felt to be advantageous to have one common support infrastructure, but in the event of the failure of specialist equipment the expectation was that it would be delegated to specialists. As the interviewee continued: ‘Telecommunications is just another specialism.’
Added value The occupier saw substantial potential for adding value: ‘I think there is definitely a premium, but I wouldn’t like to guess how big it is because this is such a fast moving market and the technology is moving so fast that the building could be out of date in twelve months; so it would be difficult to pay a premium on a five-year lease or a ten-year lease.’ Nevertheless, provided the agreement offers the ability to future-proof the technology, it still offers a considerable advantage to any business need to connect to the outside world. ‘For anyone in business now, unless you have fast access from work and from home you are in the Dark Ages. You are at competitive disadvantage.’
16 Reference to how the building is attached to telecommunications networks.
53 4.3.3 Spinningfields – developer’s and advisor’s views
Spinningfields is located on Deansgate in central Manchester. When completed it will provide 4 million square feet of high quality commercial and civic space integrated into the central business district.
Description: Spinningfields is an example of a large mixed use city centre development whose design recognises the importance of connectivity both inside the buildings and in the surrounding public estate. On completion there will be twelve signature office buildings plus retail, residential and civic uses on the 22-acre site.
Services/Infrastructure: Fully air-conditioned; parking provision; raised floors; whole site ducting; wireless broadband provision.
Key characteristics: Developer facilitation
The developer Allied London specialises in complex, city-centre, mixed-use redevelopment schemes, working with the public sector to deliver creative yet commercial projects. Currently the company has over 3 million sq ft of real estate under ownership or management. Current development projects amount to in excess of a further 4.9 million sq ft in London (829,000 sq ft), Manchester (3.5 million square feet), and Glasgow (550,000 sq ft). In partnership with Manchester City Council, Spinningfields is a mixed use development providing over 2.37 million sq ft of new office space in twelve buildings; 400,000 sq ft of retail; over 300 luxury apartments; 200,000 sq ft of civic and educational buildings; a new 200-bed 5 star hotel; and four new public squares. Tenants who have taken space on the site so far include the Royal Bank of Scotland, Deloittes, solicitor Halliwells, the Department for Constitutional Affairs and the
54 Guardian Media Group. The site also houses a new magistrates court and a Civic Education building. The developer acts as a facilitator for technology rather than an owner. In essence, tenants can purchase a complete IT solution already in place as they move into Spinningfields, with none of the planning, inconvenience and delay that is normally required in such relocation exercises. The site itself is broadband-enabled and has wireless connectivity throughout the public areas. An extensive network of ducting around the site gives the opportunity to run any kind of telecommunications infrastructure required by future occupiers. The scheme provides access to multiple telecoms providers and fibre connections into each building. Additionally, buildings themselves can be connected to meet occupiers’ requirements. As our interviewee put it: ‘Spinningfields is top-quality space. We see technology as an integral part of the product. It is impossible to say that it adds value in isolation, but it is part of the expected level of specification that we have to provide.’
The agent The nature of the development is that it is marketed to large single building occupiers. Our interviewee stated: ‘Typically these companies have their own IT guys and are able to do good deals on comms themselves. That said, we will go as far as they need us to go to make it as easy as possible to get into the space.’ Although Spinningfields is well equipped with respect to telecommunications, the technology doesn’t feature prominently in the sale. As our interviewees put it: ‘There are good property and business reasons why high profile companies would want to locate at Spinningfields. We are moving the centre of gravity to the city centre here. This is where the highest quality environment will be and the highest values. ‘Broadband, cabling and so on is just part of the landscape these days. A few years ago it was relatively new to us and we focused on it more. Now we assume that there are no problems in that area that can’t be fixed.’
4.4 Summary
4.4.1 Managed offices In the case study examples we examined, it was clear that location was a vital factor in the managed office sector. Nonetheless, connectivity was seen as having an impact on the total occupancy costs and possibly also through the rental value of office buildings in the same sector. This confirms the findings from the online survey. Security issues in technology were also important to consider. It is also important to recognise that what the sector is offering is flexibility, which also includes the opportunity to unbundle a variety of services for pricing on a disaggregated basis. Theoretically this offers greater transparency than the conventional office market where often the focus is still on rent per sq ft or per sq m (see Section 5 of report).
4.4.2 Conventional offices All stakeholders agree that connectivity is an integral part of the occupational offer. In some cases – particularly where the premises are in multiple occupation – it can add value directly. In others – particularly in large single occupation buildings – there would be a price penalty were it not provided.
55 As far as large single occupation buildings are concerned, both the case studies show the landlord as a facilitator of connectivity rather than an owner. However, added value is available through using the software layers of the connectivity model to deliver building and portfolio area networks like Vicinitee. (Allied London use Vicinitee at Skypark in Glasgow and are in discussion at Spinningfields.) In the case of the conventional multi-let building the case study shows that the occupier would have seen connectivity as an important differentiator in the selection of space. The landlord has responded by making connectivity available at the building, albeit belatedly and when the building is fully let. The occupier regards utility, reliability and support as far more important than cost in the context of connectivity. The evidence from these case studies is that, although connectivity is an important aspect of the leasing process, the agents have little knowledge of it and place little importance on it as a differentiator.
56 5 Managed Office Pricing and DCF models – Towards Added Value
5.1 Introduction This section explores how in practice connectivity can be analysed in the managed office and conventional office sectors.
5.2 Managed office pricing model Recent research by Actium Consult (2005) suggests that property-related costs for offices account for 65%, and IT for 35% of total infrastructure costs. Flexible working alters the ratios to 55% for property and 44% for IT (Figure 5.1).
Figure 5.1 Total office cost split – conventional and flexible office space (source: Actium, 2005)
2% Annualised 12% 15% Conventional Rates space 15% Rent 23% Hard FM Soft FM 33% Management
IT operations and Flexible space support 1% IT hardware and 24% software 26% Annualised costs (property) Business support (property) Property operations 12% 20% Property 9% 8% occupation Change management
Actium’s Total Office Cost Model (based on OPD (2005) Total Occupancy Cost model) comprises key components which include:
Rent/rates; Fitting out (including IT); Hard FM (including insurance, improvements, cleaning and security);
57 Soft FM (including telephones, catering, reception, post/courier); and Management.
Clearly it is important to unbundle IT services in a transparent way so that occupiers know the full cost of occupation. In some respects the managed office model enables this to be done more easily, because it follows a total office cost model basis. However, some managed office space is priced on a workstation basis and other managed office space through a disaggregated cost model. In the latter case, and for managed services, a typical example might be (£/sq ft):
Building maintenance £ 2.52 Security £ 2.40 Cleaning £ 2.23 Mail room/reception £ 0.77 Conference room Total £ 7.93
Other costs Life cycle replacement £ 1.49 Utilities £ 1.25 Direct management £ 0.74 Insurance £ 0.50 Total £ 3.98
Total building services £11.91 Management charges £ 1.78 Total services £13.69
Annualised costs CAT cabling small power etc £ 1.54
Grand total £15.23
A key issue here is to what extent connectivity also impacts on rental value. Broadband connectivity and other types of IT service are usually priced through installation and additional service costs if the landlord provides the service, but there was also evidence from our case studies that suggested that the technology offer and its flexibility would also be reflected in rent.
It is clear therefore that the connectivity issue has as much to do with financial assessment models as it does with occupier/landlord relationships. Frequently, as previous research has shown (see for example Gibson, 2000), rental cost per sq ft or per sq m is the sole financial criterion by which many in the property profession assess choice of office. But this clearly concentrates on direct real estate costs without considering amortised fit-out, infrastructure and other costs. Despite the progress made towards a Total Occupancy Cost model, therefore, it is still difficult to compare the real costs of occupation, even in the serviced/managed office market.
5.3 Hard components of value Potentially, connectivity adds value in a number of different ways – as far as the developer/owner is concerned, by: Reducing the void period between completion/availability and take-up, thereby bringing forward the income stream;
58 Potentially bringing in an additional income stream through a share of the income from the connectivity provided; and Reducing the logistical costs of managing the space. All these components are assumed to be included in the survey assessment of the likely rental premium added by connectivity.
5.4 Fuzzy components of value Whereas hard components of value are quantifiable, there are also components of value that are unquantifiable, largely because there is insufficient measurement data available. These would be: Improving the landlord/ tenant relationship through the provision of better services; Optimising the efficiency of the management process through better building systems and information.
5.5 Typical examples In all the following examples we assume that the landlord/ developer funds adequate broadband facilities to the site (ie pays the installation and connection charges) and the occupier pays apportioned line rental and any usage charges. The costs of cabling internally are assumed to be sunk in the construction costs. Using the survey results, it is possible to give a guide to the returns available. An average rental premium of 3% was suggested by the respondents to the survey, therefore a range of 2%–4% has been used.
Example 1 Assumptions o Revenue A 50,000 sq ft building with 5 occupiers paying an average rent of £40 per sq ft with 3 months rent-free. o Investment Installation of a single BT LES100 circuit plus a router estimated at £20,000.
Rental premium 2% 3% 4% Annualised IRR 4.1% 8.4% 15.0%
59 Example 2 Assumptions o Revenue A 250,000 sq ft development with 12 occupiers paying an average rent of £30 per sq ft on a 5-year lease with 3 months rent-free. o Investment Installation of twin BT LES100 circuits plus a router estimated at £30,000.
Rental premium 2% 3% 4% Annualised IRR 17.4% 45.2% 96.6%
Example 3 Assumptions o Revenue A 25,000 sq ft building organised into small office suites with 15 occupiers paying an average of £55 per sq ft on a 5-year lease with 3 months rent-free. o Investment Installation of a single BT LES 10 circuit plus ADSL router estimated at £12,000.
Rental premium 2% 3% 4% Annualised IRR 5.1% 11.0% 20.2%
In many respects these examples represent a worst case scenario, as they use standard BT options and prices. Options can be much more flexible and prices substantially lower through the use of third party bandwidth providers. The returns shown take no account of any recovery of costs through additional service charges, nor any quantification of the ‘fuzzy’ benefits identified.
5.6 Conclusions The examples show a range of different building sizes and occupation patterns. For all, the investment in the provision of basic connectivity to the building is very small by comparison with the value of the building itself or the income stream that it represents. Consequently, reasonable levels of return on that investment are apparent throughout.
60 6 Conclusions This part of the report provides key conclusions to the pilot study.
6.1 Does connectivity add value? A clear majority of the respondents to the survey and all the interviewees felt that it does. Whether this value is expressed as a rental premium on connected buildings or a price penalty on non-connected ones is not relevant. It is clear that the current specification for Grade A offices includes signal cabling as standard, but the implicit assumption is that the occupier will handle the provision of services to run over that cabling. Yet by comparison with the value of the building, the investment required to provide broadband connectivity to a building is very small and one that is borne with equanimity with respect to other utilities and even voice telecommunications. As the worked examples show, the potential returns on such an investment are perfectly reasonable.
6.2 What other factors are important? The age and status of the building are germane. Clearly the installation of the hardware aspects of connectivity are a different prospect during a development or refurbishment than they are to connect existing tenants in situ. One of the key advantages of a connected building mentioned by the occupier interviewed was the speed of occupation possible compared with the process delay inherent in non-connected buildings. Subsequently the price of connectivity was significantly less important. This would indicate that while connectivity is an important feature at lease-out of the space, post occupation installation is a less compelling proposition. Connectivity is not just limited to the provision of the hardware. The whole connectivity model is relevant to the addition of value (Figure 6.1).
61 Figure 6.1 The connectivity model
PORTFOLIO AREA NETWORK CONTENT
BUILDING AREA NETWORK SOFTWARE MANAGEMENT & CONTROL
IN-BUILDING CABLING
HARDWARE LOCAL LOOP
CABLE NETWORK
As was demonstrated in the Broadgate case study, the software and content layers of the model can also be used to add value, even where the landlord has no stake in the provision of the hardware. Building size and occupation pattern are also important here. Clearly a landlord or developer can only use his aggregation power where he is the biggest aggregator of demand. In the Spinningfields case study, for example, the large single occupiers seen as the target market are likely to have far greater buying power than the developer can deliver. In a building designed for multi-letting, the developer is likely to be best placed to aggregate the demand for the whole scheme and deliver better prices.
6.3 Is the pricing of connectivity transparent? As with other landlord services, connectivity pricing is part of the total occupancy cost of buildings. In conventional office markets, it is perhaps a case of value added being more judgemental and subjective both in terms of yield and rental impact. The managed office sector uses connectivity in a more proactive way to underpin its offer, but even here location is still very important. Unbundling the impact of technology from other factors is fraught with difficulties. This pilot study has highlighted some of the ways in which the market can disaggregate the technology-led impacts on value, but more work is needed to highlight how the economic benefits of connected buildings can be measured.
6.4 Limitations of research The main limitation relates to non-response in the online survey. However, although we were not able to analyse the reasons for non-response, it is likely that the survey offers a robust measure and snapshot of key stakeholders’ perceptions on connectivity.
6.5 Need for further research More research is needed to examine a range of case study buildings using relevant performance measurement data. It will also be important to monitor and benchmark
62 connectivity over time, as wireless and other technologies become even more ubiquitous.
In terms of the end customer, the expectation of occupiers is key to the future absorption of broadband provision into the Grade A specification. All the indications from this study are that connectivity is an important component of the infrastructure of occupation and that lack of it can create competitive disadvantage.
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