From Rents to Revenues: Can Property Become a Service Industry?

From Rents to Revenues: Can Property Become a Service Industry? An investigation of the valuation implications of the generation of non-rental income streams by property owners Patrick McAllister Department of Land Management and Development School of Business The University of Reading Whiteknights PO Box 219 Reading RG6 6AW [email protected] Tel: 0118 931 6657 Fax: 0118 931 8172 www.reading.ac.uk/lm January 2002 Report for the Education Trust of the Royal Institution of Chartered Surveyors From Rents to Revenues? Contents List of contents………………………………………………………….ii Executive summary…………………………………………………….iii Introduction…………………………………………………………….1 Methodology………………………………………………………………………2 The Market Context………….………………………………………..3 New developments in corporate finance…………………………………………..3 Unbundling the asset………………………………………………………………4 Changing lease structures………………………………………………………….4 The emergence of corporate property outsourcing………………………………..5 The expansion of the serviced office sector……………………………………….5 Why Now?………………………………………………………………8 A Technology Driven Evolution………………………………………………….8 Outsourcing……………………………………………………………………….9 Bundling……..…………………………………………………………………..10 New products……..……………………………………………………………..10 Pressures to innovate……………………………………………………………..11 A service industry?..……………………………………………………………..11 Identifying the New Revenue Opportunities………………………..13 Facilities Management…………………………………………………………..13 Relocation and fitting out………………………………………………………..14 Procurement of non-property goods and services……………………………….15 E-procurement…………………………………………………………………..15 Back-office functions……………………………………………………………17 Broadband……………………………………………………………………….18 Additional Spin-offs……………………………………………………………..21 Retail…………………………………………………………………………….22 Scale plays or economies of horizontal integration……………………………..24 i Patrick McAllister Department of Land Management University of Reading From Rents to Revenues? Prospective structures and potential impediments………..……….25 Vertical integration?…………………………………….…………………25 The Business Models……………………………………………………….26 Barriers and Scenarios……………………………………………….30 A limited market?……………………………………………………………….30 A core competency? ……………………………………………………………31 Institutional barriers………………………………………………………….…31 Liquidity effects………………………………………………………………...32 Inertia effects………………………………………………………. .………….32 Valuation Issues………………………………………………………35 Valuation methodology in the UK………………………………………………35 Plus ça change…………………………………………………………………..37 Issues emerging from valuation guidance………………………………………44 Attribution of value……………………………………………………………..47 Space with services or serviced space?…………………………………………48 Conclusion……………………………………………………………49 Bibliography………………………………………………………….53 Appendix 1 ii Patrick McAllister Department of Land Management University of Reading From Rents to Revenues? Executive summary The subject matter The potential for property owners to take advantage of their asset and tenant base to generate further non-rental income streams is attracting growing interest. This research report outlines the results of an investigation of the implications for valuation practice of this emerging trend. The first section outlines the changing financial and market context in which these developments are occurring and examines the main drivers facilitating this shift by landlords. This is followed by an assessment of the areas where there is potential for owners to generate additional revenue through the provision of services. Potential structures and impediments to the growth of this sector are also assessed. The penultimate section of the report focuses on the consequences for valuation practice concentrating, in particular, on problems of attributing value where a space-service blend is being provided. Methodology The report’s analysis is based upon a critical review of the main issues derived a literature review and interviews with key market actors. Two separate categories of property professional have been interviewed. One set of interviews was with representatives of institutional investors and major property companies. Typically interviewees were involved in asset management at the strategic level. These interviews focussed on the strategy of their respective organisations towards the provision of additional services and the areas where they perceived there to be opportunities. The second group of interviews was with the senior valuers of major surveying practices. These discussions focused on the experience of valuers in dealing with these types of income streams and their views on the implications for valuation practice. Why is this change occurring and what does it involve? The report argues that the last decade has seen a fundamental shift in the ways that many occupiers and investors regard property assets. Advisers, owners and occupiers are increasingly financially aware and innovative. The report focuses on the growing trend for occupiers to outsource property support services and seek flexibility in occupation driven by the interrelated forces of new technology, globalization and increased competition. It is illustrative that two of the most significant developments in the property sector – the growth of corporate PFI-type models and serviced office provision have at their core the outsourcing of property and other support services. iii Patrick McAllister Department of Land Management University of Reading From Rents to Revenues? Consequently, a number of major landlords have argued that structural shifts in the organisation of production provide an opportunity to transform the nature of their business relationships with tenants. In particular, there is a perception amongst some owners that investment performance can be improved by providing a range of services in addition to space. In the UK mainstream landlords have whenever practicable attempted to transfer to the tenant the costs and responsibilities associated the operation and maintenance of their assets. The tenant base has not been viewed as a business opportunity and landlords have not felt sufficient pressure to explore the economies of scope associated with the ownership of portfolios of leased property assets. This is despite competitive advantages produced by privileged knowledge of and access to their buildings and their tenants. This traditional remote style of management is changing due to pressures to improve investment performance and the enabling power of internet-centred technology. Does it raise new strategic issues? The types of strategic decision raised by the opportunity to provide services to tenants are by no means specific to the property sector. The micro-economics and business management literature devoted to the theory of the firm contains an enormous body of empirical and theoretical analysis related to optimisation of product range. The concepts and framework within these disciplines are extremely relevant to this topic. The possibility of property owners to develop new products can be analysed as a form of forward and backward vertical integration. Ironically, it is vertical disintegration within some business sectors that is providing opportunities for vertical integration in the property sector. Currently the trend in the property sector seems to be towards ‘quasi-integration’. This refers to the range of alternatives that firms have between integration and disintegration to enter, for example, into partnerships and alliances. Indeed, arguably the viability of the provision of additional services should be assessed in terms of whether they are complementary products and services. What are the potential additional revenue streams? The report suggests that it is important to be realistic about the main activities in which landlords are likely to become involved and to avoid becoming distracted by hype often associated with innovative ideas. New business opportunities are likely to be iv Patrick McAllister Department of Land Management University of Reading From Rents to Revenues? associated with the provision of property-related services, new technology or infrastructure and the growth of e-procurement. The main method of market entry is likely to be through partnership with third party providers. The main areas identified here are facilities management, relocation and fit-out services, procurement of some non-property goods and services, e-procurement capabilities and broadband. The widespread expansion of landlords into provision of back-office functions, financial services, human resource management and other mainstream business support services is difficult to envisage. Where portfolios were owned by joint ventures, it was pointed out that the party responsible for the management of the portfolio could gain returns from fees generated for fund and asset management, performance-related bonuses and rewards from implementing funding and development transactions. Further, it is clear that owners who are developing businesses focussed on the provision of additional services envisage that the services will be offered to other occupiers and not just tenants. Revenue opportunities are not limited to the property owned by the landlord. In the retail sector, large shopping centres seem to offer a whole range of opportunities. In addition to the potential for income generation from local area networks, more sophisticated exploitation of advertising sites, data acquisition, virtual malls; shopping centre owners also have the potential to contribute to their tenants business performance. The installation of broadband and development

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