Broll Broking recently completed an extraordinary deal that may completely alter the way property negotiations will be conducted in the South African office market. Broll was approached by an existing tenant to sublet their P-Grade office space within the Sandton CBD. The tenant had a surplus of office space due to the rapidly changing business climate; a situation experienced by many businesses at the moment, now even more so with the event of COVID-19.

The office space was fitted-out to the existing tenant's purposes. However, the layout was very cellular, thereby limiting the types of tenants that could use the space as is. This was a major disadvantage, as tenants looking for space are trying to reduce capital costs as much as possible when relocating by utilising existing layouts and fittings. Unfortunately, the existing internal fit-out orientation made the sought-after space niche and thus expensive, not only for the existing tenant (who would need to white-box the space for a traditional sub-tenant), but also for a prospective sub-lessee (who would need to completely re-fit the space to suit their requirements). 

As a result, there was a requirement for the existing tenant to incur capital outlay in the form of a tenant installation allowance (in line with market norms), and for reinstating the office space to a white-box condition. Current market conditions, coupled with the complexity of the transaction, may have delayed the securing of a client, resulting in a longer 'vacant' period whereby no rental revenue is generated to assist the current tenant in meeting their head lease rental obligation.

In order to assist the current tenant/sub-lessor with the letting of this specialised space, Broll introduced the space to a fully-serviced office provider as a turnkey solution. The serviced office provider would in turn make use of all the existing fixtures & furniture, which suited their operating model, and would require minimal changes to the existing office design. The serviced office provider would ultimately pay the sub-lessor a percentage of profit derived from their operating model within the premises, and not a fixed rate per square metre per month, as per a traditional sub-lease.

A serviced office provider can be described as an entity that leases office premises from a landlord (or sub-lessor, as in this case), and sub-leases portions of that whole space to other entities in a fully-fitted and furnished condition, with access to a handful of services & amenities. Major benefits of this model include flexible, short-term leases; cost control; and immediacy of occupation. 

Benefits to the sub-lessor included immediate occupation, and therefore no vacancy period.

Given current market conditions, it can take between six to nine months to secure an ordinary tenant in a similar space within the Sandton CBD, at around R220/m2 per month excluding parking.

Other advantages included no beneficial occupation or rent free periods. The norm for sub-lessors and landlords is to offer between three and six months' rent-free and beneficial occupation in similar spaces within the Sandton CBD. Furthermore, no capital expenditure was required (in favour of the sub-lessee) for white-box costs (around R800/m²) and a tenant installation allowance (around R1,000/m²). The sub-lessor was, much to their delight, not required to write off the total cost of the fit-out and furniture to depreciation in that year.

Neither was there a need for the cost of furniture storage, nor the nuisance of having to sell office furniture to a 3rd party, as furniture and fittings remained in the ownership of the sub-lessor. The sub-lessor can also make use of the serviced office provider's offering as and when they need additional space or meeting rooms, and can take the space back after a specified time, if required, with little to no changes to the existing layout.

This was a win-win solution that benefitted not only the sub-lessor, but also the serviced office provider, as they required little to no capital expenditure for fit-out and furniture. Also, the profit share model versus a traditional lease assists the serviced office provider with cash flow, given that it takes around 12 months for occupation levels to reach maturity.

The above graph (Reference article image - image 2) illustrates total net operating profit generated by the serviced office provider at an assumed mature occupancy level of 85%, versus the gross revenues generated from a traditional sub-lessee (under current market conditions). Note that figures indicated are exclusive of parking rental revenue  (parking rates are the same in both traditional and profit share model). Under the profit share model, it has been assumed that revenue growth in the first year increases incrementally every month for the first 5 months at 10% (starting at 10% occupancy in month 1), before monthly growth slows to 5% from month 6 until reaching the mature occupancy level of 85% in month 12. Expenses have been assumed to escalate in the first year of operation as per revenue growth assumptions.   Conditions assumed under a traditional sublease scenario include a starting gross rent of R220/m²/month, escalating at 8% per annum. Tenant incentives from the sub-lessor (as the landlord) include R800/m2 for white-boxing of the unit, plus R1,000/m2 as a tenant installation allowance. It has further been assumed that a vacancy period (including vacant months plus beneficial occupation period plus rent free) will total 12 months collectively, whereby no rental revenue is generated from the sublease. The before mentioned is illustrated by a negative cash flow value of -R1.8 million in Year 1 under a traditional sublease.    Total Income generated over 5-years: Traditional lease total net revenue:                                                                  R11,050,000     Total profit @ 85% occupancy:                                                                        R16,250,000 Difference:                                                                                                        R 5,200,000     The above profit figures exclude profit share allocation to the serviced office provider, and the profit share ratio is, as one might assume, deal dependant.   In conclusion, this unique deal from the Broll Broking division has provided the sub-lessor with immediate relief from its rental obligation on unused or redundant space, and gives the landlord financial security in case the sub-lessor is not able to fulfil their rental obligations. The deal also gives the sub-lessor flexibility to flex-up and flex-down in the same building within the serviced office provider's model, with both the sub-lessor and serviced office provider being able to leverage off each other's amenities.   Given current economic conditions and the recent outbreak of the COVID-19 virus, we anticipate that larger tenants may find themselves with surplus office space, and may soon be looking for an efficient and flexible solution, as we achieved in the above scenario. To this extent, Broll offers a variety of solutions for excess and redundant space; space that we foresee becoming available once the national lockdown has been lifted. As market leaders and specialists in solving problems with win-win solutions, Broll is a support base for both landlords and tenants not just now, but also when the time comes to rethink, revitalise and readjust the South African commercial property market post-lockdown.