By: Giles Fuchs, Co-founder and CEO of Office Space in Town

Surging demand and an ongoing supply squeeze in the office market has highlighted the vital role that serviced offices can play for businesses wanting a flexible solution for high quality office space. But the question is: are serviced offices undervalued?

Valuation experts may not have fully understood the absolute value of a serviced office, which is comprised of two key tranches of revenue: contracted income which includes both office fees and IT and variable service income. Surprisingly the variable income only makes up 10-15% of the total income.

The crux of the valuation issue is that, as well as the stable rental income, the value should incorporate the other income streams. First is income from contracted services, such as IT and reception facilities. The second is from variable services such as bookable meeting rooms, secretarial functions, franking, clerking and so on.

The easiest way to understand the issue is to think of an hotel. The hotelier earns an income from contracted bookings of the individual bedrooms but also receives revenue from other services such as the mini bar, restaurant, gym and meeting rooms.

So how should this translate into the valuation of the building? Let’s take the first tranche of revenue; the contracted income equal to market rent for that building is very robust and therefore should be valued, at the prevailing market yield, of say 5%.

The second tranche is the combined income from contracted and variable services, which should be viewed in line with that of hotel income, and thus valued between 12 and 14 times. For the purposes of formulisation we value at an 8% yield (12.5 times).

However, to err on the side of caution we only take into consideration 80% of this second tranche of income, allowing for 20% to act as a safeguard for income that could be affected by market changes. Loss of EBITDA in a recession will be between 10-20%.

Therefore this second tranche of income can be valued at 80% of the remaining income at an 8% yield, which can be distilled into the following formula:

Value of serviced office building = (EBITDA equal to Market rent at 5% yield) + (remaining EBITDA x 80% at 8% yield)

This formula brings to light the way in which serviced offices are currently undervalued. However, to fully appreciate this, it is also important to address some of the common misconceptions about the serviced office market.

Firstly, the stability of income generated by a serviced office is not widely understood.  The average tenure of a serviced office client is two and a half years, compared with just under four years for a commercial lease.

Additionally, the stability of revenue is increased as a result of the building being occupied by a number of different clients, meaning any one client leaving has little impact on the overall income.

As mentioned 85-90% of the income is contracted.

These factors are crucial in understanding the Fuchs Formula. Only by amalgamating all income streams together can one establish the absolute valuation of the building.

I pose the question: given what has been seen over the last 10 years in the understanding of both the hotel and student housing valuations why wouldn’t we expect the same to happen to serviced office buildings? Is this the latest big opportunity?