Executive Member for Regeneration and Economic Development: Councillor Charles Rooney

MIDDLESBROUGH COUNCIL

BOHO FIVE

Executive Member for Regeneration and Economic Development: Councillor Charles Rooney

Kevin Parkes, Executive Director for Neighbourhoods and Communities

28 February 2013

PURPOSE OF THE REPORT

1. The purpose of the report is to highlight the need for a business incubation facility within the Boho Zone to continue the growth of the digital and creative sector, and to propose that the Council leads on the development of such a facility.

SUMMARY OF RECOMMENDATIONS

1. It is recommended that the Executive Member endorses the Council’s leadership of a project to construct an incubation facility utilising the proposed funding package, and delegates responsibility to the Director of Neighbourhoods and Communities to progress the scheme, subject to a further report confirming construction costs, operational plan and funding availability.

IF THIS IS A KEY DECISION WHICH KEY DECISION TEST APPLIES?

DECISION IMPLEMENTATION DEADLINE

1. For the purposes of the scrutiny call in procedure this report is

BACKGROUND AND EXTERNAL CONSULTATION

The Boho Zone

1. In recent years, the area of Middlesbrough known as the Boho Zone has developed into a significant business hub, based around the digital sector and the economic activity generated through the DigitalCity initiative – a successful partnership between Middlesbrough Council and Teesside University.

1. Inspired by the Soho areas in New York and London, the most successful creative centres of the past forty years, the Boho Zone seeks to provide an environment where people/business come together, collaborate and thrive. Achieving this vision will ultimately require a mix of incubation and managed workspace for start-ups, accelerating companies, spinouts and established businesses; cafés, restaurants and shops and facilities for exhibitions and networking events.

1. Since 2007, the area has seen significant public and private sector investment to deliver key elements of the vision, including:

1. Boho One - 3,200 sq m of new build providing workspace for digital media companies;
2. Boho Two(Platform Arts) - 300 sq m of refurbished Victorian buildings in the Middlesbrough Rail Station precinct housing artists’ business units;
3. Boho Three (Bohouse) - 3,300 sq m of new build live-work accommodation designed specifically for digital and creative professionals; and,
4. Boho Four (Gibson House) – 1,000 sq m of refurbished Victorian building to provide space for growing digital and creative companies.

1. A further refurbishment of space in the New Exchange Buildings due to be completed in 2013 will also offer space for growing digital companies.

1. This investment in the Boho Zone has contributed significantly to the physical regeneration of the area, which now forms a key routeway linking the town centre to Middlehaven. The impact of the physical regeneration has also been recognised through a number of awards, including Boho One and Bohouse becoming joint winners of the Royal Town Planners Institute North East Buildings of the Year in 2011.

Success

1. Alongside the physical regeneration of the area, the focus on providing workspace for the digital and creative sector has been hugely successful, with the following impacts:

1. Boho One is home to 27 companies employing over 200 people;
2. Boho Two (Platform Arts) is home to 15 commercial artists;
3. Boho Three (Bohouse) is home to over 20 digital professionals operating businesses from their own homes; and,
4. Boho Four (Gibson House) is home to 14 companies employing over 50 people.

1. The overall digital and creative sector is estimated to be worth over £50 million per year to the Tees Valley economy (TVU Digital Sector Action Plan).

Occupancy

1. As the DigitalCity initiative has grown, so too has the number of companies needing space. The industry standard level of ‘optimum occupancy’ in buildings designed to stimulate economic growth is around 85%. At present the occupancy of the key buildings in the Boho Zone is as follows:

1. Boho One85%
2. Boho Two100%
3. Boho Three100%
4. Boho Four82%

1. Although further space exists in other business accommodation around the fringes of the Boho Zone, it is better suited to larger, more generic office occupiers that do not require the same bespoke infrastructure as the digital and creative sector. Recent developments in the Boho Zone have also been designed to incorporate the informal networking and collaborative spaces required by the sector and have raised the aspirations of companies looking for accommodation.

Demand

1. The growth of the digital and creative sector has clearly generated significant demand for suitable business accommodation, and this demand is expected to grow further over the next three years – in line with the continued investment in DigitalCity.

1. The new funding package for DigitalCity will see the implementation of a more sub-regional role, which will inevitably lead to an increase in demand for digital workspace outside of Middlesbrough. Whilst some demand will be captured by new developments and refurbishment projects in Darlington, Stockton, Redcar and Hartlepool, companies still see a clear advantage to being located at the heart of the cluster in Middlesbrough.

1. The high level of occupancy and continuing stream of enquiries illustrates the need for more space to be developed for the digital sector, both within the Boho Zone and beyond. To ensure that this demand can be clearly demonstrated and quantified, a formal demand study has been commissioned jointly by Middlesbrough Council and the Homes and Communities Agency (HCA) and undertaken by economic consultants at Arup. The report has confirmed that there is significant unmet demand for incubation space in the Boho Zone, and also significant demand for expansion space for established companies. The report also confirms that demand for such space is increasing rapidly.

Property Offer

1. The Boho Zone currently provides a range of space from 27 sq m through to 185 sq m for companies of varying sizes. The nature of the digital sector is such that companies expand and contract regularly as projects are won and completed, so the space on offer needs to be flexible enough to cope with such rapid change. The majority of space within the Boho Zone to date has been aimed at providing medium sized units (74 sq m to 185 sq m) for established companies. Whilst creating further space of this type will be necessary in the future, there are other gaps in the current property offer that are starting to act as a drag on the success of the cluster, including:

Incubation and fast start space

1. The opportunity to offer flexible easy in / easy out space for pre-start and newly established companies is limited, and has largely been provided away from the Boho Zone, through the Victoria Building at Teesside University. As this provision is generally full, and increasingly housing non-digital start-ups from across the University’s wider portfolio, the availability of incubation space is becoming a real issue. The numbers of digital entrepreneurs coming through DigitalCity from non-academic routes is also increasing rapidly, and Boho One is unable to provide the type and size of accommodation required. Without the flow of new start-up businesses coming in to the sector, we wouldn’t be able to gain maximum benefit from the growth potential that exists within the Boho Zone.

Grow On Space

1. The companies that have come through DigitalCity and taken up residence in Boho One or Boho Four have all grown at different rates. Some are established at a stable level and are unlikely to change their workspace requirements, whilst others have already grown beyond the capacity of the building. For example, games company Double 11 have grown from one 37 sq m unit in 2010 to 678 sq m across seven different units in 2013. The Demand Study undertaken by Arup confirms that 60% of companies in Boho One are over three years old, and should therefore be moving on.

1. If Boho One is to continue to accelerate the growth of newly established companies, it needs the flexibility to move companies around and move the more space hungry occupiers in to bespoke accommodation to fulfil their ambitions. At present, Boho One and Boho Four are in a position where they are turning away potential tenants because they lack the flexibility to respond to their needs, when running at such high occupancy levels (as the remaining space cannot be effectively subdivided). They are also unable to accommodate sufficient pre-start and new start companies to achieve the critical mass required to stimulate a collaborative, high growth environment.

Securing Private Sector Investment

1. The Boho Zone has clear advantages in attracting private sector investment, namely:

1. clear demand flows;
2. cleared sites;
3. Enterprise Zone status; and,
4. proximity to DigitalCity Business.

1. Existing properties in the Boho Zone have already seen significant private sector investment in providing medium sized workspace units, and more is planned through the refurbishment of New Exchange Buildings. It is therefore anticipated that securing further private sector investment to increase the longer-term supply is a realistic possibility, and that further public sector intervention should be aimed solely at preparing the infrastructure for new developments, rather than directly funding their construction.

1. The development of the larger bespoke units required by companies growing beyond the capacity of Boho One and Four, is also seen as commercially viable for the private sector, as this represents a more stable source of rental income.

1. The provision of incubation and fast start space is however more complex. The low pricing, high churn and more communal nature of genuine incubation space is not attractive to the private sector and is unlikely to secure commercial backing. Incubators that have previously managed to attract commercial investment rarely maintain their incubation ethos for long, as the pressure to protect ongoing rental income can outweigh the aspiration to grow companies into larger space elsewhere.

1. As no private sector investments in incubation space are planned in the Tees Valley and none currently exist at the scale required to support the Boho Zone, it will be necessary for the public sector to intervene if the progress made by DigitalCity is to capitalised upon.

Previous Incubation Proposals

1. A previous proposal for the Council to develop an incubation building in the Boho Zone was supported internally in September 2009, but was not progressed. Concerns over the immediate availability of external funding, the Council’s VAT position and the maturity of the cluster in 2009 meant that a year long trial of providing incubation space within Boho One was undertaken instead. The aim of this exercise was to provide assurance that the projected demand would materialise, with one large office at Boho One subsequently developed as temporary incubation units. The units were let within days of completion, without any pro-active marketing and retained 100% occupancy throughout the year. Although the trial was successful, the space used in Boho One has subsequently had to revert back to larger units, to accommodate the expansion of more established companies within the building.

Funding

1. Although public funding for physical development is more difficult to secure than in the early days of the Boho Zone, there are still options available for the development of incubation space. In Middlesbrough these consist of:

European Regional Development Fund (ERDF)

1. ERDF is available to secure the development of business workspace and an expression of interest has already been approved for investment into the Boho Zone. This funding would represent up to 50% of the required capital investment, subject to the submission of a robust business case.

Homes and Communities Agency

1. As part of the Boho Zone falls within the Middlehaven development area that the HCA are committed to supporting, funding would again be available for up to 50% of the required capital investment.

Proposal

1. Taking into account the need to increase the flow of start up digital companies, the views of the private sector towards incubation and the availability of funding through the public sector, it is proposed that the Council lead on the development of a facility within the Boho Zone that would provide incubation space for pre-start and start-up companies, with the flexibility to support established businesses through stages of rapid growth, prior to movement into privately funded follow-on space.

1. A range of potential sites have been considered, with the preferred site identified as an area between Bridge Street East and Winward Way (as shown in Appendix I). The site, which is owned by the HCA would accommodate a building of around 2,322 sq m in size, reflecting the outcomes of the recent demand study.

1. Current projections indicate an overall project cost of £4,200,000. The potential funding package would therefore comprise:

1. As the HCA are now being driven to invest in the long-term creation of assets rather than the traditional model of giving one-off grants, accessing their funding would require a different ownership model to be put in place to those used previously. The ownership model required to secure the HCA funding can be summarised as:

1. the Council lease the land from the HCA for a period of at least 20-25 years;

1. the Council would then develop, own and run the building, until it is free from associated ERDF clawback liabilities (hence the minimum 20-25 years); and,

1. once the potential ERDF clawback period expires, the land and the building would revert back to HCA ownership.

1. This arrangement would allow the Council to deliver an incubation building for a period of at least 20-25 years, without any up front capital costs, and would also allow the HCA to secure the long-term asset they desire.

1. As the owners of the building during that period, all running costs would be met by the Council. In line with expectations on commercially focused buildings, the first few years of usage are likely to result in an operational deficit, although the building has been designed specifically to minimise potential running costs and accelerate the breakeven point to less than three years.

1. The business plan for the building shows an operational income/cost balance in the first five years of:

1. This business plan has been built on the assumption of a ‘worst case scenario’ of occupancy building up slower than was experienced at Boho 1 (where the market for such space was more limited), although all evidence points towards a more accelerated build up of occupancy, given the maturity and size of the cluster.

1. The business plan also takes account of the fact that Boho One was designed as a hub for activity and therefore has a low ratio of lettable space to total space, with meeting rooms, DCB offices and catering facilities built into the design. As a spoke to Boho One’s hub, Boho 5 has been designed to maximise the lettable space ratio and therefore its potential to generate a profit is much greater.

1. As an ERDF project, the generation of ‘profit’ would ultimately result in a proportion of the initial grant being repaid, if it is not retained within the project. To ensure that this can be avoided, a ground rent would be payable to the HCA if the building ever exceeded projected income generation levels. All other income would be retained within the project to refund earlier trading deficits, re-invest directly into the building or to provide support services to digital companies. As long as the income generated by the building is used to refund or reinvest in this way, the rent payable to the HCA would be nil.

1. In summary, the building would potentially create a short term cashflow pressure for the Council, but the building has been designed to minimise both the size of this pressure and the timescales over which it occurs. If treated as a discrete or ring-fenced investment, initial projections of operational costs and occupancy would see the Council in a negative cashflow position for less than four years.

1. This model is similar to those being proposed on other HCA funded workspace projects across the region, and although it denies the Council the longer-term ownership of the building, the cost to the Council of utilising such a facility for 20-25 years is minimised.

Economic Benefits

1. Alongside the obvious regeneration benefits arising from a further commercial building in the area, the specific economic benefits of the project are significant, including:

1. increased jobs – the building would generate over 100 new jobs in the first three years, and over 200 by Year 7; and,

1. increased business start-ups – the building would generate a further 27 companies in the first three years, and over 50 by Year 7.

1. As jobs and business starts in the digital sector tend to attract higher than average wages and turnover, the economic impact on the area would be significant, and represent excellent value for money for the Council’s input.

Design

1. To prepare for the submission of a full ERDF business case, the project has been taken to RIBA Stage D. This has required significant costs to be incurred, although around 90% of these have been funded by the HCA.

1. The Stage D designs have been prepared by Faithful & Gould, in conjunction with XSite Architects, who were responsible for the design of Boho One, Bohouse and a number of other projects in the Boho Zone. An illustration of the exterior of the building has been included as Appendix II.

1. As the Council would be responsible for operating the facility (through DigitalCity Business) it has been designed in a way that minimises the operational costs in the early years, and reduces the extent to which the Council is temporarily exposed to financial risk.

1. The construction costs, operational plan and financial projections will need to evolve further as the building progresses through the various funding approval stages, as costs become more certain. A further report would therefore be brought forward for consideration by the Executive Member detailing final agreed construction costs and the outcome of the ERDF funding bid prior to implementation.

Next Steps

1. The full business case for ERDF needs to be submitted formally in February 2013, with a decision likely by May 2013. A decision from the HCA is anticipated within similar timescales, enabling construction to commence some time in late 2013 for completion in 2014 – subject to Executive Member approval of the final costs.

IMPACT ASSESSMENT (IA)