Down But Not Out
WeWork’s stumble may slow short-term growth in coworking, but many see sustainable demand ahead for flexible office space.
WeWork’s very public financial woes have created some bigger ripple effects across the coworking/flexible office space sector.
WeWork’s plan to go public last year flopped when greater transparency into its business model revealed a lack of profitability that resulted in a sharp drop in the company’s valuation. The company has since canceled plans for its initial public offering, laid off
hundreds of workers globally, and pulled back on aggressive expansion. WeWork is now focusing on a new strategy to get the company — still estimated at about $7 billion — back on track and generating positive cash flow by 2022. Yet that turmoil has sparked questions about the future of coworking from
tenants, landlords, and investors. Opinions across the commercial real estate industry are mixed. Some see a market that is already oversaturated, while others believe the potential for growth still lies ahead.
There is no denying the explosive growth that has already occurred within the coworking sector over the past decade. According to Cushman & Wakefield, the global inventory of flexible workspace is now approximately 125 million square feet, with the U.S. home to
more than 50 million sf. “We’re seeing demand from occupiers that is still growing, and much of that is being driven by the future generations of workers,” says Melanie Gladwell, executive managing director, Flexible Workplace Solutions for the Americas at Cushman & Wakefield.
Demand is coming from millennials, as well as up-and-coming Generation Zers who possess a value system and work requirements that are putting more emphasis on provisional space as the office of the future. In particular, Gen Z is a group of “digital nomads” who have
grown up with a fully mobile lifestyle. The expectation is that providing more flexible workspaces is going to be a must for employers to attract talent in the future, notes Gladwell.
In its December 2019 research report on the flexible office space market, Cushman & Wakefield predicted that coworking memberships in the U.S. will grow from 750,000 to 1 million by 2023. More importantly, the report highlighted a growing appetite for space among large corporate occupiers. The report cited
its survey of global corporations conducted in collaboration with CoreNet where respondents said 12 percent of employees use coworking space on a regular basis now, and they expect that to double by 2023.
Demand for coworking space runs the spectrum from entrepreneurs and independent contractors to startups and major corporations. However, the growing demand from corporate enterprise users appears to be responsible for the meteoric pace of growth. In some cases, corporations are locating entire project teams or
business units within third-party operated facilities. “Corporations are now looking at flex space as a component of their overall portfolio allocation,” says Daniel Levison, CCIM, CEO of CRE Holdings in Atlanta. Coworking space gives large companies the flexibility to sign shorter-term deals, as well as create
different work environments for specific groups. “You’re already seeing more corporate users utilize this flex space, and that is driving owners to figure out a way to provide it,” he says.
Levison has a unique perspective into coworking as a broker, landlord, and owner-operator of a coworking business. Over the course of his career, he has co-founded multiple companies, including Atlanta Investment Properties, Commercial Property Professionals, and
SharedSpace. Founded in 2016, SharedSpace is a coworking business that operates within two of Levison’s buildings in the Atlanta metro. It is very much a third-party, arms-length agreement, with the ownership of the buildings different from the ownership of the coworking business, notes Levison.
Leasing of flexible workspaces is expected to grow, though more modestly following WeWork’s difficulties.
Slower Growth Pace Ahead
WeWork has been an engine powering expansion of the flexible office market. It accounted for 45 percent of the flexible space that exists in eight metros studied — leasing about 15.3 million sf — across New York, Washington, D.C., San Francisco, Chicago,
Atlanta, Houston, Los Angeles, and Orange County, Calif., according to a research report by Savills and Workthere.
WeWork tapping the breaks is weighing on net new lease deals from flexible space providers. Cushman is predicting that net new leasing from coworking providers will continue to grow, albeit at a slower pace of around 3 percent in 2020. In the near term,
flex operators seem to be pausing expansion and are focusing more on managing existing footprints, notes Gladwell. Some operators may be taking a bit of a wait-and-see approach to see how changes within WeWork impact their own strategic expansion.
At the same time, the retrenching occurring at WeWork could also create opportunities for other players to step into that gap. WeWork is the big gorilla that everyone talks about in the coworking universe, notes Tim Vi Tran, CCIM, founder and president of The Ivy Group, a boutique commercial real estate firm based in Fremont, Calif. Coworking, however, has become increasingly crowded; a 2019 research report from Colliers International found 140 coworking providers active in the 19 major metros studied, including major players such as Regus, Knotel, Spaces, Convene, and Industrious, that have created significant footprints.
In the Fremont market, a half dozen small coworking providers have spaces that range in size between about 5,000 and 10,000 sf, notes Tran. “I think what’s going to happen is that those smaller players will step in and grab some of the market share from WeWork,” he says.
Landlords Get in the Game
WeWork deserves credit for helping to show that there is demand from corporations for shorter term leases with bundled services. What WeWork also has shown is that providers can’t just go into a building as a tenant and take all the risk, says Levison. Coworking
spaces often require a significant investment in build-out along with overhead costs related to services and amenities. In addition, coworking spaces require ramp-up time to achieve occupancy and profitability. All of that can be very costly. “That is a model that we don’t believe works,” says Levison. “The model
that does work is if you are in a partnership with the building owner and there is a sharing of risk and reward.” SharedSpace currently has two locations in suburban Atlanta that combined encompass about 40,000 sf. Both are hovering at about 80 percent
For landlords and investors, the conversation has shifted away from, “Should we provide coworking space?” to, “How do we go about doing it?” adds Gladwell. Do building owners partner with a flex operator, or do they build and operate it themselves? “Because of the
slowdown in expansion by flex operators, I think we’re going to see higher levels of investment from landlords and investors,” she says. Some landlords are already dipping a toe in the water. For example, Brookfield Properties, The Blackstone Group, Sterling Bay, and Brandywine Realty Trust are a few of the
owners who have partnered with Convene to create highly curated flexible office space within their Class-A office towers in major metros around the country.
However, running a coworking operation is a business that most landlords don’t want to tackle on their own because it’s very management intensive. “Most investors are a little more hands-off than what is required to run a coworking operation,” notes Soozi Jones Walker, CCIM, SIOR, broker and president
at Commercial Executives Real Estate Services in Las Vegas. The general business model for landlords and investors is to focus on doing long-term leases with as few tenants as possible. Not only is that less work, but it also helps with building valuations and financing. “If a landlord was running this operation on their
own, in say a 30,000-sf space with 200 or 300 contracts with different individuals, that would be a very difficult thing for a lender to underwrite,” notes Walker.
CRE Pros Have Mixed Views
Coworking has attracted plenty of critics who are wary of the added competition for landlords and the potential oversupply of flexible space in some markets. “We specifically would not do any coworking leases over the past three years, while the competition was leasing
to them in a frenzy,” says Brent W. Roberts, CCIM, senior vice president and office specialist at Block Real Estate Services in Overland Park, Kansas. Roberts handles over 4 million sf of office space in the Kansas City metro. Ownership represented by Roberts chose to avoid coworking deals
partly because potential oversaturation in the market and the underlying risk of the business model that involved leasing space to occupiers on a short-term basis that could disappear instantly in a downturn.
“A landlord would also be creating competition inside its own building as the coworking entity is trying to attract subtenants, while I am trying to fill other vacancies,” says Roberts. Successful coworking sites tend to overpark, which makes filling other vacancies more difficult, he adds.
In some cases, landlords also have upped their game to better compete with coworking firms. For example, some of the buildings that Roberts represents have become more willing to negotiate short-term leases, as well as providing some furnished space options within buildings.
Along with continued expansion, the flexible office market is both maturing and evolving with new business models and concepts. Enterprise models that create serviced coworking spaces for one business user have driven growth. Providers are working to differentiate themselves in a crowded field of competitors by offering more specialized amenities or services.
Plenty of CRE professionals ask, “How can flexible space providers position themselves for a downturn?” In some cases, coworking can be a good option for fast growing companies that have changing space needs, especially in the San Francisco Bay area with a lot of startups, notes Tran. However, the
coworking model presents a lot of challenges, he adds. From the landlord’s perspective, one master tenant is paying market rent for a space. They are going to make improvements and turn around and rent that space to sub-tenants. “What happens in a down market when there is less need for space? Does that
leave someone like WeWork hanging, which at the end of day leaves the landlord hanging?” says Tran.
Landlords are taking a very hard look at how much tenant improvement dollars they are willing to provide for coworking concepts, adds Walker. In some cases, WeWork was spending millions of dollars on tenant improvements. “The concern from landlords is that if we start sliding into a recession and small entrepreneurs
start closing offices, landlords don’t want to get stuck with those large coworking spaces that are now built out for co-occupancy and are not good for a general occupancy user,” she says.
More Evolution Ahead
Some industry experts firmly believe flexible space options are going to remain a viable option for a variety of space users. Despite the surge over the past several years, third-party operated workspaces — including executive suites, business incubators, and other alternatives — have been
around for decades. Large global providers, such as Regus, have shown they can weather downturns intact. “The staying power has already been proven, and the demand for this kind of provisional space is growing exponentially,” says Gladwell.
Along with continued expansion, the flexible office market is both maturing and evolving with new business models and concepts. Enterprise models that create serviced coworking spaces for one business user have driven growth. Providers are working to differentiate themselves in a crowded field of competitors by
offering more specialized amenities or services.
WeWork, for example, has continued to innovate with new concepts, such as its WeWork Labs, a membership-based business incubator that offers networking and mentoring opportunities. Health club chain Life Time Fitness has introduced Life Time Work, a coworking concept that combines workspace with a health club
experience. The company has more than a half-dozen locations with more in the pipeline in major metros such as Minneapolis, Dallas, Miami, and Houston. In addition, Industrious announced a new co-branded partnership with Equinox last year that will bring co-located workspaces to Equinox fitness club locations
with its first location opening last December at Hudson Yards in New York.
“We’re seeing more and more flex operators partnering with lifestyle and amenity companies as it relates to health and fitness, spas, and even medical capabilities on site within the flex space eco-system,” says Gladwell. That blend of live-work-play will likely become more critical for companies to
attract and retain talent in the future, especially with generations who have grown up with that type of thought process, she adds.
Brokering Coworking Space: Is the Juice Worth the Squeeze?
Like it or not, the expansion of coworking is pushing flexible space options more into the mainstream for office brokers. The common question many ask is, “What’s the value proposition?”
Some brokers have been reluctant to show clients coworking space options due to the short-term nature of the space. Others in the industry argue that coworking deals offer an opportunity to build both relationships and revenues. Coworking providers typically pay a higher commission rate on a percentage basis, with a starting rate of 10 percent for the first year that drops the longer a tenant stays, notes Daniel Levison, CCIM, CEO of CRE Holdings in Atlanta. Levison has a unique perspective into coworking as a broker, landlord, and owner-operator of SharedSpace, a coworking business in Atlanta.
The cost basis for commissions can be significantly higher for a coworking facility versus a traditional office space on a per sf basis. According to a research report from Colliers International, the monthly cost of leasing a single private office from a coworking provider across 19 markets surveyed ranges from a low of $480 per month to $1,160. In addition, coworking deals are much less complex than a traditional office lease. Brokers can often get a coworking deal done within a few weeks because it’s an easier document and there is less negotiation, adds Levison.
Coworking also has the potential to strengthen relationships. Broker Tim Tran, CCIM, founder and president of The Ivy Group, helped one robotics company startup locate in a coworking facility. As soon as the firm secured its first round of funding, it was ready for a traditional office space that would give them more privacy than what the coworking space offered. Tran helped them relocate, first to a 4,000-sf space and now a 20,000-sf space. At some point, that coworking space model is not a good fit for some companies, but it can be a good steppingstone to traditional office space, notes Tran. “It is a good transitional space model,” he says.
Flexible space options, much like any space, do need to be viewed through a buyer beware-type of lens. Because of what has happened with WeWork, there is concern — from both landlords and tenants — about the viability of a location, says Soozi Jones Walker, CCIM, SIOR, broker and president at Commercial Executives Real Estate Services in Las Vegas. She and her husband, 2017 CCIM Institute President Robin Webb, CCIM, were looking at coworking space options in Orlando recently where Webb is opening a new location for his investment brokerage and consulting business.
It is important to ask how much term a coworking provider has left on their lease in the building, as well as understanding all the costs, advises Walker. Depending on the provider, there can be a variety of extra costs with up-charges on everything from using the copier and plugging into the Wi-Fi network to reserving a private conference room. “So, it’s not just your monthly rent; you pay for all these additional things,” she says. “A lot of people in a coworking situation don’t realize that. They think they can just go in and sit down at a desk and work.”
Clients who sign a month-to-month or one-year office lease produce a very different revenue stream for their broker versus someone who signs a three-, five-, or seven-year lease. However, at the end of the day, brokers need to show the type of space that their clients are asking to see. As such, it is important for brokers to stay informed on the different coworking options in their respective markets, as well as understand the differences that exist between different business models, terms, and costs.