Having a roommate is not just part of the college experience — it is a growing trend in the workforce. More and more companies are working together under the same roof in nine to five harmony in what is known as coworking space: a more flexible alternative to traditional office space where multiple workers can share a single space for a monthly rent while working independently on their own projects. In the past, coworking space mostly appealed to freelancers and the self-employed who either worked from home, traveled often or otherwise had little use for costly full-scale offices. Now, the model is becoming increasingly attractive to traditional corporations looking to reduce long-term lease obligations and maximize the use of their space. DBRS, Inc. (DBRS) believes that the coworking industry will continue being a disruptor in the traditional-office-space market, whether through pioneer coworking companies like IWG plc (formerly Regus) and WeWork or through well-established traditional companies expanding their services to include more flexible options.
Coworking space is laid out in much the same way as most traditional office space, including private desks for independent work and shared areas for collaborative work. However, what makes coworking space different is that employees from different companies operate under the same roof, using what they need only when they need it. These leases tend to be short term and size adjustable, depending on how many workers the company needs to house. According to Statista, the number of people using coworking space has risen dramatically since 2010, currently resting at around 1.7 million. Exhibit 1 illustrates the dramatic rise in popularity, largely attributable to the start-up business economy, as start-ups need flexibility to expand.
Since 2010, many players entered the coworking-space market. The largest is WeWork, a coworking service company with 493 locations across 96 cities. Other start-ups such as Alley, Knotel, District Cowork, MakeOffices, Industrious, TechSpace, Serendipity Labs and Green Desk are jumping on the bandwagon across North America to provide more flexible space for workers. CB Richard Ellis, through its shared workplace subsidiary, Hana, recently opened its first location in Dallas and is planning to expand into 25 markets. Other traditional real estate companies like The Blackstone Group L.P. (which bought flexible office-space company The Office Group) and Tishman Speyer Properties (which announced the launch of Studio, a coworking-space provider, in September 2018) are exploring flexible workspace options to offer a way to disrupt the disruptor.
Coworking is not inherently specific to any single industry, allowing it to become widespread. Its quick rate of normalization in the workforce makes sense when you consider the amount of benefits coworking has for both company executives and employees alike. Coworking space provides a flexible and cost-effective alternative to what is an otherwise inflexible and expensive office model. However, not only small tenants find this alternative appealing; larger corporations (such as IBM, whose deal with WeWork places it in Greenwich Village, New York) are leasing coworking space for their entire staff and regional offices, which makes sense when you consider the benefits below
Flexibility and Affordability
Depending on the space that the company requires, shared work areas tend to cost a lot less than standard private offices, especially for smaller companies in cities with competitive office markets. This gives business owners more freedom to make the most out of a limited amount of square footage and to not break the bank when getting their businesses off the ground. Some coworking leases also include access to maintenance, cleaning, utilities and information technology services in the base subscription rate.
Coworking space offers business owners and employees increased networking opportunities with other business owners and employees. This can lead to cross-company collaboration and employment opportunities for workers looking to take that next step in their careers.
Easy Maintenance and Management
When it comes to coworking space, property maintenance and management is handled by the shared-space leasing service, allowing companies to “set it and forget it.”
Short-Term Options and Expandability
The built-in flexibility of shared space is partly the result of the short-term leases and ability of business owners to increase their companies’ space requirements to match their rate of expansion. For example, it may be problematic for a recently launched business to sign a long-term lease for a high-cost private space if it potentially needs to relocate to a neighboring market where it performs better. WeWork operates as a monthly subscription service that can be canceled with a month’s notice, unlike standard office leases that may have clients locked in for a few years, depending on the agreement.
Coworking space tends to be located in strong office markets in downtown areas. This not only means business owners can run their companies in premium locations for a minimal price, but it also means the coworking space is accessible to a diverse employee talent pool and, possibly, clients. Moreover, in the case of WeWork, a We Membership allows a company to book workspaces in other locations as needed (e.g., if a business opportunity temporarily takes employees to an additional real estate market).
Impact on Property Owners
Coworking space has received a mixed reception from traditional office property owners. Office property owners have become increasingly focused on their building’s branding in the marketplace. In some cases, these properties target types of tenants and construct an image based on a carefully curated or desired tenant mix. WeWork, as well as other shared-office providers, could challenge such efforts. An owner has no real ability to control the industry profile of the tenants in a shared-office arrangement. Owners also have noticed less demand for direct leases to smaller tenants. This change in demand could lead to the need to reconfigure floor plates to accommodate more mid-sized and large tenants. Also, WeWork, for example, has raised expectations for what office space should look like and what amenities are available. After the WeWork experience, tenants now seeking their own space will likely demand higher tenant improvement allowances to meet these expectations.
Some commercial property landlords are less than enthusiastic about the coworking business model — particularly that of WeWork — accusing it of offering space at unprofitably low prices to out-compete other leasing options in the market (Crain’s New York Business, “WeWork is city’s largest office tenant, but some landlords are wary,” September 2018). For this reason, there are notable landlords, such as Empire State Realty Trust, that will not accept WeWork as a tenant. In the buildings that do accept WeWork, the tenant often takes on a significant portion of the site’s net rentable area (NRA).
CoWorking Company Trends
There is also some controversy surrounding WeWork, the coworking giant, questioning whether the company is overvalued. WeWork’s expansion efforts translated into net losses of $1.0 billion in 2018 compared with $154.0 million in 2017 (Reuters, “WeWork revenue, and losses, surge in first release of results,” 2018). This is why a few investors were scratching their heads when SoftBank decided to invest an additional $2.0 billion into WeWork to cover its rebranding campaign, bringing SoftBank’s total investment in the brand to over $10.0 billion (Reuters, “SoftBank to invest additional $2 billion in WeWork: sources,” 2019). The initial investment was meant to be $16.0 billion, but due to a severe financial downturn in the economy in early January 2019 and investor disagreement, the number was trimmed down by 87.5%. Despite these setbacks, WeWork reported that its revenue rose to $421.6 million in 2018 from $198.3 million in 2017 and its subscriber base leaped to 268,000 paying members in 2018 from 128,000 in 2017. As well, Fast Company reported that the company raised $11.39 billion in capital, which should make up for losses and possibly fund expansion efforts. WeWork’s rebranding campaign to WeCompany may be able to cover some financial shortfalls as it corners the market on a very promising industry using its strong spread in various real estate markets, increased subscriber base and soonto-be diversified portfolio of property types. However, WeWork continues to expand its business model and pick up more iconic real estate — the landmark Lord & Taylor building — to serve as its headquarters (New York Times, “Lord & Taylor Building, Icon of New York Retail, Will Become WeWork Headquarters,” 2017). WeWork also leased 222,000 square feet (sf ) at the Brooklyn Navy Yard. Leasing brokers are now participating in selected transactions between coworking providers and their tenants.
WeWork is not the only company cornering the market: Knotel is its “fiercest rival,” according to The Real Deal (“Knotel is WeWork’s fiercest rival. Here are its internal numbers,” 2018). It was further reported that Knotel expanded to 1.7 million sf as of October 2018 from 200,000 sf in 2016, the year of its founding. In April 2018, the company received a $500.0 million valuation and managed to raise $160.0 million in venture funding. That said, Knotel is also experiencing some financial shortfalls with a net loss of $1.2 billion as of the company’s Q3 2018 financials. These trends show that there are some challenges in this alternative-office-space takeover, though the decline in cash flow may only be temporary and could be a sign of the turbulent times, with Bloomberg and Forbes warning of recession-like trends in 2019. Furthermore, if WeWork and Knotel happen to fail in the coworking office market, there will likely be another company to capture their share and provide competition for traditional-office-space markets.
CoWorking Exposure in CMBS
Properties tenanted by WeWork in the DBRS Viewpoint commercial mortgage-backed securities (CMBS) universe have an average occupancy of 94.7%, of which WeWork holds an average 56.5% occupancy of the total property NRA. Exhibit 2 offers a rundown of WeWork-tenanted properties secured in the CMBS universe as listed on the DBRS Viewpoint platform.
The currency of today’s business world is networking. Shared work spaces have offered what traditional office landlords have recently made a priority: a shared social experience, networking and collaboration opportunities and the chance to make a broader impact through local community outreach sponsored through the WeWork model. Tenants that operate in industries that require secrecy (e.g., protecting customer or client information) may find the idea of sharing spaces with others to be less than ideal, especially if these spaces are shared with potential competition. For most other types of tenants, however, shared spaces and open collaboration can be the perfect solution for them. The industries staking claim in shared office space include creative tenants, technological companies and other general entrepreneurs. Property owners would do well to continue to explore innovative ways to build this sense of community to attract both large and small tenants.
Coworking spaces are becoming so much of a driving force in the new office market that traditional office property owners can no longer ignore the popularity of firms like WeWork, IWG plc and Knotel. Nonetheless, office occupancy tends to be very strong in Class A markets, in some cases because of the flexibility that coworking spaces provide, making it more accessible to more businesses. In other words, an office building that has a coworking company tenant can enjoy the benefit of a reliably in-demand tenant; however, an office not leasing to such a service can find competition in the market. Real estate companies are adapting to these shifting office trends, showing that flexible work arrangements are here to stay, whether they are controlled by coworking companies or by traditional office providers keeping up with the times. Companies like WeWork and IWG plc are leading this charge, changing the shape of the modern office space.
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