In 2010, there were 600 standalone co-working locations – today, there are nearly 50,000. We can expect that period of exponential growth to come to a grinding halt. As I explore below, there are 3 reasons the co-working world will change moving forward: 1) impacts from COVID-19, 2) changes from employee preferences about their workspace, and 3) directional forces from the capital markets.
1. COVID-19 Impact
The chart below illustrates one of the most significant trends in the co-working industry over the past decade: the reduction in the amount of square feet per employee in a location. By some accounts, WeWork (the largest co-working provider to-date) locations are only profitable when this metric falls below 50 square feet per employee.
This poses significant challenges in the COVID-19 era that requires 6 feet of social distancing at all times. In cities such as Hong Kong and Singapore that have entered the early phases of re-opening, it has been reported that offices have divided employees up into 2 or 3 blocks for office usage. For more traditional office use, there is a bull case to be made here (higher space requirements = additional demand for square footage), but for co-working space providing high-end service levels this is an insurmountable challenge to the economics.
2. Real Estate as an Amenity
Going forward, firms are more likely to tailor their space after the model of co-working environments and provide more flexibility to employees – quality over quantity. In the world of technology and consulting, it is commonplace for even large employers to offer flex space where employees can come and go as they please, without dedicated space set to each employee. Over time, this trend should continue to spread to more traditional service industries such as finance and law. How do we know this will happen? Let’s look at two recent studies:
In a recent study of Columbia Business School students, nearly 70% of respondents said that they would prefer a ‘normal’ or more traditional working environment to a co-working space (ie, they prefer to be in a space with their co-workers, but without employees of other firms). Secondly, in the Fellowes Workplace Wellness Trend report from 2019, 87% of employees would like their employers to offer healthier workplace benefits such as ergonomic seating options, healthy meals, and fitness space/sponsorship. Many of these healthier options are provided in mid-to-high end co-working environments, so what can we infer?
The data suggests that beyond the COVID-19 pandemic there is perhaps less demand from employees to work in co-working environments than their benefactors would suggest – but there is substantial demand for the type of benefits WeWork and other offer. In a competitive labor market, employers and landlords will be pushed to meet that employee demand.
3. Capital Markets Impact
There are two components to consider in the capital markets – access of co-working firms to venture capital to support growth and the impact co-working space has on a property owner’s ability to obtain traditional real estate financing.
On the first point, it is likely that coworking firms will experience a period of toxicity in the wake of WeWork’s scar on SoftBank and then there will be a protracted period of winners and losers. A strong candidate on the winning side is Industrious – unlike WeWork, Industrious operates management agreements with its landlords as opposed to signing leases, and obtains the majority of its profit by signing end clients to above market leases while mitigating its own long-term liabilities. Recent investors in Industrious include Brookfield and Equinox (a subsidiary company of Related Companies).
Secondly, the question of how co-working space impacts a property’s financing and valuation prospects is still up for debate. In a CBRE study from 2019, the main takeaway was that a small portion of co-working space (up to ~30-40%) may actually increase a property’s value, but there is a substantial decline beyond that. There is still little evidence in debt markets to support a conclusion, but lenders will likely take a similar stance to prospective owners in analyzing metrics such as loan-to-value and future coverage ratios.
Overall, the number of standalone co-working locations will shrink for the foreseeable future, and the number of office properties offering a portion of space as flexible will expand dramatically. This growth will be driven largely by landlord-offered flexible space as an amenity to existing office tenants and as a value creator to end user employees as well as future owners & debt partners.
Contributor: Adam Kietz
Adam is a recent graduate of Columbia Business School, where he concentrated in the Real Estate Finance program and was a leader on campus of the Real Estate Association and Restructuring & Distressed Investing Group. Adam has experience underwriting and executing on equity and preferred equity transactions across multifamily, office, and retail opportunities at Related Fund Management, Format Real Estate Ventures, and Aspen Capital.
Prior to that experience, Adam spent 6 years at J.P. Morgan advising high net worth individuals on investment portfolios including capital raising efforts for private real estate funds. Adam is a CFA charterholder and lives in Manhattan.