Co-working spaces – a threat or opportunity for commercial property owners and buyers?

There are free craft beers in the fridge, hand-roasted coffee on demand, and fresh “fruit water” (don’t ask). There are high ceilings, creamy camel-coloured sofas, and lashings of raw exposed steel and textured wood.

This isn’t a luxury penthouse, however, but a place of toil. Or, more specifically, one of the hundreds of branches of WeWork, the American co-sharing office spaces that now pepper the globe.

From Tokyo to Seoul, Madrid to Stockholm, you name a city and WeWork — promoting its very own lifestyle brand of labour-intensive hipster cool — is there. In 2016 the Silicon Valley-style company, now valued at an eye-watering USD $20 billion, arrived in Sydney. Today WeWork has three buildings in Australia’s largest city, with more opening soon. The majority are located in the CBD, catering to a workforce who, it seems, increasingly want flexible terms, community spirit, and custom wall murals.

But the meteoric growth of WeWork, as well as myriad smaller companies vying for a piece of the pie here, begs the question: how will co-working offices disrupt the commercial real estate market? How will it affect owner-occupiers, landlords and leaseholders? And is this a true threat or merely a fad that will, in time, fade out?

What is a co-working space?

Traditionally, companies take out long leases on an office space, coughing up cash for both hardware (the office furnishings and fit-out) and software (the internet, reception personnel, electricity). As such – even though they might get attractive rebates and incentives – there are myriad hidden costs: ultimately, the running of the space, and all the time and money that goes into running that space, depends on the leaseholder.

By contrast, co-working companies take on the initial risk themselves, taking out the lease and doing their own fit-outs, installing everything from coffee machines in the kitchen to Wifi. They then rent out desks, either in a shared space or private office environment, to individuals or companies on a short-term flexible basis.

Ultimately, a set-up like WeWork or The Hub, another co-working company which launched in Sydney in 2013, makes money on rent arbitrage: they take on the risk as the primary leaseholder, cram in desks, and then charge multiple clients significantly more than they pay.

Rowan Humphreys, a director with Colliers International Tenant Advisory, compares the co-working movement to the way a company like DHL, a fully outsourced supply chain management, works. “A co-working space can offer much the same,” he says. “Flexibility and reduced setup cost right through to a customised managed solution. Some call it ‘office space as a service’.”

Or, as an article in The Guardian pointed out, WeWork dresses itself up as a tech company but delivers something much more traditional: “Unlike other Silicon Valley billion-dollar valuations it hasn’t built a new search engine or claimed to have reinvented the wheel. It deals in that most old-fashioned of businesses: real estate.”

It’s a mission and a movement – not just an office

Rent in co-working spaces can be sky-high: WeWork in Sydney charges $450 a month for a “hot-desk” (meaning you have to find a desk that is empty on the day) in a shared workspace and upwards of $730 a month per person in a private, lockable office. But clientele benefit both from the flexibility and the included add-ons – as well as feeling that they are part of something much bigger than themselves.

“We don’t need to spend money on marketing. Because we’re part of a mission and a movement,” WeWork co-founder Adam Neumann told The Guardian in 2016. “And if you’re part of a mission and a movement, your members will sell you. If they’re doing something great that makes them feel good and they’re excited about it, they’ll post it. Everyone wants to be part of something.”

And it’s not only for start-ups  

 Many of those who take up co-working desks are start-ups and small businesses, which don’t have the initial funds to invest in a long-term lease, or members of the growing gig economy (the roughly million Australians who make money on a freelance or semi-permanent basis).

But more established businesses are starting to take advantage, too – often to provide space for special projects; overflow when a business grows; or fast expansion into new cities and locations. The Guardian US, for example, rents two floors of private office space in a WeWork building in Manhattan and last year IBM leased an entire WeWork building in New York for 600 of its staff.

“The casualisation of the workforce is only a small portion of why this market is widely untouched,” says Campbell Mcleod, director of Home Base Share, a co-working space based in Melbourne.

“Previously, it has been only the creative and entrepreneurial groups that have had interest in communal working,” he notes. “However, as commercial property values and rents skyrocket, exacerbated by the rezoning of industrial/commercial land for residential use thereby limiting available commercial space, it has forced conventional businesses to rethink their workplace strategy for continued growth.”

Kris Flegg, director of Presentation Design Co, a well-established business with a team of six people, leased a WeWork office in Pyrmont, Sydney, in 2016, giving up his 68-square metre leased office space in the process.

“We were looking at having more social aspects, to try and replicate the feel you have when you work at a bigger company. To have a more dynamic workspace,” says Mr Flegg. Another advantage is greater flexibility: WeWork membership provides the team access to not just the office in Sydney but across Australia – so if Presentation Design Co has a meeting in Melbourne, they can use dedicated office space there.

Most importantly to Mr Flegg, however, is that the 100 Harris Street building is an A-grade commercial space – something his design business could never have afforded on its own and yet which remains integral to the business branding.

“It leaves an impression” for clients, states Mr Flegg. “Serviced offices always felt quite soulless, like business centres.”

“We don’t need to adjust technology, the billing is the same – I can adjust the number of desks as the team moves up and down in size, without having all the dramas in moving. We have a reception, a beautiful waiting room inside. We’ve got a great choice of different meeting rooms,” he continues.

While it’s more expensive upfront than a traditional lease, “the great thing is there aren’t hidden costs: from paying for the coffee machine, Internet and the like,” insists Mr Flegg. “You’re seeing all the costs together in one bill. It allows you to concentrate just on what you’re doing without having to do the little bits and pieces [of admin and office management]. All that stuff which doesn’t really add value.” 

A growing market share

 With such advantages, co-working is gaining traction as an alternative to the usual staid office space: in Sydney’s CBD alone, commercial real estate agent Colliers International estimates that there are 54 flexible workspace centres managed by 22 separate companies, adding up to 2.44 percent of the total office market.

That is paltry compared to New York and London, where flexible workspace centres make up 4 percent of the total market. From August 2016 to July 2017, WeWork became the second largest leaser of office space in America, after Amazon. The company is growing at astonishing rates: from 2016-17 it doubled its member numbers and is expecting another 100 percent increase by the end of this year.

 The co-working industry is predicted to grow at an annual growth rate of just under 16 percent over the next half decade, according to the 2018 Global Coworking Forecast. Other, smaller co-working companies – some catering to a more conservative clientele who can be put off by hipster beards and communal wine nights – are also gaining traction. As such, says Mr Humphreys, “there is definitely room for growth in Australia.”

 A word of caution, however from the heart of Sydney’s CBD: Knight Frank’s director of office leasing for New South Wales, Nick Lau, states: “Following WeWork signing for circa 9,800 sqm at 100 Harris St in 2016 we have not seen much more co-working entering the Pyrmont market. A small proportion, approximately 4,000 sqm, of the space coming to the market over the next few years is rumoured to have been pre-committed to a co-working operator new to Sydney.”

So, is co-working really inventing the wheel?

No. In many ways, co-working is nothing new. Serviced offices such as Servcorp and Regus, which offer similar benefits such as flexible contracts alongside a 5-star address, dedicated receptionist, and onsite IT support team (admittedly in a less slick setting), have operated in Australia for years.

So what has changed? It’s all about rebranding, insists Yusef Oner, general manager of Corporate House, a Queensland-based co-working office network which is looking to expand into Sydney.

 “All of a sudden the industry has got quite sexy due to the likes of WeWork,” he says. “But nothing has actually changed in terms of the offering. I don’t think it’s a fad because it has been in existence for decades and there’s always been a need for it. What has happened is that we’ve seen a lot of growth and awareness of the industry as a whole.”

 Jumping onto the (fashionable) bandwagon are the serviced offices who are re-branding themselves as co-working spaces: Regus, for example, which has 3,000 locations in 120 countries, now operates under the umbrella company International Workplace Group (IWG). IWG’s newer brand is Spaces whose tagline is: “Creative workspaces with a unique entrepreneurial spirit.” (It is also worth noting that while WeWork plays on its reputation as a shared space, a large percentage of the space it offers to clients are private offices).

 “Whilst the concept of flexible workspace is not new, the rise of co-working over the past few years in Australia has significantly raised the profile of this sector,” states Mr Humphreys.

“Serviced offices traditionally attracted small and medium-sized enterprises, together with multinational corporations that took up space for project teams, swing space of branch offices in new markets,” he says. “Co-working spaces, meanwhile, were originally filled with early stage start-ups seeking a creative hub that allowed flexibility to grow their businesses. The two have now blurred.”

Mr Mcleod, however, believes that serviced offices need to up their game: they have been, he insists, “complacent for too long and inflexible with their lease structures for small businesses not to mention the exorbitant additional costs for basic services. Given the large number of these in Australia and the general dissatisfaction with their service offering, the flexibility of co-working spaces provides a genuine threat to that industry.”

Not everyone agrees with that view: according to CBRE’s 2018 Global Investor Intentions and Global Occupier surveys (the CBRE Surveys) “[n]early half of occupier respondents still anticipate using a traditional serviced-office model three years from now. This signals the desire of some occupiers to take advantage of flexibility and a tech-enabled work environment without the fashionable community environment that co-working offers.”

Giving tenants back the power

 Sixty-three percent of millennials today claim they are happy working on a mobile device. Given the meteoric rise of the smart-phone, the way we work as a society is changing – and many don’t want to be tied to a single office location.

 Technology, too, is transforming our workplaces. Home Base Share, for example, is based on the 24-hour gym model: the co-working space can be accessed at any time of the day or night through an app on your iPhone. Having minimal staff means keeping prices low and tenants are in control (even the coffee can be ordered in advance through the app).

Mr Mcleod believes that “co-working really is the ultimate disruptor to the conventional commercial real estate model, as it provides the liquidity and flexibility that conventional models simply don’t have; it puts power back in the hands of the tenant like we haven’t seen before.” As he puts it: “the conventional lessor/lessee model cannot compete.”

Expanding from the CBD

One advantage co-working companies have is allowing their tenants to work from any office location if they purchase a membership. With the CBD “saturated, you’ll see that growth happen in the fringes and in more regional locations and that’s where the opportunity will be,” says Mr Oner.

 Home Base Share is now looking to expand into Sydney – and is deliberately looking at the North Shore. (Co-working brands already operate in locations such as Chatswood, North Ryde and St Leonards.) “We believe in the North Shore given the traffic congestion that plagues the harbour. The affluence of this area coupled with the high ratio of young entrepreneurs gives us comfort for setting up in this area,” states Mr Mcleod.

 Reflecting this, WeWork is expanding into North Sydney – taking a 12-year lease on a 4,100 square metre space in Sumner Capital’s 50 Miller Street. (WeWork is also taking a 10,000 square metre office building in Barangoo South mid this year). Craig Dolman of Sydney office leasing agency Cadigal told the Australian Property Journal that the latest WeWork expansion over the bridge shows “the continued strength of North Sydney as a corporate location. Certainly the low vacancy rates and continuing demand are also a reflection of this.”

So where does this all leave landlords?

 “Technically flexible space operators are actually a tenant themselves, so generally the landlords aren’t losing out,” states Mr Humphreys.

 Still, some owners of large office buildings, eager to stay ahead of the curve, are moving into the co-working space, he adds, “either launching their own version (e.g. Dexus Suite X and ISPT’s Flex) or seeking an operator to open a centre within their building to offer corporate tenants extra amenity by way of meeting rooms or flexible project or expansion spaces.”

 Critically, it allows landlords to attract a new type of smaller tenant, who might, if the business becomes successful, grow into a more important client as they expand. It also allows larger corporate clients to have increased flexibility – particularly if the number of employees goes up or down due to special projects or during boom or bust periods.

 According to the CBRE Surveys “45% of surveyed investors think that an ‘agile’ space strategy—space that can be procured quickly with little capital investment and very flexible terms—is an occupier trend that will have the most impact on real estate value this year.”

 “Landlords are obviously having to now innovate and I think what you’re seeing is a lot of them are replicating serviced office style fit-outs – a lot of them are opening their own serviced offices or co-working brands as well,” says Mr Oner.

 “If someone takes a three-person office and they grow and grow – at some point they get to a certain size where it might be more cost effective to take their own lease. So having a co-working provider in your building as a landlord can be a great amenity – when they grow hopefully they’ll take a [longer] lease in your building as well,” he adds.

 Another trend is that landlords are starting to do their own fit-outs, often mimicking the communal areas that are popular in co-working spaces – so that tenants can simply pay the rent and plug their devices in straight away.

 “The biggest benefit for a tenant and why they would choose a serviced office is because it’s flexible,” notes Mr Oner. “They don’t need to do a fit out, the space is plug and play and they can get really short terms. So I think landlords are trying to replicate that: they’re doing what they call spec suites, which is rather than leaving a floor vacant, they’ll actually do a speculative fit-out to try and entice a tenant.”

 Or as NSW state director at independent quantity surveying company WT Partnership Gerry Heaton told Commercial Real Estate: “It’s now becoming a real trend… They see companies like Hub and WeWork essentially taking spaces and on-passing them to people who want very short-term leases for only part of those spaces, and in the process renting them out at much higher rates. So they’re thinking, ‘Why shouldn’t we do this, rather than passing the profits to someone else?’”

Companies making the move include real estate group Dexus, who recently launched SuiteX, and the GTP Group, which has launched Space&Co – both of which have billion dollars worth of property assets in Australia. Office landlords Investa have stated that in the future most of its larger buildings will include co-working spaces.

What’s more, the trend enables landlords to utilise previously undesirable areas of the building. As Mr Heaton said in Commercial Real Estate: “There are spaces that the big tenants aren’t so keen on, and are harder to rent out, such as lower floors without views. But these less profitable areas are still attractive to smaller companies and start-ups who might just need a conference room for a couple of days rather than want to rent one every day.

That’s also a way of getting buildings more activated around, say, the podium levels. You can interface them with the general public, almost like a public library, and in that way it almost becomes part of the branding of the building too. It’s a real shift in the way these companies are operating.”

Reflecting this, 2018’s CBRE Pacific Corporate Co-working Survey – The Future if Flexible showed that corporate tenants are now also moving into co-working spaces. CBRE found that 52 percent of occupiers expected to decrease their traditional leased office space footprint and 50 percent expected to increase their use of co-working space – with the main driver for tenants taking up co-working spaces the “greater flexibility.”

Despite all the hype, the CBRE Surveys found that investors “likely are still evaluating agile space strategies [with] only 4% [of them intending] to develop their own agile space offering, while 9% intend to partner with a third-party operator.”

What’s the catch?

 There is of course a catch. WeWork – as it gets taken up by more and more corporate companies – might lose its unique selling point as it becomes more mainstream.

What’s more, WeWork’s model depends on the brand signing long-term leases – and committing themselves to years of future rent which they might not be able to pay should clients drop their membership en masse in a downturn.

Those risks are real not imagined with the 2017 financial statements lodged by the Australian operation of WeWork showing a negative net equity position of $5.5 million in 2017 driven in part by a $3.4 million “intercompany expense.” In 2016 it was negative $2.6 million. As reported in the AFR on 26 Novmeber 2018 “[WeWork’s] arbitrage and the long lease obligations…have drawn criticism globally over its model. In August, Moody’s withdrew its credit rating for WeWork’s $US702 million in borrowings after the hub’s giant released its financial results for the first time.”

“There is always risk of oversupply of co-working space, particularly if the market turns and operators could be left with high vacancy,” says Mr Humphreys. “Having said that, if the market turns we might expect large companies to lay off staff and hence see more small businesses/small consultancy firms emerge which could offset the reduced demand.”

 Ultimately, flexibility – the sector’s largest selling point – is its biggest risk factor.

 “A landlord is always going to struggle to be a flexible workspace, because building owners are typically concerned about building valuations – so if you can’t demonstrate a strong long-term rental income with commercial leases in place with your tenants then your building’s valuation will suffer,” says Mr Oner.

Being the same issue that arises with the valuation of residential property devoted to short term stays such as Airbnb rather than longer term tenants, the CBRE Surveys “suggest there is a threshold to the amount of space that can be dedicated to an agile-space offering before value is negatively impacted:

• when third-party agile space operators have up to 20% of a building’s leasable area, 42% of investors think this will increase building value and 52% think it will not impact value at all
• when third-party agile space operators have more than 80% of a building’s leasable area, 64% of investors think this will decrease building value versus 36% who think it will have no impact.”

Then there is the question of just how much of a disrupter co-working might truly be. Should a Sydney property buyer who is considering for example, investing in a strata floor or suite, be concerned that co-working will reduce tenant demand for his or her space?

“As the flexible workspace market continues to grow and mature we will undoubtedly see more overlap and competition between traditional leased premises and co-working spaces competing for tenants. Landlords here have for many years been subdividing large floor plates and offering small fitted out (spec fitout) suites on short term leases,” says Mr Humphreys.

 “In the USA, co-working group Convene offer a similar product (i.e. fitted out suites). Therefore, with increasing supply of co-working spaces and further diversification in the co-working market, we will most certainly see competition with traditional leases,” he continues. “Notwithstanding, I think the depth of different requirements in the Australian is sufficient to support a multitude of different models including traditional leases and various co-working models.”

This echoes the views of Jones Lang Lasalle, manager of many hundreds of small suites in the St James Trust Building at 185 Elizabeth Street, Sydney which has not seen any reduction in tenant demand despite the advent of nearby co-working spaces.

It’s worth bearing in mind, that not everyone is sold… 

 Co-working spaces are, of course, not for everyone. While office socialising over free booze is all well and good, there is the issue of talent harvesting (where bigger tenants poach the bright young stars of smaller tenants).

They are also unlikely to be suitable to the dental or medical professions with confidentiality concerns or a need for dedicated plumbing and other facilities.

Blue-chip corporates might be put off by the hipster vibe co-working offices often emit or want only other high tenants to brush shoulders with. As Felice Spark, CBRE’s head of office and occupier research, told the Australian Financial Review in an article published in November this year: “If you’re KPMG, for example, you want to be associated with a CBA, or a similarly blue-chip corporate tenant profile. To have WeWork in the property and half the lift full of people in flannel shirts and thongs – those things can be a bit of a culture shock.”

Ms Spark also points out that the sardines-in-a-tin nature of co-working spaces (which tend to squeeze in roughly one person for every five metres, more than twice the density of most traditional workplaces) is off putting. “That puts a lot of pressure on services including airconditioning and lifts. It can be a little bit of a negative,” she told the Australian Financial Review.

Still, Mr Oner says that co-working spaces are starting to take such concerns into consideration. Corporate House, for example, has nine locations across Queensland. But each one has a different look and feel to attract different customers.

There are the WeWorks of this world that offer “bearded men in Starwars t-shirts drinking beer,” he says. “And it wasn’t the brand and image [that many of our clients] wanted to reflect for their business. There are always going to be certain organisations that are going to want a different look and feel.”

As such, says Mr Oner, with so many options on the market the co-working space you choose can now “reflect your brand.”

So, what can we expect for Sydney?

Australia is a “less mature market – it’s less established,” than other worldwide cities, asserts Mr Oner. While New York and London have always had tight vacancy rates for office spaces – meaning that “access to conventional leasing isn’t as accessible and people will look to alternatives” – that has been less the case here.

 That said, co-working providers are now helping “the office market absorption. WeWork and The Hub have taken significant market in both those spaces, as well as more localised players.”

It is predicted that Sydney’s office vacancy rate could hit a new low of just 3 percent next year, driving up rents.

“In a tight market, rents go up and incentives would go down,” Mr Oner points out. “Incentives are normally provided to the tenant in the form of a rent-free period, rental abatement, fit out contribution or a blend of the above. If you’ve got a hundred tenants knocking on their door, they won’t necessarily need to provide as much or even any incentives to the tenant. A rise in co-working has been in line with a drop in office vacancy as the incentives that landlords have to offer tenants are not as attractive and they may then be more likely to consider a co-working or serviced office instead.”

Where to go from here? 

Data shows the gig economy is only going to grow – as such don’t expect co-working spaces to go anywhere soon.

This is an industry which will also grow. And as Mr Mcleod says: “There are up-and-coming brands that are beginning to test the larger players in the market and this creates the much-needed competition in the industry. As co-working is fundamentally entrepreneurial in nature, I think it’s only a matter of time before we see solutions and opportunities presented for super funds to purchase in the space.”