One of the challenges to evaluating the impact of flexible offices on the broader office market is the lack of good data. The available data are mainly focused on leasing by coworking operators (e.g., 4% of office space in London and 3.6% of office space in New York City is currently leased by coworking operators).
However, these estimates do not include the space offered by landlords or through management agreements. Another consideration is that just because space is leased by a flexible office provider does not mean it is occupied by tenants.
Coworking firms act as intermediaries who transfer space from the direct lease market to the flexible office market. A lot of effort is still needed to procure tenants.
There is little information available on flexible office occupancy or capacity utilization, let alone the associated rental rates, which compounds the challenge of understanding the economics of supply and demand.
Typically, analysis of the flexible space market is based on assumptions and anecdotes. Brokerage research shows that coworking operators are leasing large amounts of space, leading to explosive growth in the supply of coworking space.
In real estate markets, a growth in supply typically leads to concerns about future occupancy and the sustainability of rent levels.
The fact that coworking offerings are increasing so quickly could mean the economics are very attractive to providers and eventually the market will reach a level where there will be lower marginal rent levels charged to members as more supply of coworking options are introduced into the market.
An alternative view is that the economics for flexible offices are not strong but because so much capital is flowing to coworking companies, flexible office providers are deploying capital with limited consideration of the long-term economics.
Individual coworking firm valuations are predicated on rapid growth, so they have every incentive to try to establish a “first mover advantage.”
But, can they all succeed at once? Many may be hoping their financials will improve when they reach a certain scale. The question is whether this time frame aligns with the time horizon of a real estate investor.
Another element of traditional market analysis that can be applied to the coworking space is the signal of increasing tenant incentives. Some operators are paying brokers increasing commissions to put tenants into coworking spaces.
“Buying” tenants can be an indication of landlord weakness, not strength and is a potential warning sign regarding the fundamentals in the coworking space. Neither signal is clear, but in the absence of solid data on the fundamentals, investors may rely on these weak signals to inform decisions.
The lack of data is a risk and an opportunity. For investors, it suggests careful due diligence and possibly higher returns are required when investing in buildings where the economics of the coworking tenants are difficult to figure out.
The rising demand for coworking office space is an example of how many parts of the real estate market are migrating to a model that provides a more complete experience to tenants than just physical space.
In the highest performing sectors of the economy, firms are no longer satisfied with space in a generic building.
Instead, they are seeking amenities (in the neighborhood and in the building), services (concierge, tech support, food preparation, wellness programs, events), and community (meeting other tenants, forming business or personal connections, self-image associated with being around like-minded people).
Building owners who address these demands can create value from more loyal and profitable tenants (higher cash flows). Of course, there are costs associated with expanding services.
The economics of providing these Amenities, Services, and Community-building activities (A+S+C) is not yet proven, and we expect the provision of these services will often be out-sourced.
Flexible offices or coworking spaces represent a blended space/service model for work environments; examples can also be found in other property sectors, including rental apartments, shopping centers, and healthcare facilities.
There are also emerging service operators, such as JLL’s Curae (and numerous other offerings by other property managers), which will provide a package of services to all tenants in a building.
Owners who can capitalize on these trends in a cost-effective manner should generate a higher income stream and outperform market trends.
Those who continue using an old strategy of just providing space will lag the overall market. Others will over-reach and pursue business plans that do not make long-term economic sense.
This economic challenge applies to both coworking operators and landlords. From an investor’s perspective, owners need to underwrite coworking tenants to ensure their business models are economically sustainable, and that their presence in a building is accretive to the value of the building.
