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Monday, 13 January 2020

Despite Being a Small Part of Office Market, Coworking is Key to Filling Space

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Commercial Real Estate Direct Staff Report

Coworking companies, those that lease office space under flexible terms, accounted for 57.5 million square feet of the space in the country's 20 largest markets as of September, according to Yardi Matrix.

That would seem like a lot, and is a 42.3 percent increase from the end of last year and 114 percent more than at the end of 2017. But it amounts to only 2.3 percent of the 2.5 billion sf of office space in those markets. When the universe is broadened to the country's top-50 office markets, coworking space accounts for 93.2 million sf, or only 1.7 percent of the 5.5 billion sf in those markets.

So, while coworking has been grabbing headlines of late because of the rapid rise of WeWork and its subsequent fall from grace, it's not the big disrupter to the traditional office leasing sector that many might think. However, coworking has become a key component in helping landlords fill up their buildings and small companies occupy space to which they otherwise might not have access.

Coworking companies usually sign long-term leases for large blocks of space, subdivide it, fit it out and lease it to entrepreneurs and companies under flexible terms. They'll lease space—as little as a cubicle with a desk and Internet connection—for as little as a day. Of course, they charge premiums for that flexibility.

Coworking has been part of the national office landscape since the early 1960s as entrepreneurial companies determined there was demand for office suites and other custom spaces with flexible terms from small professional companies, including law firms. So, it's no surprise that coworking is largely a big-market phenomenon.

The gateway cities of Boston, Chicago, Los Angeles, New York, San Francisco and Washington, D.C., account for 44.1 million sf, or 47 percent, of coworking space, according to Yardi, a Santa Barbara, Calif., research company.

Conventional, direct leases in those markets typically carry terms of 10 to 15 years, making them opportunities for coworking companies.

But coworking accounts for a relatively small percentage of each market's overall office stock. Brooklyn, N.Y., has the highest percentage of coworking space of any of the country's top markets, amounting to only 3.8 percent, according to Yardi. It accounts for 3.7 percent of Manhattan's office space and 3.5 percent of Miami's space. No other market has a greater than 3 percent concentration of coworking space.

Coworking's expansion in recent years is expected to slow sharply in 2020 as a result of WeWork's pullback. The company, at one point valued at as much as $47 billion, had been leasing up mountains of space in key markets that it then would sublease as coworking space. But its aborted effort to raise public equity in order to continue its leasing activity is expected to have a profound impact on its potential growth.

WeWork has 390 spaces totaling 27.6 million sf, which accounts for 0.5 percent of the office space in the country's top-50 markets. It accounts for 29.6 percent of all space that's classified as coworking. If the company can't be as active as it previously has been, the entire coworking sector will see a slowdown.

But it's not going away.

"We're a fundamental believer there's a real business driver (in coworking) today and in the future, and it will grow," said Jeffrey DeVuono, executive vice president and senior managing director at Brandywine Realty Trust, a Philadelphia REIT. DeVuono oversees a 12 million-sf office portfolio in Pennsylvania. "But we were never comfortable with some of the projections that coworking would take over the planet."

About 2 percent of Brandywine's overall office portfolio of 24.6 million sf is leased to coworking firms. DeVuono said that coworking companies are "great complements to our existing portfolio," but he expects they'll remain a small part for the foreseeable future.

During the early 1960s, a company called OmniOffices Group Inc. subleased small spaces in buildings primarily to business executives or attorneys who used the space either as meeting rooms or offices.

CarrAmerica Realty Corp. had acquired OmniOffices in 1997 and bought HQ Business Centers a year later, forming HQ Global Workplaces Inc. In 2004, Regus Group PLC purchased HQ Global.

Regus' acquisition of HQ Global gave it about 950 locations around the world. But Regus, which was formed in 1989 in Brussels, Belgium, and entered the U.S. market in 1998, ran into financial issues. In 2003, the company's United States arm filed for bankruptcy following the economic downturn that began in late 2000. As the economy soured, Regus saw vacancies climb, pinching its ability to stay current on its obligations.

Regus, which changed its name to IWG PLC in 2016, emerged from bankruptcy in 2004 and is now the world's largest coworking company, with more than 50 million sf in 112 countries. It is a major player in the U.S., with about 21.1 million sf in the largest 50 markets, according to Yardi. WeWork, in contrast, has 45 million sf in 29 countries.

Top Coworking Markets

Market

% Of Office Stock

Brooklyn, N.Y.

3.9

Manhattan

3.7

Miami

3.5

San Francisco

2.6

Los Angeles

2.6

Seattle

2.5

Salt Lake City

2.1

Nashville, Tenn.

2.1

Boston

2.0

Orange County, Calif.

1.9

Source: Yardi Matrix

But unlike WeWork, IWG is profitable. The company, which is based in Switzerland, generated an operating profit of $66.4 million on $1.7 billion of revenue during the first half of 2019.

IWG, like WeWork, mostly subleases its space to small companies and start-ups, but both have inked deals with large companies, including Facebook, Adidas, Microsoft and IBM.

"When you think about commercial real estate today, flexible working is a known commodity whereas before, we spent a lot of our time educating the customer as to the benefits," said Michael Berretta, IWG's vice president of network development. "Now the customer demand is self-evident."

The investor community agrees, as it has plowed plenty of capital into the sector.

SoftBank Group Corp. of Japan invested billions in WeWork before its failed initial public offering. It invested another $9.5 billion in October, increasing its ownership to 80 percent.

Meanwhile, Convene, which was founded in 2009 and has 30 locations with 1.5 million sf in Boston, Chicago, London, Los Angeles, New York City, Philadelphia and Washington, lined up $280.5 million of equity from investors that included Brookfield Property Partners, RXR Realty and the Durst Organization.

And Knotel Inc. has raised $560 million, valuing the company at more than $1 billion. Its investors include NKF, Norwest Venture Partners of Palo Alto. Calif., and Wafra Inc., the investment arm of Kuwait's sovereign wealth fund. Knotel, founded in 2016, has signed leases for more than 4 million sf in more than 200 buildings.

Industrious, meanwhile, is a slightly different animal. Instead of leasing blocks of space and subleasing it like other coworking companies, it manages coworking space that landlords have set aside. It's raised $222 million of capital from investors that include Brookfield Property, TF Cornerstone and Wells Fargo Strategic Capital. The company, which was formed in 2013, has 90 locations in the U.S.

Industrious earns a management fee for the work it does. Its model is similar to those of Marriott International and Hyatt Hotels Corp., which manage hotels for their owners. Among its clients are Blackstone Group's EQ Office affiliate, for which it operates 140,000 sf at the Hughes Center, a 1.4 million-sf office complex in Los Angeles; as well as Hines, for which it operates coworking space at 717 Texas Ave., a 697,195-sf office complex in Houston, and the Kearns Building, with 166,939 sf at 136 South Main St. in Salt Lake City.

Such agreements are still rare, but they are expected to become more common as coworking companies seek to generate more stable cash flows and landlords look to meet the demands of tenants that prefer shorter lease terms.

Coworking as a third-party service concept is "still in the initial roll-out of implementation," said Scott Homa, JLL's director of office research. "But we're definitely expecting the lion's share of growth in the future to come in the form of those management agreements."

Some landlords, including Washington REIT, Tishman Speyer and Boston Properties Inc., have set aside space in some of their buildings for coworking. But instead of partnering with companies that specialize in the sector, they manage, design and lease the space themselves.

Boston Properties launched its concept, known as Flex by BXP, two years ago on the 29th floor of the 52-story Prudential Tower in Boston. It also plans on setting aside coworking office space at the Hub on Causeway mixed-use project it is developing in Boston.

Tishman Speyer’s initiative, dubbed Studio, was started in 2018 with 35,000 sf at 600 Fifth Ave., a 371,200-sf office building in Manhattan's Rockefeller Center. It since has expanded the concept to other properties it owns, including 125 High St. in Boston, 900 19th St. in Washington and 407 Maple Plaza in Los Angeles.

WashREIT’s coworking initiative, called Space+, is offered at 14 office buildings, spanning a total of 200,000 sf, or about 5 percent of the company's 4 million-sf office portfolio. The company expects to set aside another 100,000 sf in the program next year to meet tenant demand. The cost to lease coworking space under the program is roughly 8 percent to 10 percent more than through conventional leases. But in return, a tenant gets term flexibility plus a fully furnished office.

"If you look at the building as a whole, part of the ecosystem is that flexible, coworking space," said Rob Walters, a principal at Avison Young. "That's a portion of the tenant demand. Landlords are trying to capture that."

Jeff Shaw, chief executive of Bridge Commercial Real Estate of Atlanta, which owns 103 office buildings with 13 million sf in 14 states, noted that the demand for flexible, coworking space remains strong. So, the company has signed leases for about 2 percent of its space with coworking companies and it's close to completing a deal with a coworking company that will manage space in its buildings.

Shaw noted that Bridge expects to open five to 10 locations in 2020, of between 25,000 sf and 50,000 sf each, that it would lease on a short-term basis.

"There is definitely going to be growth (in coworking)," Shaw said. "It's something landlords need to pay attention to and it needs to be a part of their strategies in the future. It's still fairly cutting edge."

Comments? E-mail Tim Casey or call him at (267) 397-3347.



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Read 86 times Last modified on Monday, 13 January 2020

Data Digest

 

CMBS DELINQUENCY VOLUME

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CMBS SPECIAL SERVICING VOLUME

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Top Bookrunners Domestic, Private-Label CMBS - 2017
Investment Bank #Deals Vol$mln MktShr%
Goldman Sachs 17.59 11,819.34 13.68
JPMorgan Securities 14.52 10,968.11 12.70
Citigroup 12.04 10,012.71 11.59
Wells Fargo Securities 14.02 9,936.06 11.50
Deutsche Bank 12.55 9,879.74 11.44

 

RCA CPPI

 

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CMBS 2.0 Spreads

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Top CMBS Loan Contributors - 2017
Lender #Loans Vol$mln MktShr%
Goldman Sachs 146.89 11,719.34 13.63
JPMorgan Chase Bank 117.68 10,114.14 11.76
Deutsche Bank 198.48 9,689.97 11.27
Morgan Stanley 166.18 8,539.78 9.93
Citigroup 199.05 8,088.24 9.41

 

 

 

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