COLLIERS MINNESOTA

The Critical Questions of Coworking

 

The hottest trend in commercial real estate in the last five years has been the emergence of “coworking.” The growth of this business model has been nothing short of meteoric. But it does lead those working in commercial real estate to ask some important questions about how coworking has changed the office landscape and what could we see shift in the future.

 

What exactly is coworking?

Generally speaking, coworking is when a lease administration businessowner takes on a master lease within a property and then subleases out access to common areas or modest-sized private “offices” to startups, small organizations or individuals who are looking for office space but don’t want to commit to a long-term lease or don’t need as much space as what traditional offices offer. Coworking provides flexible lease terms for top-level, fully-furnished space for these smaller groups. 

 

In addition to providing space for smaller users, coworking companies have recently expanded to start creating space for larger corporate users. Examples could be companies who are growing quickly and need more move-in-ready space; taking on a project in a new market; moving a division into separate space or simply companies looking for cool office environments for employee recruitment. This emerging model is very attractive for coworking companies because they are subleasing a large portion of their space to one credit-worthy group and can parlay that into future business in other markets.

 

While the concept of coworking was once thought of as one long table with twenty people sitting at it with laptops and headphones, much like a crowded coffee shop, the coworking companies have been shifting their model to include more private suites and are now even allowing some larger users to brand their space. 

 

Are coworking companies really the fastest growing office user?

As a subset, coworking companies are the fastest growing office tenant type over the last five years. A perfect example is WeWork, which signed its first lease in April of 2011 in New York and has already grown to become the largest tenant in Manhattan by square footage. They currently have 5.2 million square feet of space in just Manhattan alone.

 

In addition to local coworking companies, all the major national coworking groups have entered the Minneapolis market in the last five years. WeWork opened two locations in 2018, one in downtown Minneapolis and the other in Uptown. The Uptown location had to double its lease size before it even opened, due to a corporate user’s desire to move 200 employees to this location. In total, WeWork has over 150,000 square feet of new space this year and are very vocal that they are looking to significantly increase their footprint locally in the coming years. 

 

Metro-wide, a total of over 800,000 square feet is currently occupied by coworking concepts, with that number expected to continue to rise. As a point of comparison, that is enough space to occupy the top 40 floors of the IDS Center in downtown Minneapolis.

 

What is the cost difference?
Coworking pricing varies depending on the location, but there is a cost premium per employee no matter where the coworking space is located. However, the cost benefits often outweigh this premium – coworking spaces offer amenities such as a receptionist, printers/printing, sometimes parking and other items like coffee, water, pastries and in some places, beer is also included as part of the all-in rate. Also included in the all-in cost is the premium for flexibility to downsize and expand a small company’s coworking footprint based on their month-to-month space and staff needs. Arguably, the biggest cost-saving benefit of coworking comes from the sublease tenant moving into a fully built-out space at a premium address, this is because as construction costs continue to rise, not having to foot the cost of a build-out can create significant savings.

 

An important item to note is that in other markets, where traditional office rents are double or triple per square foot than rates in Minneapolis-St Paul, the calculations of cost-savings can change significantly.  So, while coworking pricing is also different in other cities, the “breakeven point” of traditional space versus coworking space still skews more towards coworking.

 

Are these deals leases?
Many companies, including WeWork, call their contracts membership agreements, which makes the paperwork different than if it is a lease. The specifics of these differences are a subject matter to be examined by legal and accounting professionals.

 

Is the growth in the coworking industry sustainable?

Since the rise of coworking five years ago, there have been concerns about the viability of the model in an economic downturn. When your business is providing high dollar rent to low or no credit tenants, there is a higher risk, as statistically these types of tenants are usually some of the first companies to either significantly cut costs or dissolve altogether in a slump. 

 

Using WeWork as an example, the company has an estimated $18 billion in outstanding lease obligations in the coming 8 years. This massive cost, while being the product of strong growth, is also the most dangerous item financially for WeWork. With that said, there has been a significant shift in how office space is being used, so the idea that the coworking trend will completely dissolve or revert is unlikely, even in an economic bubble. Because of the rise of the “Uber Generation,” where memberships and pay-as-you-play are becoming more common, direct ownership will likely see a decline which is why WeWork and similar models will likely continue to affect the future of commercial real estate use.

 

It should also be noted that the early leases of 2011, 2012 and 2013, were signed in a very different part of the real estate cycle and renewals which may be coming up soon could have very different terms now than the original leases. It is possible that the rental rates could significantly increase if WeWork wants to stay in existing locations. This could impact their growth if existing locations become financially impractical and force relocations, even within a market.

 

What are some other business models for coworking?
Understanding that while access for premier, high rent assets for small groups is a major selling point for the coworking model to achieve success, there is no denying the risky financial implications of this model because of long-term, significant rent owed. So, we are now seeing a shift towards coworking companies buying buildings as well.  

 

In the last six months, two buildings in downtown Minneapolis have sold to Novel, a new-to-market coworking firm. Novel is a coworking company that, unlike others, purchases buildings to enter markets, which they argue helps keep costs lower for their members. The two buildings add up to roughly 200,000 square feet of space. 

 

WeWork is entering this space as well. They have countered the lack of assets on their balance sheet by partnering with veteran investment firm, Rhone Group, to create a fund with the purpose of purchasing buildings for WeWork to operate. The stated goal is to benefit from the property appreciation that it creates as a tenant. This spring, WeWork Property Investors launched and soon after paid $850 million for the Lord & Taylor’s building in Manhattan, which will become the new WeWork HQ. In a separate deal, WeWork partnered with TH Real Estate and PF Ejendomme to purchase a $800 million office complex in London as well.

 

The shift to becoming a full real estate landlord provides WeWork with saving margins on ownership versus leases and creates more control in general. The strategy helps to vertically integrate their presence in the commercial real estate market, wherein the same group is buying the building, managing, doing their own build-out through their own designers and then “leasing” that space out.  Controlling costs at all points allows the company to potentially boost overall return and find a place to park the cash they build.

 

Another potential business model is the idea of franchising coworking spaces into a model where ownership may be one party and the coworking group becomes an operator. This is a low-risk option for both parties and could be a way for building owners to enter the space and tap into an existing network with no direct work. This also provides a potential angle for operators to either pivot or grow their brand in an increasingly competitive coworking world. 

 

What if a coworking group closes? What happens to the subtenants?

From a user/subtenant side, this is a legitimate concern, but as the coworking concept is so new, we have seen very few closures. The reality is that for smaller users, if the master coworking company went out of business, the subtenants or member’s agreements would be terminated. Basically, small groups would likely be out of luck and would need to find new space immediately. However, larger tenants may be able to sign direct leases with the landlord and stay in existing space if the layout permitted it. But these direct option contingencies are not included in terms with coworking groups, so it is a risk.

 

How does the coworking trend affect landlords?
From one perspective, tenants who are taking up coworking space did not exist ten years ago, so all growth has been positive new absorption which has helped overall market leasing. However, it is not hard to project that leasing for some smaller spaces may be impacted if new tenants continue to look to coworking office concepts over direct leases.

 

Some building owners see the potential of the coworking model and think that they can run a cost-effective way of creating speculative (spec) suites that have some shared amenities, to directly compete with these coworking groups. A landlord can build out a floor or several spaces and even provide some of the benefits coworking spaces provide like a lobby, concierge and space activation, all at a lower price point for tenants. Turnkey options appealing to immediate or flexible tenant demands are becoming more common and some landlords are becoming direct competitors to the coworking boom.

 

National examples include large landlords like Tishman Speyer and RXR Realty who have already entered into agreements to launch their own coworking models into their buildings. This is an example of a hybrid business where the landlord is creating spec suites and contracting out the management and operation duties to an established coworking group to handle.

 

Locally, Osborn370 is a unique example of coworking space in downtown St. Paul. Ecolab sold their former headquarters building to a group of investors that were looking to invest in and capitalize on the entrepreneurial spirit of the city. In addition to having several incubator tenants, the building also has a flex floor that only has short term small spaces for lease. This acts as both a demand pressure valve for existing tenants who may be in growth mode, or for new companies that ownership is priming to become full-time tenants in the future.

 

How do landlords underwrite having a coworking tenant?

Credit is a major concern for building ownership and coworking groups don’t necessarily have good credit. The companies are new and in growth mode, therefore taking on debt and fundamentally, many of their coworking tenants are low and no credit organizations. Coworking groups therefore often need a letter of credit or need to provide legal guarantee. Some of the larger and more well-known coworking firms may find it easier because their name brand will carry some additional weight in the landlord’s eye. So, this may be bigger factor for smaller, new or local-only groups.

 

Does a coworking tenant affect resale or valuation of the buildings?

The impact of coworking tenants on the valuation or resale of a building may be impacted by who the tenant is- a new, local group or a nationally or regionally known group. One factor that always impacts resale value is credit of tenants, so depending on the group it could be a slight negative or a positive.  However, many potential buyers would also like to have some exposure to new, fast growing office sector which would bring in interest. Safe to say that taking out situations where it is a single-tenant coworking building, the valuation of a building would not be negatively impacted and depending on the coworking tenant, could be positive force on value.

 

Coworking is the fastest growing office using sector, nationally. It is changing how companies take on space and capitalize on the trending demand for flexibility and immediacy. But because coworking is so new, there are many unanswered questions as to how it may change the real estate industry. With coworking fracturing from the old, “one-big-coffee-table model” into a million different flavors, we will have to track the trend and analyze its impact, by continually asking the critical questions of coworking.

 

 

Tyler Allen

Senior Research Analyst

Colliers International | Minneapolis - St. Paul 

Connect with Tyler

Share on Facebook
Share on Twitter
Share on LinkedIn
Please reload

FEATURED POSTS

September 6, 2019

November 5, 2018

Please reload

Untitled design (29).png
  • LinkedIn Social Icon
  • Twitter Social Icon
  • Instagram Social Icon
FOLLOW THE FUN ON INSTAGRAM
Colliers_Logo_PMS_Rule_Flat.png
  • White LinkedIn Icon
  • White Twitter Icon

ABOUT COLLIERS MINNESOTA

Defined by our spirit of enterprise, Colliers Minnesota is a leading, full-service commercial real estate services organization.  We are dedicated to providing clients with innovative real estate solutions and the most comprehensive market knowledge. We specialize in understanding our client’s unique business needs in every commercial property type.

Headquartered in the Twin Cities with regional offices in Minnetonka, Minneapolis and Shoreview, Minnesota, Colliers International | Minneapolis-St. Paul consists of more than 240 local professionals. Our expertise extends into every aspect of today’s commercial real estate business including architecture, brokerage, facility services, investment sales, project management and property management.

Globally we are represented by more than 15,000 Colliers International professionals operating out of 502 offices in 67 countires.