Coworking: What Does it Mean for the Commercial Real Estate Landlord?

Wednesday, July 13, 2016

Real Estate Indicators from HFF Director Ben Sayles and Senior Real Estate Analyst Andrew Gray of HFF's Boston office.

“Innovation does not happen in isolation.”

– Jeff Bezos, founder and CEO of Amazon.com


Phil Knight knew it. Bill Belichick believes it. Steve Jobs saw it. At Apple, it was said that the best meetings were meetings that happened spontaneously in the hallway. This early version of coworking, or creating “forced collisions,” is responsible for your iPhone, your iPad and even Siri (thank you, Siri).     

Many of the innovations we take for granted started somewhere: in the workplace. The concept of "workplace" has always been defined as a strategic, geographical location where people with shared goals and objectives come together to do work.

  • Large corporations, whether they be in the fields of professional services, manufacturing or technology, built large complexes with spaces for numerous different functions all under one roof.
  • Small- to medium-sized tenants set up shop in multi-tenant buildings where the space suited their needs but possibly never fit perfectly.
  • Small companies and start-ups in particular were often priced out of the market and forced to conduct business out of a garage apartment or a local coffee shop offering free Wi-Fi (after the purchase of a cup of coffee, of course), reminiscent of the humble beginnings of now-major corporations Dell, Apple and Facebook.

And this is how it was until about 10 years ago. So, what changed and why? Both answers are very clear with immensely unclear long-term implications.

The “why” may be obvious to most: technology and demographics.

  • Technology:  By the mid-2000s, the concept of telecommuting became a legitimate alternative to going into the office. The increased presence of laptop computers, the widespread availability of broadband Internet and Wi-Fi, remote file access, the increased importance and efficiency of email and the proliferation of cell phones allowed workers to be as productive in the office as in their home, at Starbucks or on the road.
  • Demographics:  By the mid-2000s, the first wave of millennials (those born between the early 1980s and 2000) entered the workforce at the exact same time as the oldest baby boomers started retiring. The very complexion of the workforce started to change, and that change is continuing today.  According to PricewaterhouseCoopers, by 2020, millennials are estimated to make up approximately 50 percent of the global work force.

This combination of technology and the demographic shift has changed the traditional concept of work. No longer do you need to work for a massive company as a faceless employee for your whole career. Forget the typical “nine-to-five” workday; today, employees distribute their work between the hours of 7:00 a.m. and 10:00 p.m., while mixing in a workout class, lunch and some “time away from the desk”. It is this flexibility that has changed the way people design, utilize and occupy office space.

Enter the “what”– coworking. Coworking is a style of work that involves a shared working environment, often an office and independent activity.  Unlike in a typical office environment, those coworking are usually not employed by the same organization. While coworking is not new (Regus dates back to 1989), the modern concept originated on the West Coast in the mid-2000s, with a focus on community, collaboration and interaction.

Dramatic Growth

Coworking spaces have grown dramatically throughout North America, Europe and Asia. Growth has been fueled by millennial demands, but also partially driven from the Great Recession where companies were forced to scale down and become slimmer and smarter by implementing cost cutting solutions. According to a coworking magazine, deskmag, there will be:

  • 10,000 coworking spaces worldwide by 4Q16
  • Approximately 735,000 members utilizing coworking space
  • The industry will realize a 30 percent increase from 4Q15

Not surprisingly, coworking has experienced rapid growth in younger demographics and urban technology hubs of Boston, New York, the San Francisco Bay Area and Los Angeles.  Coworking companies like WeWork, CIC and Serendipity Labs are growing in popularity and planning to open new locations, both nationally and internationally.

Impact on Commercial Real Estate

Coworking has had a major impact on the performance and utilization of commercial real estate. From a performance standpoint, coworking operators have been responsible for a significant amount of positive net absorption in major metropolitan markets. This is understandable as this nascent industry barely existed 10 years ago. Coworking has also created a disproportionate amount of “new” companies that often take space in the same building or general vicinity as the incubator they came from.

From the landlord’s perspective, coworking has spurred additional investments into restroom upgrades/expansions, improved HVAC capacity and, often times, substantially overhauled vertical transportation. While employee density has increased over the past 10 years (from 250 down to 180 square feet per employee), coworking spaces are even denser – sometimes twice as much when compared to a traditional office user.

Perhaps, the biggest impact on commercial real estate landlords is the reliance on coworking operators to withstand any future economic downturn. Landlords have been making heavy investments, not only into the base building, but also into these coworking spaces themselves. While highly functional and attractive to the end user, these space are often quite different (i.e., denser and more heavily built out) from what a traditional user might require.

Real Estate’s Future – A Coworking World?

All of this begs the question: What is in store for the future? Already, traditional users of real estate have started to adopt some of coworking’s best attributes: better employee work experiences, shared resources, variety of working areas and happy hours.

While much change has already been experienced by the commercial landlord, much more is yet to come.

  • Joint Ventures:  Given the success and profitability of many coworking operators, the market may start to see joint ventures between landlords and operators. These two groups can buy, develop or reposition buildings to focus on coworking space, which would allow the opportunity for both parties to better monetize this fast growing trend.
  • Continued Redevelopment:  As the creative office trend shows no signs of slowing down, outdated office and industrial buildings will continue to be redeveloped and be particularly attractive to coworking operators. While coworking has been primarily confined to major markets, coworking operators might also spread to secondary and tertiary markets in hopes of capitalizing on untapped markets and potentially higher returns.
  • Short-term Leases:  For small- to medium-sized tenants, the typical term of a lease is likely to trend shorter, as flexible coworking spaces become a viable alternative to traditional office spaces.

Coworking has changed the way sole practitioners, startups and small businesses look at office space. It has helped lower vacancy rates while creating new companies in many markets. Coworking operators have emerged as some of the most desirable tenants in the market today, with valuations often exceeding those of their “brick and mortar” landlords. However, the long-term impacts are still unknown. Coworking has started a trend that many companies are being forced to mimic. Tenants are downsizing their footprint by leasing more functional space. If this trend continues, it will allow more tenants to populate the urban core, increasing the density that exists today.

To today’s worker, the work environment is as important as the physical space. Coworking has led to transformations in company policy, culture, working environment and facilities. People, specifically millennials, are migrating toward firms that allow for flexibility and promote a creative culture. Traditional companies are learning and adapting to this trend, and the traditional office space, tenant and lease are evolving in sync. We live in a disruptive world, and just as firms such as Uber, Airbnb and Apple disrupted the status quo of their industries, coworking has the same potential to impact the commercial real estate market.

About Ben Sayles

Ben Sayles is a Director in the Boston office of HFF with more than 15 years of experience in commercial real estate. He is primarily responsible for investment sales transactions focusing on office, multi-housing and retail properties.

A graduate of Trinity College in Hartford, Connecticut, Mr. Sayles is the Director of the Commercial Brokers Association and an Executive Committee member of NAIOP Massachusetts. Additionally, he is active in several other notable commercial real estate professional groups, including Urban Land Institute and International Council of Shopping Centers.

 

About Andrew Gray

Andrew Gray is a Senior Real Estate Analyst in HFF’s Boston office. He is primarily responsible for preforming complicated financial modeling, preparing investment memorandum for all capital markets activities, marketing activities and coordinating the due diligence and closing process.

Prior to joining HFF in May of 2016, Mr. Gray was a Senior Associate at Hillwood, a Dallas-based private equity investor and developer.  Mr. Gray is a 2012 graduate of Texas Christian University, where he received a Bachelor of Science degree in finance with a concentration in real estate.     

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