- We spoke to eight people in the flex office space about their predictions for 2020. We asked about the potential for industry consolidation and how demand is shaping up for next year.
- JLL has predicted that 30 percent of office space will be flexible by 2030.
- Several said they expected a shift in design focus for flex offices, particularly those offering coworking spaces, and that the cliched idea of 2010s office design will make way for more practical design.
- They observed that growth in single-desk coworking has largely flatlined, and one noted that VC money has dried up for the space.
- Meanwhile, a crowded field is pinning its hopes on growth in demand for flex-space from big companies.
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Over the last 10 years, WeWork brought coworking and flex-offices to the mainstream. And in 2019, a failed IPO brought WeWork to the front page.
The subleasing model WeWork is known for was flagged by the Boston Federal Reserve as a potential systemic financial stability risk. And real estate magnate Sam Zell based the approach, saying that every company that had tried it has eventually gone broke.
WeWork, which slashed jobs and is desperately looking to shed businesses it bought just months ago, has had a high-profile rise and fall. But there’s still a constellation of other players as well as real estate incumbents that say the fundamental flex-office model is sound.
“WeWork showed the world that if you give people the option of flexibility, people want it and will pay for it,” Jonathan Wasserstrum, chief executive and cofounder of online marketplace and brokerage company SquareFoot, told Business Insider.
The industry was built on expectations for rapid growth —JLL has predicted that 30% of office space will be flexible by 2030, up from just 5% now.
We spoke to eight executives in the flex office space about their predictions for 2020. We asked them if the industry is heading for consolidation, what approaches have the greatest chance of success, and if there’s any continued WeWork fallout.
They observed that growth in single-desk coworking has largely flatlined, and one noted that VC money has dried up for the flex space. Meanwhile, a crowded field is pinning its hopes on growth in demand from big companies.
The WeWork Effect
While WeWork remains one of the two largest flex office providers (veteran IWG is the biggest), some flagged that its size is only a blip in the larger flex office landscape.
“WeWork is 3 percent of the global market, but they make 99 percent of the noise,” Brian Dice, cofounder and CEO of flex office consultant and research company OfficeNetwork, said.
WeWork investors were spooked by its wide losses, governance issues, and lack of a clear path to profitability. After WeWork’s IPO imploded, it needed a SoftBank bailout to avoid running out of cash.
“I think most landlords are furiously trying to figure out what this all means,” Jamie Hodari, CEO and cofounder of coworking startup Industrious, told Business Insider in an November interview.
Some of the experts we spoke to said that landlords are avoiding doing business with coworking operators, while others said that this period of caution is already passing.
“Some refuse to deal with it,” SquareFoot’s Wasserstrum said.
Bill Bennett, CEO and founder of Novel Coworking, said: “a lot of them have lost a lot of money on the value of the leases they’ve done with their third-party coworking operators.”
But some coworking execs say that the WeWork drama hasn’t impacted demand, and some WeWork competitors are actually benefiting from it.
“I have heard that some competitors of ours that overlap with WeWork for target clients are getting more demand,” said Mark Hemmeter, CEO and founder of coworking franchise Office Evolution.
Still, WeWork’s rapid expansion and high-profile stumble has prevented the industry from “setting what a true market equilibrium is,” said SquareFoot’s Wasserstrum.
WeWork’s new status as a parable of the risks of large amounts of venture funding may also keep venture money away from flexible offices.
“The story for 2020 is that demand continues to rapidly rise and VC funding is dead to the sector,” Novel Coworking’s Bennett said. But Bennett believes that private equity, sovereign wealth funds, and conventional real estate will rise to replace VC funding.
Ben Munn, managing director of flex space at office behemoth JLL, thinks that funding won’t evaporate, but it will become more discerning.
“I think the level of awareness and understanding has just gone through the roof in the last few months,” Munn said. “Investors are more savvy about the things they need to look at to make those decisions.”
A focus on enterprise customers
While WeWork has made financiers and landlords more conscious about potential risks of the lease arbitrage model, execs we spoke to said that big companies are still interested in the option of flexible space.
“From a corporate occupier standpoint, the clients that we do business with, they’re very bullish on the flex office world,” OfficeNetwork’s Dice said.
JLL’s Munn agrees, highlighting HSBC’s 1000-desk deal with WeWork this June as just one indicator of how flex-offices has changed the way corporate real estate is done.
“It will continue to be bigger and bigger part of the way that corporate portfolios are managed and delivered,” Munn said.
The executives we spoke to cited everything from tax rules that bring operating leases onto the balance sheet to the highly uncertain and rapidly changing nature of the business world as reasons for this shift.
While some expect these corporate and enterprise customers to sign master service agreements with one or a few providers, cutting down the time and effort required to negotiate and approve deals in new buildings, OfficeNetwork’s Dice said that this approach can actually cost a lot of money.
“What we have found when we’re working with those companies, is that when they get to the point of not looking at the marketplace, they’re overspending by 20 to 30 percent,” Dice said. “That ease of use is expensive.”
Hodari from Industrious said that big deals can come with big concentration risk, and potentially big costs.
“That’s the part of the industry that requires pricing to a loss,” Hodari said, explaining that companies catering to this size are “subsidizing the product in order to get revenue growth.”
Hodari and Novel Coworking’s Bennett both expect growth in demand from mid-size companies, while Bennett said that desk-rental — meaning traditional coworking —has flatlined. Others agree that traditional coworking may be oversaturated.
“I’m less bullish about the coworking,” Jim Underhill, CEO of tenant-side brokerage Cresa, said. “I think that may have already been flooded.”
But Office Evolution’s Hemmeter said that his business has not seen any slowing in demand on the coworking side. He highlighted the importance of segmentation to focus on specific customer subsets.
Management partnerships will become the norm
2020 will see landlords making firm decisions about whether to avoid or embrace flex offices. While many have already been making decisions about the space, WeWork has forced their hands.
“There are some very thoughtful landlords, but no one has a crystal ball,” Industrious’s Hodari said.
Many said landlords will turn to managed lease partnerships and managed agreements, where operators share revenue with the landlord after a certain point, instead of operators simply paying a lease and keeping any upside from re-renting space out. Hodari’s Industrious and competitor Convene are making big bets on this play.
“One of the biggest trends is the rise of the management agreement between owner and operator,” Charlie Morris, practice leader for commercial real estate company Avison Young’s flexible office solutions. He cited WeWork’s large lease obligations as one of the factors behind this change.
A management arrangement means landlords burden more of the risk and more of the potential revenue upside, while significantly decreasing balance-sheet risk for the operator, according to Cresa’s Jim Underhill. Some landlords are bringing in branded solutions, while others are partnering with operators to create white-labelled providers specific to a landlord’s own portfolio.
Other landlords, such as Tishman Speyer with its Studio brand, are cutting out coworking operators entirely. But that can be tough for landlords that don’t have much experience with actually running a coworking space.
“It’s difficult for landlords who are more asset-management or investment oriented to operate a business,” JLL’s Munn said.
A focus on practical design
Several people we talked to said they expected a shift in design focus for flex-offices, particularly those offering coworking spaces, and that the cliched idea of the 2010s aesthetic will make way for more practical and pragmatic design.
“People built some pretty cool-looking offices that were all open floor plan environments that were excruciating to work in,” Industrious’s Hodari said.
“A water slide, a cool neon art installation, or anything else can’t fundamentally change whether somewhere is a productive work environment,” Hodari said. “The whole market has moved very quickly to obsessing not on aesthetic design but on functional design.”
Hodari thinks that we will continue to see office providers move towards the sorts of designs and aesthetics that retain customers, instead of merely being eye-catching.
Outlook for consolidation
With some history of consolidation in the space, operators may look to M&A as either a way to get paid for their equity or as a way to quickly grow.
“There are two real ways to cash out,” OfficeNetwork’s Brian Dice said. “You can go public, but smaller providers aren’t going to do that. Or you can can be bought out.”
Dice highlighted that only WeWork and IWG seem like they’d be in a position to acquire any of the other brands, and that with WeWork shuttering or looking to unload prior acquisitions at huge discounts, it is unlikely to acquire anything more.
SquareFoot’s Jonathan Wasserstrum said that we are probably near the beginning of consolidation, but that it might not happen in 2020.
But JLL’s Ben Munn saying that large-scale consolidation is unlikely from operators in the space without some sort of economic downturn. And if we do see consolidation, it will likely come from companies outside of the flex-office space.
“We can look forward to some external players in parallel industries such as hospitality who are interested in entering the space,” Munn said.
“We are still in mode 1.0 in the development of the market,” he added.
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