It seems like every week we’re hearing about another coworking company taking space in the region or a company branching out into this business line.
In addition to the most well-known WeWork, Regus, and MakeOffices and the regionally based Benjamin’s Desk (now merged with 1776 out of Washington, D.C.), newcomers to the coworking business will potentially include Life Time Work in Ardmore (adding this business line to its existing fitness and spa categories under the Life Time brand) and the proposed urban country club at 2400 Market. Where did this industry come from, what is driving its growth and what will its impact be on the future of corporate real estate?
There are lots of reasons, but one thing is for certain, it’s here and it doesn’t look like it’s going away any time soon.
What is Driving the Demand?
Coworking spaces provide companies with flexibility to grow and contract quickly with minimal commitments while also allowing them to preserve capital for their core businesses. They also free up executives’ time so they can focus on their primary business and not worry about real estate. Finally, they appeal to today’s Gen Y and Millennial workers who are just looking for something different than the isolated and anonymous office environment of their parents’ generation.
Today business is changing at an increasingly rapid pace making things a lot less predictable when it comes to planning for the future. 10 years ago, who saw Amazon buying Whole Foods, General Motors committing to making only electric cars within 10 years or large law firms having to all but abandon their long-standing leverage model? On a more macro level, the Dot-Com bubble that burst in 2001 and the Great Recession of 2008 taught us that the world can dramatically change overnight, and corporate leaders would be wise to incorporate flexibility into their game plans.
Not only is it becoming harder to predict the future, but companies today are also under increasing pressure to achieve short term results. Wall Street and private equity investors want companies to achieve quarterly financial goals which makes operational flexibility imperative. Companies need to be able to adapt quickly to both opportunities and setbacks in order maximize income and minimize losses.
Unfortunately, real estate leases tend to be relatively long-term commitments and, therefore, don’t always provide the flexibility companies need or desire. One of the first things we ask our clients to do when kicking off a transaction is to provide expected head count estimates over the next three to five years, so they don’t take too much or too little space going forward. That used to be a much easier exercise than it is today.
Leases are not only a long-term commitment, they also require a lot of capital (which could otherwise be deployed in a company’s core business) and time to plan and execute. In today’s economy where we have more and more startups who are burning cash to get up and running, committing dollars to real estate isn’t always a priority.
Finally, there may be generational differences driving the need for these new co-working spaces. Lots of Baby Boomers voice a common concern about their children’s generation: they have no patience and want immediate gratification. If true, it’s not their fault. They are the beneficiaries and perhaps victims of today’s “on demand” world. Everything they want—be it music, movies, food or information– is available at the touch of a button (or voice command) whenever they want it. Not surprisingly then, when today’s entrepreneurs want to start or grow a business, they want space now—they don’t want to wait six months to negotiate a lease and build out new offices. Also, for them, “long term” means one to two years, not five to 10.
What Does the Future Hold?
Coworking spaces originally targeted very small businesses and entrepreneurs who otherwise were working out of their homes or in a local coffee shop. The idea was to build a community of people who could support each other. Rather than living a solitary existence, these small business owners could now network with other entrepreneurs every day, share ideas, provide each other resources and even share a beer over ping pong. That model, however, is changing and it will ultimately challenge landlords to rethink the product they are providing.
If you think about it, coworking businesses have been saviors to today’s landlords. In Center City alone, they have absorbed over 500,000 square feet of office space with workers who would otherwise never be able to get space in these buildings. Because most commercial landlords would not be interested in small businesses seeking short term leases, they have not viewed co-working firms as competitors. To the contrary, they have increased overall demand for class A and class B office space even as most of corporate America is consuming less space. A gift from heaven?
Not so fast. The problem is that coworking companies are now looking to attract larger enterprise businesses who, for the reasons discussed above, are looking for flexibility, reduced capital costs and turnkey solutions. These companies are taking entire floors or large suites in co-working spaces for longer terms of 18-24 months (as opposed to month to month or maybe six months). When they have a major project, and need to hire dozens of temporary workers for one or two years or simply want to put their toe in the water in a new geographic market, these coworking arrangements can be preferable to committing to a five-year lease term and the build out of new space. Coworking arrangements also allow companies to take on more space or shed excess space as headcounts fluctuate without having to get into the sublet business or undertake major real estate projects.
As more and more Fortune 500 and other larger companies start opting for coworking environments, coworking companies will compete more directly with the core business of their commercial landlords. Because competition is always good for the consumer, what will it mean?
We are already seeing more and more commercial office buildings in the Delaware Valley creating common amenity spaces for their tenants that mirror hip coworking environments including upscale gyms, outdoor terraces, fireplaces, pool tables and conference facilities. It is likely that, going forward, landlords (and their lenders) may also have to re-examine their fixation on long term lease requirements and their resistance to expansion and contraction rights. These coworking spaces will not compete on price, they will compete based on flexibility and ease of execution. That’s good for tenants.
On the other hand, as coworking spaces start to compete more directly with commercial landlords for their bread and butter tenant prospects, landlords may either shrink their appetite for coworking tenants (thereby cutting off their life blood of desirable locations) or decide to get into the coworking game themselves. This is especially an option for large landlords who have millions of square feet of inventory spread across the country. Given the premiums that successful coworking locations are realizing, commercial landlords may decide they can in fact get up to speed on the operational and marketing skills necessary to effectively compete in this space.
The emergence of the coworking industry over the past five years has been a boon to commercial landlords by absorbing millions of square feet of vacancy with an entirely new class of tenant. However, change may be in the air for the real estate industry as these co-working companies start to evolve their business model and more directly compete with landlords for larger, better credit tenants. Landlords are being forced to rethink their business model which has been pretty much unchanged for the past 50 years. With the future hard to predict and a need to adapt quickly in the short term, tenants will need real estate solutions that are more flexible and that minimize capital and lead time. With coworking companies ready, willing and able to fill this need, it looks like real estate may be primed for the next big transformation.
This article was published in the Philadelphia Business Journal on November 14, 2017