By Richard Sexton, MBE
The global pandemic has placed a large magnifying glass over the role of the office and made companies rethink the way and thus where, their employees work. The battle is now on to be your future workplace. The parties fighting for you are the traditional office, flexible office operators and your home! This article looks to navigate you through the battleground and help determine the likely winners and losers.
Over the last decade, for progressive companies, the office has played a key role in the, “War for Talent” – on recruiting and retaining the best people. ‘Flexibility’ and ‘agility’ have been the main lexicon of workplace strategists, understanding that productive staff want a range of workspace, whether it is a large open plan meeting room for collaborative projects or a high-top in a quiet area to be alone and think. The Internet of Things (IoT) enabled companies to collect data on how space was being utilized and “PropTech” companies responded with software to maximize the efficiency on building and space use.
Concurrently, leveraging the above factors, a revolution took place in the “flexible workspace” sector. The dour private executive office suite became, contemporary “coworking” space for communities, with WeWork leading the charge. The emphasis was on “Workspace as a Service” (WaaS) with a plethora of amenities provided and pricing bundled into one monthly payment. Long-term leases gave way to short term licenses, re-branded as more friendly, “Membership Agreements”. It was effectively the convergence of outsourcing and hospitality applied to the commercial real estate business.
The movement disrupted an industry which favored the traditional landlord who sought long-term leases to secure cash flows to create value and leverage lending. While many established companies were comfortable signing 10-15yr leases, many smaller ones and particularly the fast-scaling tech startups, could not predict where they would be in six months time. Flexible office solutions were perfect for them.
Exponential growth was predicted, in 2015, JLL wrote “up to 30 percent of corporate portfolios could be co-working or flexible space by 2030”
Traditional landlords sat up and took note.
Everyone wanted a piece of it. Some landlords created their own products, for example Studio by Tishman Speyer or Storey by British Land (UK). Others created strategic partnerships like RXR Realty with Convene or Hines with Industrious. What started as an upgrade from the coffee shop for entrepreneurs and small businesses would grow by 1000% by the end of the decade to be an office solution for large enterprise companies like Facebook, IBM and HSBC.
In Jan 2019 JLL doubled down on their 2015 prediction, Then a year later came a global pandemic and the Working From Home (WFH) phenomenon which would re-draw the battle lines.
The Impact of Shelter-in-Place
The tensions that are rising within the industry are due to the pandemic’s, “double whammy” – a recession and a realization that employees can work productively from home. In a recession companies look to reduce overhead and as workforce is reduced so is the need for square feet. Likewise, an increase in WFH policies will further reduce the amount of office space a company requires. Everyone is therefore fighting for a piece of a smaller pie. Some would argue that with social distancing companies will require more space, but I expect, with the emphasis on capital preservation, that this will be off set in the short term by re-purposing existing space and having staff return in teams on alternate days.
Much has been written about the policies and procedures needed to welcome people back to the office and it does not paint a pretty picture for anyone, flexible or traditional. With Summer now upon us, most LA folks are looking to post Labor Day, September 8th, as the natural return point – with the phased reopening of LA starting today things could be quite different in 3 months.
In the short term, WFH wins!
The Challenges Ahead
The battle is really for the hearts and minds of companies in the longer term once we have emerged from the pandemic and living in a society where we are either managing the R Value or we have a vaccination and are once again embracing social interaction.
I have seen several predictions that this is the end of flexible workspace. This would seem counter-intuitive in a recession when uncertainty, unpredictability and preservation of capital would see companies push for shorter term leases requiring little to no capital expenditure.
Critics point to 3 pressure points; higher density, pricing, and lack of control (sharing with other companies).
The problem, as I see it, is the negative press puts flexible workspace in one bucket and tars it with the same brush as WeWork’s highly publicized problems.
It focuses on operators who provide the open plan coworking centers in the traditional flex office business model. Critics are correct, this is high-risk, long term liabilities with short term assets. It involves the operator taking a long lease – albeit with favorable incentives like rent free periods and contributions to fit out. The operator then fills the space with companies on short term license contracts on a pricing model that incorporates all their costs plus a profit. Works well when there’s high demand but right now, centers will have high vacancies and suffering from severe cash flow issues as entrepreneurs and smaller companies run for the hills. The dense open plan and “community” led models will be unpopular while social distancing protocols remain in place, so it is unclear when their target client will return.
When they do, the operator will be competing with a market awash with subleases and landlords offering cheaper direct leases. For these types of operators to survive they will need to renegotiate more favorable terms on their own leases and hope people’s comfort level for returning happens ASAP.
There will no doubt be those that do not make it through this. In their favor is that the centers are typically, “Single Purpose Entities”, easier to wind up and so it will not necessarily create a domino effect and operators can focus on those that work while closing those that do not.
However, landlords who have leased to operators on these arrangements are very exposed right now. I suspect they will recast leases as partnership agreements or bring in third parties to run the spaces. It is in no one’s interest to see the space sitting there idle, it needs to be put to work. Interestingly, last week in Hong Kong, we saw the first time IWG took over a WeWork. Deals are there to be done!
Not All Operators Are The Same
As described earlier there are many different players in the flexible workspace industry and that in turn means there are nuances in the services, products, and business models. While “coworking” in its truest sense will struggle, I see those that focus on partnerships and profit sharing with landlords will do well, for example Convene and Industrious.
Their centers are a hybrid of high-quality office suites (less dense than most) and contemporary common areas. They give landlords the ability to outsource a flexible component to their buildings while they can focus on their core business of longer leases. Thereby giving their customer a “core and flex” choice within the building.
All these providers recognize that their customers are looking for absolute flexibility and are therefore adapting their suite of products to cover all workplace eventualities, even using technology to link with companies WFH experience.
Flexible workspace operators are also promoting the values of their ‘networks’ on the basis that as companies adopt more WFH policies, accessibility to quality workspaces closer to home with minimized commutes will become more in
The knives have been out for WeWork and to a lesser extent Knotel, for a while now. They say that people that suffer from serious underlying conditions are more at risk from Covid-19 and that is certainly true of companies. Both expanded rapidly in an upward market flush with cash, with a voracious appetite to take on leases and grow teams (many of whom have now been cut). It will be interesting to see how they fair. WeWork have been moving away from servicing smaller clients to be more “Enterprise” driven, that is focusing on solutions for larger clients. They also have the largest network and are keen to leverage this as, “Hub & Spoke” becomes the flexible workspace industries latest buzzword.
Knotel have a different model more akin to a “Managed Solution” but rather than create bespoke spaces for specific needs, they acquired a portfolio of spaces for companies to scale (up or down) into. The problem is they were burning cash when sitting empty and that problem will only be exasperated by the lockdown and recession. To their advantage they lease whole suites to a single company so do not have the sharing and control issues of the others. Breather has a similar product but have gone about their business with less razzmatazz than Knotel; not expanding so aggressively and a focus on real estate rather than hiring large teams, so I expect them to come out of this quite well.
Making The Right Choice
Of course, all this is speculation, but the ultimate winner will be the companies who correctly match the spectrum of workplace opportunities to their business.
Whatever the future holds it is at the bottom of the market that the real estate industry is at its most creative, think WeWork beginning in 2010. Already 24 leading flex operators have come together for the first time to create, The Workplace Operator Readiness Council in response to the pandemic.
One thing I can predict with confidence is that the bargaining strength will be with the tenant for a while to come, so make sure you have an advisor that can help you navigate all the opportunities across flexible and traditional solutions, and with so much chaos, ensure you do your due diligence on landlords, buildings and operators.
About the author: Richard Sexton, MBE, is the CEO/Founder of Office Concierge LLC, an independent tenant representation advisory firm. Richard has held senior positions at traditional leasing firms, as Partner, Knight Frank and Senior Managing Director, Newmark Knight Frank, and with specialist flexible workspace brokers, Office Freedom, as President.
