The Rise of Coworking: The Momentum behind Flexible, Ultra-Short Leasing Strategies
By Rebecca Green, Master's of Real Estate '14, Cornell University While completing studies to earn her Master‚Äôs of Real Estate from Cornell University, Rebecca Green also conducted extensive, original research which has earned her notable distinctions. Her intriguing article explores the market for flexible, short-term coworking space: it may be bigger than you think. Introduction The ubiquitous ‚Äòcoffee shop entrepreneur‚Äô who migrates from her home-based office to the nearest cafe has given way to a new group of start-up-oriented individuals and businesses who recognize the need for innovative and functional space. Changes in technology, attitudes toward work, and an increase in funding for start-ups have given rise to more people choosing when, where, and how to work. As sources of seed and venture capital have reemerged, the majority of startups still do not have the cash or required credit needed to rent traditional office space. This new generation of workers, which is growing rapidly, is demanding more flexible and affordable office space, yet property owners have so far largely failed to recognize this group. According to 2010 Census data, 4.3 percent of the 137 million workers in the United States telecommuted compared to 3.7 percent in 2005. This is an additional 4.5 million people who are¬†seeking alternative and flexible workspace. In addition to the rise of the ‚Äúfree agent,‚Äù many property owners have faced higher vacancy rates as stable and corporate tenants have downsized their footprints, to lower operational costs and meet the desire for more integrated workspaces. According to the CoreNet¬†Global Corporate Real Estate 2020 Survey of 500 corporate real estate executives,¬†the average amount of square feet per worker has decreased from 225 SF in 2010 to 176 SF in 2012, and projected to drop to 151 SF by 2017.¬†¬† Property owners who do not respond to the trend of scalable office space and smaller footprints are susceptible to obsolescence, and are already being¬†challenged by a new breed of office providers who are meeting the growing demand for flexible, collaborative, scalable, short term office leases ‚Äì the so-called ‚Äúcoworking‚Äù space. ¬†This article explores the relationships between property owner, coworking operator and start-up in New York City and offers strategies for property owners and investment managers who want to enter this market, as well as potential implications for wider dissemination of this burgeoning trend. ¬† What is Coworking? Coworking, in its most basic form, offers ultra-short office leases ‚Äì anywhere from a day to a month - that give people space to work independently, collaboratively, or in small teams. Coworking as a use of space is not a new concept but this type of real estate has seen tremendous growth in the last half decade. According to Deskmag, an online magazine about coworking spaces, the growth of coworking spaces has been 100 percent annually for the last seven years. Access to coworking spaces and membership varies depending on the operator but credit checks, large down payments and long term commitments are typically not required which make them an attractive option for many individuals and start-ups. Most coworking operators vet applicants before granting membership, and often include nontraditional screening methods. The Community Manager at¬†WeWork Bryant Park emphasized "fit" as being important by stating that "we like to see our members contribute to the collaboration and information sharing here at WeWork so everyone is working toward creating a sense of community‚Äù. Coworking typically exists in high-density urban markets. New York City is one of the largest markets for coworking. It is clear that coworking often emerges in markets with strong technology sectors, as evidenced by coworking growth in the tech hubs of Austin, Seattle, and along New York City‚Äôs ‚ÄòSilicon Alley.‚Äô The coworking model works in large urban areas because the cost of real estate is high, there are a large number of start-ups, and it is often difficult to find smaller and scalable floor plates to accommodate the needs of a start-up. Start-ups and businesses locate in high density urban markets to benefit from knowledge spillover, clustering, and access to capital. Recent interviews with coworking operators revealed zero percent vacancy and waitlists for memberships. Many operators were planning to expand their footprint by offering more locations under their umbrella‚Äîand these expansions are not just limited to the same regional market. The aforementioned WeWork has locations in New York, California, Seattle, Washington D.C, and Boston and is opening new spaces in Chicago and London. Another operator Grind is also expanding from its native New York to Chicago. As coworking becomes a more acceptable‚Äîand even demanded‚Äîpart of the office experience, many operators are fielding requests from current and prospective members for a seamless national platform that allows an individual or start-up to visit multiple locations in cities around the country under one membership. Coworking-type spaces have also influenced corporations. Major tenants including Bloomberg, NBC, and American Express have created more open and flexible office layouts and aim to adopt the startup methodology to open up channels of communication, retain and attract employees and keep ideas in-house.¬† The federal government, which occupies millions of square feet in the Washington D.C area, is also moving in this direction. When the General Services Administration completes its renovation in 2015, the new building will accommodate 2,000 more workers than it had previously because of shared work spaces and telecommuting. The changing demographics of today‚Äôs economy dictate a rise in nimble, technology-focused businesses and the eschewing of traditional, highly-populated manufacturing firms. In New York City there has been a 21 percent jump in information technology employment. Crain‚Äôs recently reported that employment in the Technology industry is catching up to Wall Street. In addition, shrinking square feet and increased VC investments all indicate that demand for flexible workspace will continue. ¬† Source: NYC Department of Labor. Data is for 2007 and February 2012. IT jobs are measured by computer systems design and related services. NYC jobs include only private sector jobs. New York City - The Submarkets of Coworking In New York City, 108 coworking spaces and 55 operators were identified offering a total of 2.4m square feet. The majority of these spaces are run by coworking operators, who lease from property owners and then sublease to start-up companies or individuals. In some cases, a coworking operator will manage just one or two locations; however, several operators manage multiple locations. There are also property owners, such as SL Green Realty Corporation and Vornado Realty Trust, that have entered the market directly by subdividing floor plates and self-operating shared work stations. Coworking possibilities can be divided into these distinct classes: Executive, Entrepreneurial and Creative. In New York City, the Executive coworking group offers the most square footage and locations. The Executive coworking group predates many Creative and Entrepreneurial operators and caters to business travelers and executives. Historically, operators in the Executive space have been less concerned with collaboration and information sharing, and more focused on efficient floor plates that maximize the number of rentable offices that can be turned over quickly and rented at high volume. In 1989, Luxembourg-based Regus was one of the first operators to offer Executive offices and office suites on a short term basis. Today, Regus is the largest operator in the Executive business sector of office sharing. Regus has 40 locations in New York City and in the past two years been developing more "open, collaborative" designs in its facilities.¬†¬† The Entrepreneurial coworking space is the fastest growing. Operators including WeWork, NeueHouse and Grind have become market leaders in size, number of locations, and brand recognition. Most operators in this space go beyond what's offered in Executive-oriented platforms by offering classes, lectures, networking and business services to help facilitate knowledge sharing and a collaborative and energetic work culture. Several Entrepreneurial operators have noted that renting out event space and hosting classes are becoming an important source of revenue. For example, The Centre for Social Innovation, a large operator with locations in NYC and Toronto, hosts workshops and lectures on business plan development and sourcing seed capital by reputable practitioners in the field. Another large operator, The Yard, hosts regular happy hours for coworking members and non-members to network and share ideas. These events attract a majority of members and operators can drive revenues by often requiring additional fees for access to highly demanded events beyond members‚Äô dues or rent. Many coworking operators are seeing an increase in margins attributable to these types of events. These operators recognize the importance of location and service to their business model and as such, it is not uncommon for these operators to have real estate personnel on their teams to lead leasing, landlord and tenant relations, operations and marketing. The Creative submarket is the smallest submarket. This submarket is typically made up of individuals who serve an immediate and local community. These spaces often cater to individuals, rather than businesses, which use these spaces for artistic and other creative endeavors. It is estimated there are less than 20 Creative coworking spaces in New York City, though there could be more as they tend to be informal spaces found through word of mouth. Examples include 3rd Ward (now defunct), Brooklyn Writers Space and coworking space offered at Brooklyn Lyceum. ¬† Property Owner Strategies There are three leading strategies for property owners to enter the market. These include: 1) renting out space to coworking operators, 2) entering the market directly by subdividing floor plates and self-operating shared work stations, which can yield new companies that grow into tenants in their own right, or 3) providing ‚Äústep-out‚Äù space for smaller companies. According to Michael Chen at Colliers International, the first strategy has grown in popularity as property owners looking to include coworking in their portfolios have found standard leases for operators the easiest way to enter the market. Because coworking operators have been able to create destinations for technology companies and hubs, property owners might consider leasing to an existing coworking operator if they have a building in a less desirable area or a floor plate that is hard to lease. Because coworking spaces offer interactions between members and flexibility of workspace, irregularly shaped space is less problematic to rent to operators. An early example of this strategy is Thomas Campenni who fifteen years ago leased out 20,000 SF at 41 East 11th Street to TechSpace. Like its competitors, TechSpace manages shared workplaces for start-up enterprises and has tripled its footprint in the 11-story, 220,000-square-foot building. ¬†Renting out space to coworking operators has grown in popularity because renting to the operator, rather than individual start-ups or individuals, most closely resembles a standard lease, and thus provides the most security. This strategy also allows property owners to take an otherwise underperforming asset and improve its financial performance by creating a technology destination that brings credibility to a building in the eyes of entrepreneurs. Furthermore, it creates an opportunity to attract next generation tenants who occupy the building while the property owner does not take the credit or rent risk beyond the operator itself. This strategy may also offer lower build-out costs and tenant improvements because many coworking operators prefer to take their space relatively raw and incorporate their own design in the fit-out. This is a fast growing market and new operators are emerging every day. In selecting a coworking operator tenant property owners should be thorough in their due diligence to select the best operator.¬† The second strategy includes property owners who have entered the market directly. This group includes SL Green Realty Corporation and Vornado Realty Trust. By leasing to start-up firms by offering coworking space directly, property owners can provide homes for new firms.¬† This strategy may have cost advantages if the landlord is able to ‚Äúoversubscribe‚Äù the space to multiple parties. For example, because of the hoteling concept often used in coworking spaces, and the varying uses of the space at different times, it may be possible for property owners to lease out 120 percent of the space knowing that only 85 percent will be used at one time. This may require a sophisticated back end system that tracks usage so that vacancy can be estimated and optimized. The last strategy is less defined but offers property owners the ability to offer smaller floor plates to start-ups who need step-out space. As is often the case with many successful start-ups, once teams grow to a certain size and products becomes more specialized, teams needs more privacy and space than what coworking operators are typically able to provide. While WeWork's Bryant Park location offers teams private office spaces to grow, more often than not members need to step out into new spaces to accommodate their growth and size. In such a case, creative options could be explored, for example, partnerships where property owners rent space to emerging small companies with no name recognition but high growth potential. In these cases, the property owner hopes that the emerging business may grow and need additional space to expand their businesses. In some cases, a property owner may offer a discount on rent but take an equity stake in the company, meaning the property owner is entitled to a portion of profits of the company. With the many coworking spaces launching on a national basis, it is possible for investment managers to start investing in these spaces and creating investment funds. Would it be possible for this now niche submarket to grow into a larger asset class and compete with what we think of as traditional commercial properties? Or is this an opportunity for investment managers to diversify their portfolio as managers continue to seek alpha-generating strategies for their clients? Are there arbitrage opportunities between different operators and spaces, and how does an investment manager understand the space and leverage new opportunities? These are questions that property and investment managers should explore to determine on what scale to finance, develop, or invest in these projects. Towards a Coworking Future Changes in technology, space needs, and attitudes towards the traditional work environment have combined to create a new paradigm in office space usage‚Äîcoworking. Often more efficient than long-standing office designs and more socially integrated than its predecessors, coworking spaces and their operators take many forms. The spectrum from Executive-style office suites to niche offerings in the Creative segment has developed and expanded as more people and businesses embrace this market trend. New York City has seen a rapid increase in these types of spaces and coworking‚Äôs popularity is traversing the nation‚Äîand the globe‚Äîas individuals, corporations, and start-ups alike recognize the need for flexible and collaborative work space. One of the slowest adaptors to this burgeoning trend has been property owners and investment managers. Historically more inclined to rent to large-scale corporations and professional service firms, property owners have been cautious in welcoming these seemingly risky and ‚Äòedgy‚Äô coworking operators into their buildings. Those who have, however, have seen a number of tangible and intangible benefits. To meet the needs of today‚Äôs office culture, flexible access and use of space will become an integral part of business ‚Äì and worth investor consideration. Rebecca Green can be best reached at firstname.lastname@example.org or 917-474-7393.  Haya El Nasser, The office is shrinking as tech creates workplaces everywhere, USA TODAY, June 5, 2012, http://usatoday30.usatoday.com/money/workplace/story/2012-06-05/tech-creates-workplace-everywhere/55405518/1  NAIOP, Changes in Average Square Feet per Worker, September 2012, https://www.naiop.org/en/E-Library/Perspectives/Changes-in-Average-Square-Feet-per-Worker.aspx  See deskmag.com.  Based on a recent conversation with the Community Manager at WeWork Bryant Park NYC  Interviews with several coworking operators revealed the race to becoming one of the first national coworking platforms that integrates user preferences and data across locations.  TechStart Newsletter  See El Nasser, USA TODAY.  See Elstein, CRAIN‚ÄôS NEW YORK.  See NYC Jobs Blueprint, NYC is a Growing High Tech Hub, Apr. 1 2014, http://nycjobsblueprint.tumblr.com/post/81393732255/nyc-is-a-growing-high-tech-hub  Information was gathered through interviews and primary and secondary sources during 2013-2014  Stephen Kleege, Startups find places to grow, CRAIN‚ÄôS NEW YORK, May 19, 2013, http://www.crainsnewyork.com/article/20130519/REAL_ESTATE/305199980/startups-find-places-to-grow#  See A creative Space to Work, and Network and http://brooklynbased.com/blog/2014/02/04/a-creative-space-to-work-and-network/  See Kleege, CRAIN‚ÄôS NEW YORK.  See Kleege, CRAIN‚ÄôS NEW YORK.