Coworking 2018 - The workplace evolves
The flexible workplace evolves
A Research & Insight Publication
The rise of the flexible workplace has been one of the driving factors of recent positive office performance, particularly in Central London.
Across Central London alone, flexible workplace providers have taken over 21.0% of office space in 2017, while competition in the regional cities is intensifying.
In response to such growth, industry stakeholders are rapidly examining their approach not only to the sector but also to flexibility in general.
How will this fast growing sub sector evolve and what does it mean for traditional office space? In this report, we consider how the sector has expanded across Central London and the regions and how business models from both operators and landlords are adapting to changing customer demands.
CENTRAL LONDON FLEXIBLE WORKPLACE PERFORMANCE
Central London has one of the largest and most mature flexible workplace markets across the world and over the last five years has cemented its global position.
As the sector has evolved, it has become an increasingly important part of the Central London office leasing market. Cushman & Wakefield estimates that flexible workplace operators currently occupy around 10.7 million sq ft of space across Central London. This equates to around 4.0% of the Central London office stock.
Our data shows that the stock of space has increased by 2.7 times since 2007, but most of this growth has occurred in the last five years.
While the sector has gone from strength to strength with increasing levels of take-up, like any sector there are also business casualties, Mergers & Acquisitions and restructures, which have marginally reduced sector growth. Cushman & Wakefield estimates that around 1.5 million sq ft of space has ceased to operate over the last 10 years. Most recently, Rainmaking Loft announced that they were closing their operation in St. Katharine Docks in response to the proliferation of competing operators across London and more specifically WeWork leasing space within the same building. British Land meanwhile terminated Regus’s lease at 338 Euston Road to allow them to expand their Storey offering.
"Knowing when to leave is just as important as knowing when to show up 1"
Location patterns across Central London have continued since our last report - Continuing the Evolution of the Workplace, The Office as a Service - in 2015. The largest stock of space occupied by flexible operators is in the City (26% of total flexible workplace), followed by the West End (23% of total flexible workplace). The proportions of stock in the core have fallen marginally over the last two years, with higher growth evident in the non-core locations due to the delivery of new buildings, which have supported faster letting activity to the flexible workplace sector.
There has been a shift on the concentration of flexible workplaces over the last five years across the different submarkets. Back in 2012, Clerkenwell, Southbank and Covent Garden were the areas that had the highest proportion of stock let to the flexible workplace sector but five years later Aldgate & Whitechapel, Shoreditch and Paddington have the highest concentration.
Between 2012-2016, the flexible workplace sector leased a total of 4.5 million sq ft in 210 transactions.2 This compares to a total of just 1.2 million sq ft in the preceding five years and clearly illustrates the sector’s expansion path. To put the latter into perspective, there has been 2.5 million sq ft let to the sector in 2017.
2 Transactions over 5,000 sq ft only included in the analysis
As well as the sector generally becoming more active, there has been a notable shift in the size of operators across Central London particularly since 2014. This growth is twofold - the increasing number of hybrid operators and the acquisitive nature of new entrants into the market, specifically WeWork.
The average flexible workplace unit size is estimated at 22,300 sq ft, which is an increase from circa 15,000 sq ft two years ago. There are an estimated 30 units in excess of 50,000 sq ft (open or committed) in Central London - the largest being WeWork’s pre-commitment to 283,000 sq ft at Southbank Place, SE1.
WeWork has been the most prolific taker of space across Central London since 2012, taking more space than companies in any other business sector. In fact, flexible workplace operators account for four of the top ten biggest takes of space, alongside the emergent tech giants of Google, Amazon, Apple and Facebook. WeWork now has the largest volumes of space commitments behind only the Government.
The growth in the flexible workplace market is starting to impact on the traditional leasing market. Looking at London, a slowdown does seem evident at the smaller end of the spectrum, particularly in units of less than 5,000 sq ft, albeit this is only back to levels seen in 2015 and may be too early to attribute directly to the sector.
"It is cheaper for us to take space in flexible workspace than renegotiate to extend our lease for another 6 months"
–Central London occupier
The Output Group in action at Workspace's The Record Hall, London EC1
The reasons for the growth in the sector are well documented. These interrelated trends have challenged the sector to evolve to meet the changing needs of their customer base and to embrace new opportunities. Considering the sectors potential for growth, it is more important to understand if these trends are likely to continue to support future activity.
Growth of start-ups and SMEs
The growth of flexible workplace is occurring across all cities in the UK, not just central London. The increase in start-ups and SMEs is a trend seen across all of the major cities, while new working practices are not location nor sector specific. These trends have fuelled the demand for flexible workplaces up and down the country.
The shift to self-employment post Global Financial Crisis now seems to be a permanent feature of the UK economy rather than just a necessary reaction to economic crisis. Self-employment has reportedly grown by a quarter since 2009 to nearly five million people, and the freelance sector, who tend to be knowledge-based workers, is one of the fastest growing sub-sectors up by more than a third since 2008.3 This section of self-employment, estimated at 1.91 million people in the UK, is likely to be the primary source of demand for flexible workplace.
"The GFC was positive for the sector, because it changed the opportunity cost of setting up a business"
–Flexible Workplace Operator
"The growth in flexible workplace has to be a good thing for London’s economic vibrancy…providing a wider range of opportunities in Central London”
PeoplePerHour, an online freelance marketplace, forecasts that one in two people in the UK will be freelance by 2020. While in a survey of 9,000 knowledge-based workers across the UK, United States and Germany, over half said that they would consider changing to a freelance or on-demand model of work over regular employment if it were offered.4
4 Unify - The Way We Work
Whether you believe the speed of this growth, the underlying trends seems to suggest that in the future more of us will be working in positions that are more likely to be housed in flexible workplaces.
Technology as an enabler for change
Structural changes in how, such as the rise of job casualization, and where we work are changing the demand for traditional office space. Technology has revolutionised the way we work. Technology has enabled change, especially the exponential growth in the smart phone over the last 10 years, and has been a key factor in the rate of business growth and offers a great opportunity for the self-employed.
New lease accounting standards
Looking forward, the advent of the new lease accounting standards (IFRS 16) is likely to boost demand for flexible workplaces.
Leases or licences under 12 months can be excluded from IFRS 16, which is expected to result in an uplift in demand for flexible workplaces as there will not be a requirement to capitalise the rental liability on the occupier’s balance sheet. IFRS 16 also provides a new definition of a lease for accounting purposes that seems to suggest that flexible workplaces are likely to fall outside the scope of the regulation.
It is the latter point that is relevant. Typically, a flexible workplace operator will hold the property interest (freehold or leasehold) and provide the occupier with space and services. This is unlikely to be treated as a lease for the tenant under IFRS 16 because the operator can substitute the area demised to the tenant within the space.
All this should drive more demand to flexible workplace operators. In a Cushman & Wakefield survey of UK landlords for this report, one third believe that the proposed change in lease accounting standards would definitely drive demand from traditional leased space to flexible workplace, with the remaining two thirds stated that it was likely to result in a shift in demand. Not one respondent thought it would have no impact on future demand.
Do you think that the proposed changes to lease accounting standards (IFRS16) - which is likely to remove serviced office space off balance sheet - will drive more demand from traditional leases to the flexible workspaces?
Use of flexible workspaces by corporates
The area of greatest concern to traditional landlords is the shift for traditional corporates to consider flexible workplaces as part of the real estate strategy. As flexible operators shift away from short-term membership to offering accommodation for 1-3 years then this is encroaching directly on traditional landlord territory.
Flexible workplace operators are reportedly attracting increasing numbers of larger corporate occupiers into their space for longer terms. Many larger companies are examining their business models in a bid to encourage creativity by providing a more unstructured and less centrally controlled environment than their traditional business.
Flexible workplaces are used as a strategic tool where employees come together on a short- term basis, to inspire and innovate in an environment outside the usual corporate constraints. WeWork report that 20% of revenues globally come from enterprise clients that typically take a lease for 1-3 years, while Workspace targets established businesses on short-term leases rather than startups – its average lease length is 2 years.
Flexible workplace operators anticipate demand from larger occupiers to accelerate in the future. This helps the operator de-risk the weaker covenants of young companies by supplementing them with established firms with greater financial strength.
The future success, or otherwise, of these managed solutions will depend upon the propensity of larger corporates to integrate flexible workplaces into the real estate strategy.
FLEXIBLE WORKPLACE BUSINESS MODELS
Flexible workplace covers an increasingly wide spectrum from traditional serviced office operators to coworking spaces, while embracing both managed and virtual offices. As the sector has evolved, increasingly hybrid business models are emerging. This is in response to the demands of the customer and to improve profitability of the operation.
Expectations of work have evolved flexible spaces. For start-ups and SMEs, many who are initially faced with uncertain growth and cash flow expectations, flexibility is a key attraction: they can house themselves in flexible workplaces rather than signing up to a long-term lease. The shift in demand profile, from security to flexibility, as well as the vast potential of emerging technologies, provides a strong platform for flexible workplace operators to remain competitive by evolving their business models. There are a number of ways that they can do this, with some mentioned below
Enhancing service offering – flexible workplace operators are offering additional benefits, products and services which include HR, payroll, food and beverages, legal services and gyms.
Having a community/cultural agenda – this typically will involve the use of a technology platform to connect people, but will also include the regular hosting of both informal and formal events to help foster a collaborative environment.
Education – this is still developing, but WeWork have recently acquired Flatiron School, which provides offline and online training courses in coding. WeWork members will be able to benefit from these courses, demonstrating WeWork’s commitment to helping their tenants grow. This trend could well continue with other operators keen to offer similar schemes.
‘Unique’ Selling Point – flexible workplace operators are seeking ways to differentiate themselves from competitors. This could be as simple as targeting the high-end of the market (The Clubhouse, Fora or Servcorp for example), it could also involve a number of other features; architectural features (The Dock, Shoreditch), social/environmental agenda (Impact Hub) or regular art shows from local artists (ArtFix, Woolwich).
How will business models change in the future?
The reality is that traditional serviced offices are becoming less appealing to today’s occupiers who are seeking flexible space. There is evidence of operators changing their business model to reflect this trend. IWG is focusing on expanding its Spaces brand while BE group has just announced that it has purchased Headspace to enable dramatic future growth.
Operators are turning to enterprise solutions to provide an end-to-end service from sourcing the property to ultimately operating the office. WeWork have launched a new initiative, aimed at companies of any size, whether they want a single-person satellite office in a new location or a 500-person headquarters. In London, for example, WeWork have said that they could theoretically offer an entire building to a single tenant and manage the custom build-out of the space. This is not an entirely new offer with other operators offering similar solutions via a managed solution service. BE Offices, for example, provide bespoke space via their BeSpoke division, which is aimed at corporate occupiers looking for flexible space.
Not every operator follows the leasing model. Workspace fully owns and manages its multi-let buildings, retaining complete control over the customer experience and enabling it to invest in refurbishments and redevelopments to adapt to evolving customer needs.
The Clubhouse flexible meeting space at Angel Court, London EC2
Where the sector is really changing from earlier generations of serviced offices is the diversification into additional services, which provide further revenue. End users are getting something which makes them want to stay. This is a lifestyle location akin to a member’s club for business with a carefully curated client base and events calendar to create an environment for business opportunities to flourish.
Figure 10 shows where the focus of services/amenity provision from both an operator and users perspective. There is a consensus regarding the most important amenities/services with meeting rooms, connectivity, break-out space and networking opportunities ranked top.
"Security and good broadband are key criteria in choosing a new workspace"
– Flexible workplace occupier
Increasingly, flexible workplace providers are seeking to integrate vertically with other businesses and services in order to provide a wider range of benefits to their users. This marks the shift towards ‘space as a service’, a fundamental structural change in how we use, occupy and operate space. The real estate industry is becoming less product-focused, and will instead provide access to features and services on demand.
"The office sector is the forgotten sector. If you consider hotels, restaurants, leisure or your home - the level of expectation of what we will receive in those places is much higher but the irony is that we spend most of our life in the office."
By leveraging their comparative size, flexible workplace operators can bundle their real estate products with other useful business services at a discount, due to economies of scale. This also benefits the occupiers, as small businesses are able to access high-cost services that were previously too expensive.
WeWork’s growth is driven by this focus on user experience. They are not alone and a number of other operators are also entering into partnerships with third parties to provide their members with discounts on business services such as insurance, healthcare, payroll, technology support and finance. This lets companies focus on their core business while others take the administration strain.
" Property is the next sector coming into the hospitality industry"
– Flexible workplace operator
We are also starting to see providers seek space in non-office buildings. There are several recent examples of vacant retail space being utilised for coworking, including WeWork purchasing the Lord & Taylor building on Fifth Avenue in Manhattan. With the retail market shifting away from traditional stores towards a smaller, experience-led offering, coworking operators are well placed to take advantage of the potential vacant space.
However, it is not just the operators; landlords of non-office buildings are also considering providing flexible workplaces as a way to monetise space. In London, Heals has already opened a café and coworking space at its store on Tottenham Court Road, with 14 desks to rent. Other retailers are also reported to be mulling over the idea as a solution to surplus retail space.
Opportunities are not limited to shops. Pubs, hotels and libraries are also of interest to flexible space providers. Central Working operate coworking space in partnership with the Zetter Hotel. The space operates as a flexible workplace during the day and by night turns into a bar and restaurant. Coffee shops have already been the workplace of choice for many workers for some time - leading some commentators to coin the phrase the “Coffice”.
The Entrepreneur’s Pub in Sheffield is a pop-up coworking space in a traditional pub. As well as providing space for entrepreneurs to work, they held a series of events and workshops to coincide with the MADE festival: a gathering of entrepreneurs and students. In London, Space Haven transforms restaurants and bars closed during the day into affordable coworking space. Their first space in a private dining room in Fulham has opened with a further five to follow.
In short, any brick-and-mortar business that is vacant for a period during the day could be utilised for flexible working. Not only could this boost struggling businesses with increasing overheads, but it also provides occupiers with a greater choice of locations in which to work.
WeWork at London's South Bank
The barriers to entry can be relatively low. What this also means is that competition can also be high and that the market can easily reach saturation point. Without the ability to invest and to stay ahead of the competition, spaces can become obsolete and uncompetitive and this affects occupancy levels and desk rates.
The other issue with the sector is that there are low levels of differentiation between the many operators in the market. Most flexible workplaces contain the same facilities, such as desks, furniture, IT connections and meeting rooms for example and it is increasingly difficult to set flexible workplace operators apart from each other.
Flexible workplace operators in the main operate at a low margin and low volumes. Real estate is the largest operating cost for flexible workplace providers, accounting for 40% of operating expenditure6, which is significantly higher than for a traditional corporate.
Revenue from flexible workplaces is derived from two streams: licence/membership fees and the bolt on services. As a benchmark, a profitable operator will be seeking circa 80% of revenues from rental/membership fees. The revenue balance comes from additional services, usually focused on meeting or conference room bookings, IT and telecoms services, events, beverages and food services to name a few. Flexible workplace operators’ profits are therefore heavily reliant upon the level of space occupancy.
Scale is the only way to improve volumes and to improve margins. Operations have high maintenance demands and are management intensive due to high turnover of occupants. This is why there are actually very few pure co-working spaces, and why the hybrid model has become more prevalent. Figure 11 shows a strong linear relationship between the number of co-working members and the level of profitability.
Profitable occupancy rates are typically quoted at 80-85%% but the business model, location and the split between dedicated office space, co-working spaces, meeting rooms and common areas, determine the profitable occupancy rate. Pricing policy is influenced by the rent paid for the space and anticipated demand for the space. Profit margins are determined by the differential between the two and occupancy rates.
Rents paid by the sector vary by typology of the operator type, scale and location but there has been a steady uplift in the rents paid by flexible workplace operators over the recent past. The average rent paid for Grade A space, by operators in the five year to 2012 was just under £50 per sq ft but in the subsequent five years, it has increased to over £60.00 per sq ft.
"No sensible commercial organisation would only go into the co-working sector… it rarely makes money"
– Flexible workplace operator
£65.50 per sq ft - average rent paid by the sector in 2017. Up 10% compared to 2016 average
TOG at Albert House, Shoreditch EC1
Operators can influence their margins by increasing their density rates. The BCA report that increasing numbers of operators are seeking densities of 50 sq ft per desk across the UK and in some cases down to 30 sq ft per desk. WeWork’s new centres are now being planned at 35-45 sq ft per desk.
The map over the page shows the profit margins based on the highest rent paid by the sector for a lease since 2013 and Cushman & Wakefield’s upper end indicative desk rate. Our analysis shows that positive margins are only achieved in some of these areas due to the high-density rates and generous rent-free periods.
"Demand for space in London is there, it always has been, but it just has to be priced right in a downturn. It’s more difficult in regional cities because the quality and depth of demand is not there"
– Flexible workplace operator
FLEXIBLE WORKPLACE TRENDS IN THE UK REGIONAL CITIES
Despite the focus on London, around two thirds of the UK flexible workplace market is located outside the capital. Instant Offices estimates that the UK market includes approximately 52 million sq ft of flexible space in just under 3,000 centres. This equates to almost 5% of the UK total office stock.
We estimate that the main regional cities7 currently house around 3.8 million sq ft of flexible workplaces within their respective city centres, and this figure almost doubles when suburban and out of town centres are included. Focusing solely on these CBDs, the flexible workplace sector accounts for an average of 3.2% of the total stock, which as a proportion of stock is similar to Central London.
The factors that have boosted the growth of the sector in London are also instrumental in driving the expansion in the regional cities (see figure 14), while competitive costs have supported business expansion in the regions. The cities of Bristol, Birmingham and Manchester have seen strong growth in their stock of flexible workplaces, with more than 600,000 sq ft of flexible workplace within the city centre.
Analysis of the operators in the regional city centres shows heavier reliance on more traditional business centres than in Central London, but this is changing with new operators setting up centres with a greater focus on coworking and hybrid operations.
New operators setting up include, Our Space who are shortly to open two new coworking operations in Leeds and Manchester, to complement their global operations in Miami, Dubai and Hong Kong, while Spaces has ten branches outside central London including Glasgow and Newcastle.
Pure Offices, Nottingham
There are only a handful of truly national operators; Regus remain by far and away the largest operator, with a presence in each city while I2 Office and Orega also have a strong regional presence. Of the other, large London operators, TOG only have two offices outside London and WeWork has opened its first regional office in Manchester.
It must not be forgotten that a number of operators have a significant presence in cities outside London, preferring to concentrate growth outside the capital. Pure Offices for example have 20 serviced offices around the UK, with a presence in Leeds and Edinburgh, while Bruntwood is a major player providing a range of options including coworking and serviced offices across its portfolio.
Without exception, operators in the regional market stated that their market had become more competitive over the last 12 months. Take-up of flexible workplace across the year has increased in all cities. Flexible workplace transactions accounted for less than 2% of all city centre lettings in the main regional office CBDs between 2012-2016, but this has more than tripled in 2017 to over 7.0% of take-up, which was largely due to transactions to WeWork and Spaces.
Burgeoning tech sectors and supportive environments for start-ups should boost future demand for flexible workplaces, while companies seeking to reduce overheads may turn their attention towards regional cities around the UK.
GLOBAL TRENDS IN FLEXIBLE WORKPLACE PROVISION
Global Trends in Flexible Workplace Provision
At a country level, the UK and US are leaders in the flexible workplace market, accounting for more than half of all centres across the world. We estimate that the stock of flexible workplaces in the key US cities currently stands at around 27 million sq ft, which is growth of 20% over the last two years.10
10Miami/Phoenix/Minneapolis/St. Louis/New Jersey/Orange County/NY- Brooklyn/Houston/Northern VA/Denver/Long Island/ Philadelphia/Seattle/Atlanta/Chicago/Los Angeles CBD/Manhattan/San Francisco/ Washington DC/ Boston/ San Diego/Dallas
The US has more operations than the UK but the sector accounts for a relatively small proportion of the total office stock - around 2% across the major cities. Central London is globally dominant in terms of the number of centres and the proportion of office stock leased to the sector, easily outstripping New York Manhattan in terms of its scale.
As with the UK, IWG is the main operator of flexible units, through its Regus and Spaces brands, but WeWork is not far behind in terms of scale. The market is far more concentrated in the US than in the UK, with these two operators accounting for 72% of the flexible workplace market.
TOG at Eastbourne Terrace, W2
Flexible Working - London vs. Manhattan
At a city level both Manhattan and Central London flexible workplace markets are equally mature. However, flexible workplace providers account for a substantially higher proportion of total leasing in London than Manhattan. Since 2012, flexible workplace leasing has represented an average of 2.9% in Manhattan, compared to 10.6% in London.
One of the key drivers of this growth is the emergence of WeWork as a large-scale provider. The table over the page shows the volume of space let by WeWork compared to the rest of the flexible workplace market in both cities. In 2015 and 2016, WeWork accounted for over 90% of space let to flexible workplace operators in Manhattan. There is a more even distribution in Central London, with WeWork accounting for 45% and 50% in 2015 and 2016 respectively.
Whilst both the UK and USA have seen strong growth in the flexible workplace sector in recent years, there is potential for a tapering of momentum as other regions particularly Asia and Europe start to expand.
The flexible workplace offering across the main European cities has lagged behind London in terms of both take-up and total office stock. We estimate that the main European cities currently house around 13.9 million sq ft of flexible workplace, accounting for an average of just 1.0% of the total stock. The exception is Amsterdam, where the flexible workplace accounts for nearer 6.0% of total office stock.
Amsterdam has one of the highest proportions of independent workers in the EU, with an entrepreneurial and creative culture. It has one of the most mature flexible workplace sectors across Europe with a range of operators present. Spaces was originally a Dutch company, with three locations across Amsterdam, before being purchased by IWG, while WeWork entered the market in 2015.
The expansion seen in the UK is also evident across the key European cities. For example, the amount of flexible workplace take-up across Dublin increased from 0.7% of total take-up in 2016 to 7.9% in 2017. Similarly, Munich recorded 375,000 sq ft of take-up in 2017 compared to 77,000 sq ft in 2016. We anticipate that this growth will continue to accelerate across Europe, riding on the growth of the tech sector, a flourishing start-up environment and projected office-based employment forecasts of growth of circa 6% in the next three years.
Volkshotel, Amsterdam Photo credit: Mark Groeneveld
Key cities to watch for growth in the flexible workplace sector
The flexible workplace sector is increasing in the city. According to Click Offices, 4,500 new desk spaces are expected to be delivered within the next nine months, equivalent to 230,000 sq ft.
One of the most mature flexible workplaces markets in the world. Flexible office providers accounted for over 7% of total take-up in 2017, an increase from 4% in the whole of 2016. Vacancy levels are at the lowest levels for over 10 years and demand for flexible workplace looks likely to continue.
The growth of the tech sector has led to positive employment forecasts across the Nordic regions. Declining vacancy rates, coupled with high rents will help the growth of the flexible office market. The city is one of the leaders in innovation and boasts one of the most successful tech hubs globally.
One of Europe’s main tech hubs, it is expected to be a beneficiary of Brexit as a home for start-ups. WeWork have huge expansion plans up to 100,000 sq m. Regus continue to acquire space along with Mindspace, Rent24 and Spaces.
The flexible workplace market is developing in the cities with business centres like Regus and other collaborative spaces increasing their offer. In 2017 there has been almost 316,000 sq ft of take-up from providers such as Regus, Lexington and WeWork. Barcelona is more active than Madrid in this kind of office space, but we expect players such as Spaces and WeWork to expand in both cities.
A relatively small market to date. France is currently working on reforms to increase flexibility in the workplace. Station F – a new start-up superhub, which can house up to 1,000 start-ups opened in June.
Station F restaurant, Paris
Target audience is fast developing start-ups, freelancers and venturing corporates. Skanska became an equity stakeholder in Business Link, a co-working business. Skanska will provide Business Link with space in their next 10 office projects across the CEE region enabling Business Link to scale in the coming years.
The Asian market is relatively immature compared to both the US and Europe but has been expanding at a faster rate over the last couple of years. Cushman & Wakefield in Asia forecast that the sector will account for 15% of total office supply in Southeast Asia by 2030. Key Asian cities earmarked for growth are Hong Kong, Singapore and Shanghai.
Local and regional operators dominate the Asia market but global companies are also showing interest. WeWork recently acquired Spacemob in Singapore - its first acquisition in Asia - while Spaces are present in ten countries across the region. This international competition is leading to a number of regional mergers and acquisitions to provide regional scale. For example, Shanghai-based ‘naked Hub’ has merged with Singapore’s JustCo to create the largest premium coworking space operator in Asia.
In general, growth in the region comes from both start-ups and larger corporates. Start-up ecosystems are being encouraged by more supportive government policies across Asia along with a greater access to investment and crowd funding. The number of start-ups, freelancers and entrepreneurs is increasing. As a result demand for affordable flexible workplaces is rising in parallel. As occupiers strive to contain costs in some of the world’s most expensive office locations, demand for flexible workplaces is going mainstream. Large corporates are increasingly looking to the sector to reduce overheads while it is perfect for new entrants who may not be ready to take up a long-lease in traditional offices at the outset.
Start-up ecosystems are being encouraged by more supportive government policies across Asia along with a greater access to investment and crowd funding.
Case Study: WeWork and Knotel
In the few years since it entered the UK market, WeWork has disrupted the London property market. New entrants have followed but not with the scale or ambition of WeWork. However, one of WeWork’s rivals in New York, Knotel, is now making its first foray into London.
Both of these operators are vying for market share and trying to grow at a rate whereby the scale of their respective portfolios reach critical mass. To many occupiers both appear to be offering a very similar real estate solution; flexible terms, room to grow/downsize, in-house services and the opportunity to be in a more ‘millennial-friendly’ environment. Both are adamant that they offer a distinct product to occupiers, with their respective enigmatic CEOs driving bold visions for their future.
'Community is our catalyst'
Founded in 2010 in New York by Adam Neumann and Miguel McKelvey.
23 cities in USA
47 operations in New York
3.7 million sq ft in New York
Largest operator in New York
Unique Selling Points
Anything from ‘lunch and learns’, networking events, investor events to meditation sessions are on offer in every WeWork space. This helps to promote the community both within the building and within the wider WeWork network.
To assist with the collaborative and community-driven values of the company, WeWork provide their membership with access to their in-house app, which can be used to book meeting rooms, RSVP to events or access a social feed.
This is perhaps one of WeWork’s key selling points, where they take advantage of their leveraging power and partner with HR and healthcare providers on behalf of their members. This helps young companies save money on essential services, as well as enabling them to focus on their own business. The healthcare provision was a key factor in WeWork's US growth.
As WeWork have a head start on the London market, this could well prove to be their biggest advantage over other competitors looking to expand. WeWork have acquired nearly 1.5 million sq ft in London in 2017. This scale gives them the flexibility to accommodate a large variety of tenants within their portfolio, across an expanding geography.
'headquarters as a service'
Founded by Amol Sarva and Edward Shenderovich in New York in 2015.
2 cities in USA
23 operations in New York
500,000 sq ft in New York
Plans to grow to 1 million sq ft
Will become 3rd largest operator in New York behind WeWork & Regus
Unique Selling Points
Unlike most popular coworking operators, Knotel provide branding unique to each occupier; arguing that it promotes a 'successful, cohesive culture.'
Knotel says it focuses on tenants with 20 or more employees who want to scale quickly – whilst avoiding having to share with other companies as you would in a coworking space.
Knotel quote that meetings can absorb 15-50% of a company’s collective time – so they provide 40 meeting rooms for every 100 seats. This avoids the competition with other companies for meeting room bookings.
Knotel only grant access to a company’s individual employees, as opposed to the shared spaces found in a coworking operator. This arguably solves some issues around intellectual property, security and privacy – but does it inhibit the sharing of ideas and innovation between firms? How does this affect the concept of community?
The most significant difference between these two companies is their respective target markets – WeWork will cater for any company size, whereas Knotel want to attract slightly more established businesses to their space. However, the impact of this differentiating factor could be eroded by WeWork’s ‘Enterprise’ offering.
IS THE MARKET REACHING SATURATION POINT?
Is the Market Reaching Saturation Point?
The high share of take-up witnessed in recent years has alarmed some within the real estate community. As we have seen, the penetration rates in the UK are much higher than across Europe and the US, as the institutional lease and the growing entrepreneurial nature of the UK workforce are key factors that have supported growth in the sector.
A structural shift in the workplace has enabled the growth of the flexible workplace. There is a strong positive correlation between the number of self- employed and the increase in flexible workplace take-up. With above average growth anticipated for the target customer, this should support a greater market share for the flexible workplace operators to accommodate this expansion.
“Growth is going to continue… larger companies are coming into our spaces”
– Flexible workplace operators
“It is inevitable that the sector will grow…we all laughed when WeWork said that they wanted a two million sq ft footprint but look at them now”
Those we interviewed and surveyed believe that there is more growth capacity within the market. It is no surprise that the operators believe the optimum market share is higher than landlords’, but both groups believe that the proportion could be higher than currently recorded. The average preferred exposure by landlords to the sector was between 5-10% of the portfolio, while most operators felt that the market could see capacity of more than 15%.
In reality, for the sector to double its footprint in Central London, flexible workplace operators will need to lease an additional 15 million sq ft. To put this into perspective this is more than is currently available on the market. To reach that level of market share over the next ten years would be equivalent to leasing 1.5 million sq ft per annum.
Growth rates of other operators in the market are also much slower than that of WeWork and it is unlikely that any other operator will be seeking to change their business model to provide that level of market scale in one city over the next few years. If you exclude WeWork from the equation, then while the sector has expanded in terms of sq ft across Central London, the pace of growth in percentage terms between 2007-2012 and 2012-2017 has been broadly similar.
“Geographical expansion was to look at other UK cities but post Brexit we would now rather go and test other non UK cities”
– Workplace operator
The limited availability of space, not only in London but also in the regional cities, could curtail recent growth rates over the next few years, as operators find it harder to secure appropriate space in the right locations.
There has already been anecdotal evidence of operators’ searches in the West End frustrated by a lack of stock with appropriate floorpates and higher rents making new operations unviable.
Operators will need to seek prelets, off market space or purchase buildings, which are not really options for most operators seeking smaller units of space, if they are to achieve these high levels of market share. As a result, we would expect the pace of growth to start to slow down as the sector reaches maturity.
One way landlords can accommodate the sector within their portfolio is to allocate a proportion of space in new developments to flexible workplace, either to let to a third party operator or to operate themselves.
Analysis of 45 completed Central London multi-let developments over 150,000 sq ft since 2012, show that a third had let part of their space to a flexible workplace operator, with an average of 17.5% of total floorspace let to the sector. Our interviews with developers suggested that they may adopt this strategy for new buildings in the pipeline, but was dependent upon the scale of the building and its location. The optimum proportion mooted by landlords was around 20% of floorspace.
“We are alive to more space being let to the sector in multi-let buildings, but if a single large occupier was on the table that would still be our preference”
If every potential speculative office scheme that could complete over the next five years allocated and leased 20% to flexible workplace this would provide an additional 3.4 million sq ft of flexible workplace to the circa 800,000 sq ft that is already in the pipeline committed to the sector. This would take the market share to around 5.5% overall by 2022.
This seems a sustainable figure based on other factors including the growth in SMEs. Looking further into the future, we estimate that a market share of 10% could be reached by 2030.
CALCULATING SPACE METRICS
Significant leasing activity to the sector has supported total market volumes and landlords continue to benefit from the associated income stream. However, realistically this space needs to be let and total supply levels are being disguised.
Our survey of operators supports data from the Business Centre Association, which shows that flexible workplaces were typically operating at 84% capacity in Central London in 2016 and slightly lower in the regions. WeWork report an occupancy that on mature centres at 95%, Workspace’s like for like occupancy is 92.4% and Regus was around 75%.
Occupancy rates have been increasing. Over half of the operators we surveyed stated that their occupancy rates had increased over the last 12 months, with the remaining largely stable.
Occupancy does not relate to the whole building, with space allocated to meeting rooms and membership space excluded. WeWork for example have a build-out loss factor of around 20%, while our survey averaged a 25% loss factor amongst other operators. This space is not included in occupancy metrics and is often seen as a loss leader.
Given that most operators aim to reach target occupancy within 12 months after fit out, then we estimate that the shadow space from Central London flexible operators is currently in the order of 1.8 million sq ft. The impact of this shadow space on the vacancy rate is approximately 70bp. This has not surprisingly, increased as the size of the sector has grown and we estimate that the impact was around 25bp five years ago.
We estimate that the impact of the sector is greater on the City vacancy rate given the higher rate of take-up recorded.
What happens in a period of slowing economic growth? If we assume that the occupancy rate falls to 60%, with a slower interim growth, then we believe that this would add an additional 1.3 million sq ft to current shadow space. The other issue is that, at this level of occupancy, many flexible workplace operations become unprofitable and we would anticipate a higher level of closures, which would bring back more space to the market directly. While it’s unlikely that occupancy rates would get this low, it is worth remembering that Regus’s occupancy rate reportedly sank below 60% in 2003, when the company underwent a significant restructuring of the business.
It is estimated that densities in central London flexible workplaces average one workstation for every 80 sq ft but with desk densities as low as one desk per 45-50 sq ft, this grey space could accommodate between 20 to 36,000 employees compared to 18,000 employees in conventional space.
Until very recently, traditional property owners have engaged with the flexible workplace model by simply leasing space on long-term leases to operators. This worked well – with landlords benefiting from the association. However, as flexible workplace operators expand both footprint and deal size there is increasingly a realisation from developers that they are losing control, creating competition and potentially missing a trick.
“The big landlords have been slow to adapt their business model quickly enough”
– Workplace operator
The growth of the sector has shaken up the property industry and has seen increasing numbers of landlords considering strategies to incorporate flexibility into their portfolios. Without exception, the landlords surveyed all stated that flexible workplace operators represented a higher proportion of their property portfolio than five years ago and that they anticipated this to follow an upward trajectory in the near term at least. Nevertheless, exposure remains relatively low. We estimate that the main London landlords have an average exposure to the sector of less than 2%, while those property owners responding to our survey have an average exposure of 3%.
Operators are changing the mind-set of occupiers over what they can expect from their real estate and this is challenging the traditional model. This creates opportunities for landlords to reposition their portfolio. There are three possible strategies that landlords appear to be contemplating: partnering with a provider, buying an operator or setting up their own flexible operation.
For many this means providing shorter, flexible leases rather than any major move into the sector, as landlords take the view that they do not have the scale nor the expertise to enter the sector directly. It is easier and less risky for landlords to partner with specific operators, that can complement or re-position a building’s profile and brand. This would play to the strengths of both the operator and the landlord.
The challenge for any landlord looking to set up their own flexible space would be to put the necessary supply chains in place to run a profitable operation. Operating flexible workplace is a margin-play, and requires specific skills to generate significant returns. Most operators we spoke to felt that this was outside the capabilities of a traditional landlord.
Through direct partnering or their own offering, landlords will provide increased competition for established flexible workplace operators. The concern to some operators is that landlords are in a better position to expand, as they already own the real estate and have the scale, funding and flexibility to take a risk. This was identified as a major threat to operators’ growth in the future, behind increased competition from other operators, and a weaker economic environment.
Purchasing interests in flexible workplace companies is emerging as an alternative route into the sector. Blackstone purchased a majority stake in TOG, while Brookfield and Onex made an indicative cash offer for International Workplace Group (IWG) at the end of 2017. While a formal offer has yet to materialise, and others may now enter the bidding, it demonstrates the interest in the sector.
Those landlords not looking to enter the sector directly are taking the opportunity to consider how they can be more user friendly to their occupier base, whether through simpler lease documents or harnessing the latest technology to create a more engaging user experience across their portfolio.
A number of platforms are available to landlords to upgrade their existing space to provide more services to their current occupier base and to aid tenant retention. Platforms targeting the UK market include District Technology, Equium and Convene. In the US, Tishman Speyer has launched Zo, which provides a suite of amenities and services for its tenants through service partnerships covering HR, travel services, wellness for example.
District Technology achieves this via a tenant engagement platform and mobile app that ‘connects users in the building with the things they love’.
At its heart is the creation of a digitally linked community, providing opportunities for networking, events and education. It also serves as a medium to buy services and food and drinks, manage the allocation and booking of space, control ambient conditions, and provide powerful data on building utilization.
Convene, based in the US, partners with landlords to provide integrated “workplace-as-a-service” platforms providing tenants access to a growing network of premium meeting and event spaces, flexible workspaces, hospitality services, and curated experiences for users.
THE IMPACT ON VALUATION AND PRICING POINTS
Investors attitudes to flexible workplace operators as a tenant
As we have noted, where previously prominent landlords shied away from the sector, there is now a greater willingness to accommodate flexible workplace operators within their portfolios.
The willingness of many serviced office operators to provide their landlords with not only conventional lease structures, but also importantly stronger and better established covenants as opposed to complex ring-fenced SPVs is changing landlord sentiment.
A nervousness is still prevalent amongst institutional investors. This is in part due to the reputation and/or covenant strength of a number of operators but also due to the risk associated with the sector’s short-term income stream against long-term lease commitments.
“The lease arbitrage model looks brilliant if there’s a ton of demand, but when you go through a cycle…”
– Flexible workplace operator
With the recent rapid expansion of the sector, there is an expectation from some that the bubble may burst, leaving a number of landlords having to renegotiate leases or with empty properties on their hands. As we have noted, flexible workplace providers are vulnerable to a downturn, as they have fixed liabilities that they might struggle to meet if demand weakens. The recent profit warning by IWG has done little to alleviate this apprehension around the sector.
“Landlords are going to have to think differently about lease structures”
– Flexible workplace operator"
There are two sides to valuing the sector - the valuation of buildings let to a flexible workplace operator and the valuation of owner occupied buildings.
When it comes to valuing a building with a flexible workplace provider as the majority tenant, the quality of the real estate still remains paramount as the covenant of operators is still viewed as not as sound as most corporates. Many investors may seek a higher return to compensate for the risk around the security of income.
There is a different landlord perspective to operators who lease space on a couple of floors in a large-scale office building. The owner benefits from having a flexible workplace operator in the building, with the provision of amenities and services as well as flexible overflow and project space for incumbent tenants. The right flexible workplace brand can enhance or re-position a building’s profile, with the additional upside potential of tribe attraction from conventional lease occupiers who want to mix and associate with the flexible workplace brand, its clients and its clients’ guests. A multi-let building could see its value enhanced through higher achieved rents in the rest of the building.
The White Collar Factory EC1
“I would argue that the concept of covenant strength is out of date…just look at Lehmans. All the expanding companies leasing space are young companies with limited accounting history.”
– Flexible workplace operator
There is limited sales evidence to date. The investor universe is smaller than for buildings let to traditional tenants, as a number of investors still will not consider buildings let to the sector. Historically, sales with a significant proportion let to the flexible workplace sector have tended to trade at a discount. Given the increase in take-up to the sector, more investments have been traded with a flexible workplace operator as the majority tenant, which will start to bring greater clarity to the investment markets attitude to the sector. The majority of these sales have involved overseas purchasers seeking a foothold into the capital.
The valuation of operational assets
When valuing an operational asset, the underlying property asset is not the only factor to consider and valuations will take into account the potential profitability of the business as well as the property asset. This type of valuation requires specialist knowledge to value the trading potential of the business. To provide accurate valuations, it is imperative that the type of operation, the level of services offered and maturity of the centre are understood as these will have an influence on how well a centre is trading.
Workspace is one of a handful of operators already following an asset ownership model which ensures control and adaptability of their portfolio but other operators are now turning to freehold models to boost balance sheets. IWG recently acquired Basepoint, whose centres are held freehold, for a reported £100 million, which fits with IGWs strategy to increase the number of freeholds in their portfolio. Both Blackstone and the Carlyle Group recently purchased interests in the Office Group and Uncommon, which involved the purchase of freeholds. WeWork has set up a fund to purchase freeholds, including the recent exchange on Devonshire Square where it expects to benefit directly from the uplift in prices paid per sq ft in the space operated as flexible workspace.
"Being both the owner of the property and owner-operator of the business sets us apart from the flexible office competition."
– Peter Stoll, Managing Director at The Carlyle Group
The flexible workplace is here to stay, as the world of work has fundamentally changed.
A new breed of flexible operators who constantly challenge the traditional business model is now disrupting the real estate industry. Bodies of evidence from all parts of the globe prove that the sector is going to remain an important segment of the real estate industry in the future. Landlords and investors are sitting up and taking note.
London has cemented its position as the global leader for flexible workplaces, easily outstripping New York in terms of both space and number of operations. The sector is still a relatively small part of the office market - currently accounting for around 4% in London. Nevertheless, take-up to the sector has increased year on year. 2017 has been the most active year for the sector, with 2.5 million sq ft of lettings completed, which was a market share over 21%. WeWork was responsible for more than half of 2017 take up.
The regional cities are evolving, with new entrants providing a different offering from the tertiary centres that have for so long dominated the regional cities. We would expect growth in the core cities to accelerate as operators turn their attention to new markets. WeWork has made its first entrance into the regions during the year with two spaces in Manchester.
Sector performance remained robust post Brexit, with increasing levels of occupancy evident around the UK. An occupancy rate of 80% is the average required to be profitable. High occupancy combined with increasing densities are supporting profit levels across the sector. Margins will be squeezed if occupancy rates fall below this level or if the desk rate is reduced, which may occur if rents for conventional space fall in response market uncertainty.
Structural changes will continue to drive growth within the sector but a number of factors could slow the pace of expansion.
In addition, the pace of growth will be impacted by operators reaching critical mass, while the limited supply of new space will act as an inhibitor to those seeking larger spaces.
Conventional landlords are faced with a dilemma: on the one hand they recognise the benefits that having a flexible workplace provider brings to a building, on the other they are increasingly viewing the larger operators as direct competition. Landlords will look to reassess their real estate strategy.
While realistically few will enter the sector directly, due to its margin play and specialist skillsets, we envisage more property owners will collaborate with operators while at the same time providing more short-term flexibility into their portfolio, to help retain their tenant base. This is a natural response to changing occupier needs and will be accompanied by the increasing provision of amenities within the building in a bid to attract an increasingly empowered workforce.
There is evidence of some operators moving into managed or enterprise solutions to accommodate larger enquiries and this segment is likely to expand with new operators targeting the UK market. There will be some casualties along the way, but that is inevitable as the flexible workplace adapts to changing demands from the customer. But that’s not to say that there is not a place for increased differentiation of product.
Looking forward, the need for a wide range of flexible offers will be instrumental for the continued growth of the sector. There is a place for both mature and innovative operators; especially if the sector is to appeal to a wide range of business sectors, with a range of both price points and specifications.
Expansion will also include setting up operations in non-office buildings as landlords seek to monetise vacant daytime space. This growth is increasingly likely to include landlords' own flexible offerings, such as the Storey offering from British Land. Cushman & Wakefield anticipates that this combination could lead flexible workplaces to account for market share approaching 10% in the next ten years across the UK.
Our research shows that it is clear that the concept is no longer just about an office building, but about where and how people want to work. Real estate provides a platform for more services to be incorporated into the office. There will be more vertical integration between service offerings but this will be dependent upon scale of the operator. WeWork have set the benchmark but others are following in their wake. New technology platforms will provide opportunities for property owners to incorporate added services into their portfolio and to compete with the flexible service provision.
The research also considered the impact of the expanding sector on total supply. While conventional lettings to the sector supported total volumes post Brexit, this is viewed as effectively moving available space from one landlord to another. Occupancy rates are reportedly above 80% across the UK, and have been increasing year on year. This will insulate the traditional leasing market from this shadow space. Cushman & Wakefield has calculated the effect on vacancy rates, and as the sector has expanded so too has its impact on vacancy. Across Central London we estimate that the impact on the vacancy rate is an additional 70bp. This shadow space will rise further into 2018, as a number of prelet operations open and space taken in 2017 reaches target occupancy.
Investors are less wary about the sector as they understand how flexible workplaces operate. We have seen both direct corporate investment and the sale of properties with a substantial flexible workplace tenant in place. Blackstone, Carlyle, Brockton are all examples of companies investing directly into the sector, and there will be other similar plays as operators seek new capital to support their business strategy and investors seek ways to increase exposure to the sector.
Overseas investors have driven the purchase of flexible workplace led offices and in part this is due to weight of money targeting the London office market and the test for the sector will come when thinner investor demand is evident.
Valuation models for operational assets are evolving with recognition that buildings let to the sector need to be approached in a different way to conventional office space. For investment properties covenant strength remains an issue and a yield adjustment is typically made to reflect this where a higher percentage is let to a flexible workplace operator. Having a proportion of a building let to a flexible workplace is viewed as enhancing the office building in terms of amenity, brand and ultimately in rents that traditional occupiers are willing to pay.
In general, our research concludes that flexible workplaces will continue to be a major influence on the future direction of the UK office market, with London at the helm. It is clear that the concept is no longer just about an office building, but about where people want to work. There are opportunities for growth but a number of constraints may temper these. Nevertheless, both landlords and operators will seek to gain a larger foothold on the flexible workplace sector.
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Evolving the Flexible Workplace was researched and written by:
Elaine Rossall MRICS
Head of UK Offices Research & Insight
Direct: +44 (0)20 3296 4297
Mobile: +44 (0)7793 808319
Senior Insight Analyst, UK Research
Direct: +44 (0)20 3296 2069
Mobile: +44 (0)7850 062059
Christopher Dunn LLB
Senior Insight Analyst, UK Research
Direct: +44 (0)20 7152 5700
Mobile: +44 (0)7432 700951