Coworking: the sceptics’ viewpoint

Coworking’s rapid expansion has unsurprisingly raised questions over the sustainability of demand, particularly during stressed phases of the economic cycle, as well as concerns over the covenant strength of the operators themselves.

Paul Heaton, analyst in Deutsche Bank’s research team explained in a recent CMBS analyst note:

“When the business cycle turns, small tenants will reduce property obligations where they can – but the landlords cost remain the same.”

While there is clearly a major structural shift among office occupiers under way, UBS-AM Real Estate & Private Markets argues there are still some serious unanswered questions related to the underlying business models of coworking operators.

“Ultimately, the model works by the serviced office provider signing long dated lease commitments with a landlord, and then effectively sub-leasing the space to companies and individuals on short term contracts. This clearly works well in a growing economy, but what happens in a downturn? Serviced office operators typically claim to be recession proof by pointing out that in a downturn occupier would actually want even more flexibility so are more likely to look at serviced offices than traditional leases.

“There is a major flaw in this claim however, which is that the vast majority of companies now taking space in serviced offices also have traditional leases in place which won’t necessarily end or break at the right time to give them that option. To give an example of how this might actually play out – a major bank takes 500 desks as expansionary space to house a creative team, on a rolling six-month lease with a serviced office provider. But in two years’ time there is a significant slowdown and the bank cuts 10% of its workforce.

“In the environment that is likely to surround the slowdown, the bank would almost certainly exercise its flexibility with the serviced office lease to take the creative team back into the empty space in the HQ, and save costs. The serviced office provider however still has contractual obligations to pay their landlord, at a rent which will have been fixed during the economic growth era and therefore above the prevailing market rent at the time. It is potentially a huge mismatch of liabilities which could have severe consequences for the wider market.”

The positive momentum driving demand for coworking should not always guarantee success for providers.The discrepancy between credit spreads of certain operators, which have expanded rapidly, and the lack of a discount on buildings occupied by such operators, is a noteworthy concern, addsUBS-AM Real Estate & Private Markets.

“It appears real estate markets are not reflecting risk perceived in the debt market; in the long term one or the other has to be right.”

james.wallace@realassetmedia.com