UBS, its Q4 Real Estate Outlook report, reviewed the controversy surrounding the untested coworking business model and what the implications are for real estate in the mid-to-long term, following WeWork’s aborted planned public listing.
Zachary Gauge, European real estate analyst, UBS-AM Real Estate and Private Markets, explains:
“Fears about the coworking sector were renewed and questions raised about the viability of a business model which pairs long-term lease liabilities with variable revenue from short-term occupants, with the latter particularly tenuous and exposed to uncertainty in a weakening macro environment.
“In our recent interactions with investors, there was a sense of skepticism about coworking, but in our view the emperor has always been wearing his ‘new’ clothes; i.e. it was not a new fault line raise by a few, but often deliberately ignored by many more.”
Part of what feeds this renewed fear, according to UBS, is the reliance that office markets have come to have on the coworking sector as a demand driver. The issue is that coworking operators are not expanding as a result of organic growth but are doing so in order to gain market share, which results in a situation of obligations that are unbacked by earnings, explains USB.
Zachary Gauge adds:
“Thus far, landlords have been willing to sign on such operators, partly driven by the belief that the way people work is changing and partly by the ability of operators to pay high rents, but in all likelihood it is also due to a lack of options as absorption from the traditional space guzzlers like banks, shipping and commodities companies dried up. The credit risk of coworking operators as tenants is high, especially for many that have relied on venture capital cash and have yet to turn a profit. And, on the more extreme end, there exists a real risk that coworking operators become ‘too big to fail’ even if they default on their lease obligations, as market exposure to such a business model holds landlords to ransom.
“Many landlords have implemented measures to mitigate the risks while still getting exposure to the sector, such as by running a flexible office set-up on their own.
“Despite its detractors, we have to agree that the coworking sector has fundamentally changed the way that office users and owners are utilizing space. What used to be an old-school serviced office business has now created new, structural demand through the provision of supplementary offerings and clustering of networks, which are ever more important to new economy users.
“Furthermore, there are clearly companies who benefit from the flexible leases offered by co-working spaces, such as smaller enterprises and tech start-ups. As, the economy slows, some traditional companies may also turn to coworking spaces as an interim solution while they wait and see how things turn out. To that end, we have even seen investors teaming up exclusively with coworking players in strategic partnerships to extract the premium from this structural change in how work space is being redefined.
“And while WeWork might have been aggressive in spending, other operators which have been more disciplined in expenditure and diversified in revenue streams have shown that it is possible to be profitable. The bigger implication, in our view, is that the pace of expansion by coworking operators is likely to slow from its breakneck speed.”