Too Much Of A Good Thing: Landlords Say Coworking Is Best In Moderation

Coworking has become the darling of the office industry, with providers eagerly leasing up blocks of space during the industry's rampant expansion. But there remains a lot of hesitation as to their future from both office landlords and investors, panelists at Bisnow's Atlanta State of the Market said last week.

“The jury's out on that right now,” Seven Oaks Co. CEO Bob Voyles said.

Voyles was part of a lineup of some of the city's top commercial real estate and financial executives who discussed a range of topics from the health of debt financing in today's market, lessons learned from the Great Recession and a host of project updates.

Many office landlords are attempting to manage the number of square feet coworking operators lease in a single building. Any more than 20% to 30% of the total square footage and an office building's value can take a hit in the eyes of investors, Voyles said.

Reached by phone after the event, Marcus & Millichap Senior Director Paul Johnson said coworking is a growing concern among office investors, especially a building's exposure to them.

“At the end of the day, what they're selling is co-habitating office environment. So that does present a risk that office building owners haven't experienced before,” Johnson said. “They're turning over like 20% of their building to somebody who is almost in some form or fashion a competitor.”

A recent CBRE study also found a similar pattern. Sixty-seven percent of buildings that have less than 40% of the total square footage leased to flexible office operations, investor paid cap rates — the percent that quantifies a premium an investor is paying for the existing rent — the same as their peers without coworking or flex office tenants.

Once the share of the building coworking and flex office takes up rises above 40% of a building's footprint, 64% of the sales showed less favorable cap rates than their peers.

Last year, coworking companies leased 384K SF in Metro Atlanta. In terms of the total volume of leases last year, they only account for 2% of the total square footage inked, according to Colliers International Atlanta.

Even the start of this year, with coworking companies — especially WeWork — leasing more than all of last year at 428K SF, the total still only represents 7% of total office leasing year-to-date, Colliers Director of Research Scott Amoson said.

But when it comes to absorption — the total amount of space leased after subtracting the total amount of space given up by companies, a key indicator of an office market's health — coworking is having a much larger impact.

In 2018, coworking operators accounted for 10% of all office absorption. So far this year, they account for 34% of total absorption, Amoson said.

Some of the bigger players in the industry, especially WeWork and Industrious, have been pursuing more corporate clients as tenants. Most recently, Bisnow reported that BlackRock is using WeWork space at Coda while waiting for a permanent Atlanta home.

That move up the tenant food chain is making some landlords more willing to lease space to the bigger coworking players.

“I'm encouraged by what WeWork is doing today relative to its move more toward enterprise,” Portman Holdings Executive Vice President Hunter Richardson said during the event.

In a recent interview with Bisnow, though, Serendipity Labs CEO John Arenas said it is that reach for more enterprise business — especially companies taking entire coworking locations — that may be the chink in the armor for WeWork and other major coworking operators.

“In these top coworking markets, this [Facebook, Amazon, Netflix and Google] demand is actually driving full-floor and multi-floor [deals],” Arenas said. "In my mind, that isn't true coworking. That's an arbitrage to a suicide mission."

Arenas said the risk coworking operators are taking in entering into sizable enterprise deals with big companies is the nature of WeWork and others' short-term deals. As the economy sours, many companies will empty leased office space and attempt to sublet those floors to other companies to offset their costs.

As soon as companies using coworking space realize they can save money by taking sublet space — and they don't have to pay their coworking landlord a large termination fee — that could be a big danger for the coworking industry.

“There's a moment in time when that works,” Arenas said. "Then your tenant has an [opportunity] to get out. They have options, they have lots of sublet they can go back to. These are big bets on these 100K SF single-tenant locations."

CBRE Vice Chairman John Shlesinger said he expects that the coworking industry will ultimately consolidate into fewer, and bigger, players.

“You can't survive as a small coworking operation,” Shlesinger said. "You can only build on scale."