Coworking Is Surviving Its Trial By Fire
The business model is untested, they cried. You need to see how it performs in a recession, they said. The flexible office space had not seen a downturn before. Well boy, it has now. And so far, it has performed better than a lot of people expected.
It is early days, of course, and this crisis still has some (maybe even years of) distance left to run. But data drawn together by Bisnow shows the flexible office business model has had resilience in the face of a perfect storm of problems, and that demand is starting to return.
There are some big hurdles to overcome; principally, how a sector that boasted of how it allowed people to interact convinces people it is safe in a world where interaction is forbidden. Some operators will not make it through the crisis, and others will be forced to shrink. But with the way people use offices going through the most radical overhaul since the concept was invented, flexible office have the chance to capture any growth opportunities that emerge in the new world.
“It has been like driving a car into a brick wall: You can’t expect it to come out unscathed,” Labs Chief Commercial Officer Matt Watts said of a year when governments across the world told workers not to go into the office, leaving pretty much the entire flexible office sector open but unoccupied.
Rather than rely on anecdote, what does the data tell us about how the sector has fared in the UK?
In terms of demand for space, Watts’ analogy is not far off. Demand dropped to 35% of pre-pandemic levels in the UK in April, according to data from Instant Offices, an online flexible office portal. Fellow portal HubbleHQ pegged demand in London at 20% of pre-coronavirus levels in April.
But actual occupancy levels were fairly robust. Average occupancy in the UK fell from 92% to 77% from March to June, according to Workthere, the flexible office advisory division of Savills. Of course, a 15% drop in occupancy in the space of a month is not ideal, but it is not as bad as it could have been.
“When looking at assets leased to flexible operators, valuers have been working on the assumption that in a downturn, all the customers leave,” Workthere Global Head Cal Lee said. “This is the worst possible recession and it only dropped 15%. That’s very positive, and demonstrates the strength of the sector in the longer term.”
In a survey Workthere found that 28% of UK operators had been forced to offer discounted rents to members, and Instant found that discounts offered ranged from 5% to 50%, with the average coming in at about 15% to 20%. That has further hit the margins of operators, and some might not make it to the other side.
“We won’t know until next year who has done well and who has suffered,” Lee said, pointing out that some tenants are still deciding not to renew leases as they come due, and demand for new space is not yet at normalised levels. Until those two things balance out, the true state of the flexible office market won’t be known. In general, operators aren’t making a profit on a space unless it is at least 70% occupied.
The red flags Workthere looks for that indicate operators might struggle are reliance on onerous long-term leases, a high proportion of very small businesses among clients and a lack of support from cash-rich backers, Lee said.
Some operators will clearly retrench. WeWork, the most famous name in the sector, is reviewing its portfolio and is reported to be pulling back from deals agreed before the pandemic, both in London and beyond.
But demand is coming back, and confidence with it. Instant said UK demand is still 25% below pre-pandemic levels, but rising every week. Looking to other markets where lockdown has already been lifted, it said of its 13 largest markets, 10 are within 15% of pre-pandemic demand levels and five, including the Netherlands, Germany and the U.S., are seeing demand above pre-pandemic levels.
Savills said 74% of the global operators it surveyed in May are feeling confident about the next 12 months, compared to 64% who felt confident in April. In the UK, 85% of operators said they are confident about the next 12 months.
“The medium and long term look good; now it is just about getting through the next six months and winning back customer confidence,” IWG UK chief executive Richard Morris said.
IWG is the world’s largest flexible office operator, and last week raised £315M to take advantage of opportunities to expand it expects will come about as a result of the downturn. That in itself is a mark of how confidence in the sector has bounced back: As recently as March, IWG’s shares were underperforming the broader index due to fears about how badly flex offices would be hit by the coronavirus, and now investors are giving it cash to expand.
“April was bad, people didn’t know what was going on, but now businesses have more information and are able to start to plan,” Morris said.
He said the equity it raised would be in part used to acquire rivals that might struggle due to the downturn — even before the coronavirus, IWG was snapping up businesses that had hit the rocks.
“It is a fragmented sector and there are a lot of operators out there which are barely profitable,” he said. “Scale is important in this business. You need economies of scale, and we can take on other businesses if they have assets that we would want to be in anyway.”
Demand is coming back, but it will not quickly return to normality, nor will the pattern of recovery be the same as in other recessions, like the 2008 financial crisis. Labs' Watts pointed out that in the wake of that crisis, pricing, occupancy and revenue all dropped but demand remained robust, as entrepreneurs and startups flourished and required small amounts of flexible space.
This time around that demand won’t be the same, with venture capital-backed companies less likely to emerge, and companies potentially happier in the near future to have employees work from home.
“The rest of the year will be about keeping existing occupiers happy and trying to secure new business where you can,” he said.
The biggest factor in keeping existing customers happy, and thus willing to pay for space, will be safety. There are several concerns about the flexible office sector’s ability to keep workers healthy in the new world. In particular, the amount of communal space that flexible offices typically offer, once an amenity, is now a bug; and providers will need to battle the perception they are denser than traditional offices, and so social distancing is harder to enforce.
In terms of how operators are approaching this challenge, here again some data comes in useful. HubbleHQ surveyed 55 London flexible office providers and found that 81% are changing office layouts, 56% are introducing one-way flows through buildings, 14% are installing antiviral air filtration systems and 49% will ask for compulsory hand-washing upon entry.
“COVID-19 has caused a seismic shift in how we think about office space, and the speed with which the respondents to our survey are reacting is testimony to their understanding of their customers’ needs,” HubbleHQ chief eexecutive Tushar Agarwal said.
According to the website of The Office Group, one of London’s largest flex office providers, communal space is being cleaned more regularly and thoroughly with specialist products, and companies can also pay to have their private space deep cleaned, including a full chemical sanitisation of the office, carried out by an ultra-low-volume machine, dispersing a chemical in mist form.
“We’re looking to reduce the amount of touch points,” Watts said. “You won’t be putting your hand in a bowl of fruit in the kitchen any more, that will all be packaged up.”
On the density point, operators said genuine coworking, communal space used by companies or individuals that don’t have their own private office, is actually now only a very small part of the flexible office sector: For most operators, even if they cut back on this entirely, they wouldn’t miss the revenue.
Workthere’s data has consistently shown that communal space is the least profitable part of a flexible office facility, and it may well die as a result of the coronavirus. The Office Group told members in an email that it would not be selling new lounge or coworking memberships, so that existing coworking members had more space, and it said existing coworking members would be allocated a specific desk to prevent desk sharing.
Beyond that, many operators made the same point about density: A company can use its office space as densely as it wants to.
“We have some customers who might take a five-person office for themselves because they like a lot of space, and others who do use it very densely,” IWG's Morris said.
That is unlikely to lead to companies enlarging their offices significantly to lower density, though.
“Unless you are willing to pay three times more, you’re not going to get three times the space so you can spread people out,” Instant Offices Head of Marketing John Williams said. “Companies are not going to want to take on that overhead.”
Companies are much more likely to only bring a certain portion of staff in on any given day, having the rest continue to work from home. Operators are almost across the board improving the technology in workspaces to allow hybrid meetings on platforms like Zoom or Microsoft Teams.
“This is a business that is built on density,” Workthere’s Lee said. “You have dense offices so you can have those amazing breakout spaces. In the short term you might see meeting rooms converted to desk space, but in the long term I don’t think it will change.”
A long-term change that could come about as a result of the pandemic is a move from operators taking long leases toward management agreements with building owners.
“That is a real partnership between asset owners and operators where they share the risk and share the reward,” Lee said.
Morris said some of IWG’s equity raise would be used to enter into more of these agreements, which it sees as a key part of its expansion, as it looks to reduce its exposure to lease liabilities.
And ultimately, the long-term confidence exhibited by operators stems from the belief that, if the short-term challenges presented by the coronavirus can be overcome, the office world is heading inexorably in the direction of flexibility, and the current crisis will only amplify this trend.
“People’s preferences will change, companies will want to be more flexible and more agile, and will only want to pay for space when and where they need it, rather than having longer-term commitments,” Morris said.