Our 2020 outlook for coworking and flexible office space in the US
The market is diversifying, not consolidating
We know from Instant’s US Market Summary that the 10 largest providers now make up 36 percent of the market in the US, which is less market share than they had in the prior 12 months. Many commentators are contemplating consolidation in the market – after the rapid expansion of the last five years, but our data would suggest that this isn’t going to happen over the next 12 months.
There are still many cities where demand exceeds supply for flexible space. This is a fragmented and niche industry, and one that is growing rapidly outside of traditional urban bases. Conservatively, there were an additional 250 providers of the flex space over the past year in the US.
As clients gain experience in procuring flexible space, providers are going to have to become more accommodating around specific demand from second or third-time buyers of flex. This dynamic will only increase customization, specialization and nichification in the industry.
Are desk rates on the slide?
New York remains the most expensive market per-desk in the world (according to Instant’s Global Cities report), averaging $1,063 per desk, despite a market decrease in desk rates of four percent. The decrease was largely accounted for by a supply increase year-on-year of 21 percent, much of which was in Brooklyn and Queens, which command lower desk rates.
Key locations in the world’s global cities have seen a rapid expansion in a very short time. It is inevitable that providers are going to move outside traditional business centers or central locations which is in turn lowering desk rates. Providers are moving outside traditional business centers to meet the demands of stronger work-life balance and greater access to talent.
After a period of expansion, providers in the central office markets of London, NYC, LA, Hong Kong and Sydney are under intense competition. While these markets cool from a pricing perspective, we would anticipate the “outer” markets of these cities really starting to fire with NYC at the forefront of this market evolution.
We will begin to see more franchising in the sector
Some of the players already doing so include Venture X, Serendipity Labs, and Office Evolution. But the biggest statement in this area came from Mark Dixon, CEO of IWG who, in lines with a franchise model, has sold off his Japanese business and will launch 30 new centers with partner companies in the coming year. As an industry expert, Dixon knows the market, and recognizes that the franchise model is a rapid way to scale his business but also make the most use of IWG’s vast back office operations.
We have cited the similarities between the flexible workspace model and hotel operations on more than one occasion, and the franchise model sits comfortably between the two. New entrants to the market can benefit from the brand of a large organization, its lead generation capability including digital marketing and customer services. All of these elements are hard to scale from scratch.
Office space is rapidly shifting to flexible
Perhaps stating the obvious, but the supply of flexible workspace is increasing! The US market now consists of more than 6,000 locations – making it the largest such market on a global basis. If the growth in rural markets and smaller towns continues at the same rate we are currently seeing, in addition to the continued spread of flexible locations into major metropolitan suburban markets, we could see upwards of 10,000 flexible locations across the US by 2023.
Vacancy rates in this critical component of the conventional office market are on the rise as clients seek flexible alternatives. The outcome is an inevitable rise of hybrid flexible / lease solutions, with landlords now catering for additional flexible demand that has been impacting the high-volume, transactional element of their market.
Our prediction, based on our proprietary data, is that globally by 2023, 12.5 percent of commercial real estate will be in flexible workspace. This is dependent on a number of factors, mainly the ability of the flexible workspace market to produce enough supply to match demand which we believe is going to take some more agreement and better understanding between landlords and providers. But the demand is definitely there from a client perspective and with market penetration – i.e. the total amount of flexible space as a proportion of total office space – as low as six percent even in the large city markets, there is room to grow.
How will a potential recession impact the growth of flexible space?
There are several ways of viewing this – from a pure supply perspective the flexible market was formed in 2008 in the aftermath of the Global Financial Crisis, as companies of all sizes looked to more agile ways of working, which included committing to long-term leases. In the 11 years since, we have seen the market grow at 35 percent each year like clockwork.
There has been much talk around risky leases and the cash squeeze that may occur for some providers if occupancy rates fall in a downturn. This is the same for any business, but in the instance of our sector it is also highly dependent on the mode of occupation for provider i.e. whether they have a freehold, signed a lease, management agreement with a landlord etc. There is no ‘one size fits all’ model for the sector. And many of the new providers in the market have backers with very deep pockets, who will support their investment through a downturn.
Profitability of coworking spaces has long been discussed and will be fundamental to the success of the sector moving into 2020 and beyond.
The Deskmag 2019 global coworking survey identified two critical factors in running a profitable flex space: -
- Number of members significantly increases profitability with 84% of locations of 250+ members reporting a profit (24% of centers with less than 25 members are profitable)
- There is a correlation in the number of locations with improved profitability (72% of operators with 3 or more centers reporting a profit VERSUS 36% of operators with 1 location are profitable)
Corporates taking bigger bite out of flexible – for the last five years we have seen the size of flexible requirements increasing as 25+ and 50+ desk deals have grown faster than the coworking membership element of the market.
In reality, flexible space is now a fast, agile route to market for companies of all sizes, and our view is that adoption of flexible space will only increase once the procurement arms of larger organizations work flexible options into their processes. Commercial real estate has been procured in one way – the conventional lease – for more than a century and it is a large oil tanker to turn around.
WeWork, Knotel, Second Home to name a few, are flexible providers that are taking space four times the size of the average coworking center (100,000 sq ft as opposed to 25,000 sq ft) to try and meet this corporate demand. If we look at the data for locations solely opened in 2019, the average size has increased to 28,526 sq ft- over a 50% uplift. WeWork states that 43% of its business is now “enterprise” and works out as 66% cheaper than conventional lease equivalents over the lifecycle of occupation. That is a good deal for any corporate client.
Included within this model, we are also seeing a rapid increase in the number of third parties that are offering outsourced workplace solutions for corporate customers. The rise of flexible office space has produced more demand for agile solutions while retaining the elements of corporate identity and privacy that most brands currently enjoy. This provision of workspace services from third parties also removes the risk around delivery of space and the ongoing issues of management. Demand from corporates increased in 2019 and will undoubtedly become part of the wider make-up of the CRE sector over the coming year.
We predict that by 2023, 35% of corporates will be using flexible real estate. From our view of corporate real estate strategy, we note that larger organisations now see flexible offices as a way to mitigate risk by offering agility, lower capital expenditure and cost transparency. Business planning cycles have shortened, and firms are seeking solutions that allow them to remain nimble particularly at times of uncertainty.
With this in mind, companies are “flexing out” elements of the office requirements under 20,000 sq ft, which incorporates the “long tail” of their workspace and can amount to as much as 75 per cent of their portfolio (and half its costs). The challenge is now for operators of flex space to have the right space mix an be in a position to offer the right services to appeal to this burgeoning corporate demand.