Whats The Deal With Coworking? 7 Questions Answered.
In Manhattan’s commercial real estate market, coworking companies have become the newest heavy hitters. Some industry analysts speculate that the coworking industry has created a commercial RE bubble in New York City, claiming that startups have taken on more office leases than they’re prepared to fill or maintain—and yet the industry continues to grow by leaps and bounds. So what’s going on with coworking?
How Big is Coworking NYC?
Startups like WeWork, Knotel and Industrious have become the city’s biggest office tenants overnight; between 2009 and 2018, coworking leases jumped by 600%, and coworking companies have already signed for 3 million SF of Manhattan office space in 2018 alone. WeWork has led the pack in snapping up space, with 5.3 million SF of office space currently on the books in Manhattan, making it the city’s largest office tenant.
Are There Really That Many Freelancers?
So—who’s actually filling these offices? The answer is more complex than you’d think. WeWork and most other coworking startups were founded to provide modern, attractive and flexible space for freelancers, independent contractors, consultants, and other remote-work professionals looking for amenities and communities outside of their local coffee shops. That’s the concept of coworking—it banks on giving people who would otherwise work from home access to nice office space, supplies, and fun groups of other freelancers.
In theory, the idea fills an obvious market gap—but in practice, it hasn’t been as profitable as companies would like. More Americans are freelancing than ever before, but many of them work at least some of the time in their contracted employer’s existing offices and have access to resources there; accordingly, the vision of bright, industrial-chic coworking spaces filled with houseplants and freewheeling creative professionals hasn’t turned into the cash cow most companies thought it would.
In the meantime, coworking startups backed by massive venture capital investments have acquired more and more expensive leases on offices in prime neighborhoods. They have tons of speculative funding, but they’ll eventually need to find more people to sublease all the desks they’ve scooped up.
That’s where “enterprise clients” come into the picture.
What Is An Enterprise Client?
The freelance client market has continued to slow, leaving coworking companies to pivot to other approaches in order to fill their spaces. The most common tactic is to actively solicit “enterprise clients,” as WeWork has named them: large companies searching for flexible, attractive, short-term office space without having to commit to binding commercial leases or pricey building purchases. Knotel specializes in these clients, claiming that 95% of its customers are enterprise-level companies with 100+ employees. WeWork, Industrious and other competitors are following suit, with enterprise clients currently making up over a quarter of WeWork’s base. WeWork is more stringent in their definition of what makes a company “enterprise,” giving the title only to firms with 1,000 or more employees—so they may be even closer to Knotel’s 95% enterprise base than than we’re privy to.
As large-scale enterprise clients increasingly make up coworking companies’ clientele, there’s been a corresponding tightening in the market for large, magazine-worthy “prestige” office spaces to serve them.
Why Is The Office Leasing Market So Competitive ?
Although WeWork and its peer companies already lease the majority of office space in Manhattan, competition for new space is incredibly fierce. Not all offices are created equal in the eyes of the coworking giants dominating the niche—these companies stake their reputations on offering aesthically-pleasing, conveniently-located, amenity-filled spaces that are eminently Instagram-able. While some dark, low-ceilinged midtown cubicle farms may languish on the lease market, any loft-like, light-filled space in New York often fields 3-4 lease bids from coworking firms. Having a market monopoly on beautiful office spaces in the city gives these coworking firms an advantage, so they’re all gunning to own more space than their competitors, even if securing these leases initially comes with a financial loss.
How Is Everyone Paying For This?
In short: venture capital backing. This is the other reason enterprise clients are becoming so valuable—small businesses and independent contractors don’t bring in the big money these coworking companies need to stay afloat. Much like other prominent industry disruptor startups like Netflix and Amazon, almost all coworking companies are operating at a loss as they acquire market share. In the meantime, they’ve been backed by billions in VC funding; over the past two years alone, the top 9 coworking companies have received over $6 billion total from VC firms. Meanwhile, WeWork has already operated at a loss of $723 million for the first half of 2018, but supposedly has an incoming investment of $20 billion from SoftBank to offset its losses. Big investors believe in coworking, even if it’s not profitable yet—they’re picking their favorite industry players now and hoping to see long-term payouts when coworking firms have completely cornered the leased office space market.
What Is An Exclusivity Clause?
Of course, it’s hard to corner the office lease market when landlords are eager to cut deals with multiple coworking companies in the same building. In the past, landlords were willing to grant “exclusivity clauses” to office building tenants promising they wouldn’t try to rent space in the building to the tenant’s competitors. This is increasingly rare, with some landlords choosing to hedge their bets and lease to 2-3 different coworking companies in the same building. The coworking craze has been astoundingly profitable for the city’s landlords, driving up PPSF through intense competition and endless VC funding. If coworking companies want a building exclusively for themselves, landlords are now making them pay ever-increasing premiums for the privilege.
What Will Happen To These Companies In the Future?
Some industry insiders have argued that there are too many coworking companies for the economy to sustain long-term, and that the competitive lease-chasing in the industry has created a pricing bubble that’s ready to pop soon. The majority of smaller coworking companies will likely be eaten by their larger competitors, eventually leaving an industry much like the hotel/hospitality business—mostly dominated by a few large brands with distinct identities and price points, but with room for smaller players in niche roles. Many coworking firms have already hired former hotel execs to prep for this shift. Enterprise clients will likely continue to grow until they become the dominant customer base, with coworking firms continuing to reshape their businesses to serve them. Most interestingly, many coworking firms will likely expand into brokerage and co-management—some of the big firms have already taken the first steps towards securing management agreements with landlords, giving them more power and equity in the landlord-tenant relationship without the risk of owning real property.