This article is from the Australian Property Journal archive
THE breakneck speed at which co-working operators have been expanding to gain market share will likely slow next year, renewing fears that office markets have become too reliant on the sector as demand from traditionally big tenants, such as banks, drops off, according to UBS.
In the wake of the high-profile WeWork debacle, the latest UBS-AM Real Estate & Private Markets’ Real Estate Summary, Edition 4 – 2019 paper shone the spotlight on the untested co-working business model and what the implications are for real estate in the mid-to-long term.
The report said fears about the co-working 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 scepticism about co-working, 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 is the reliance that office markets in APAC have come to have on the co-working sector as a demand driver, where take-up by the sector accounted for as much as ~30-40% of total office net absorption in cities like Singapore and Hong Kong in 2018,”
Although WeWork is the most talked about co-working company, it is not the only operator facing difficulties. Recently the Urban Land Institute (ULI) and PwC report found companies in China are having trouble servicing debt.
Recently operator Kr Space reneged on an agreement with Chinachem to take seven floors in One Hennessy in Wan Chai and WeWork is considering surrendering a portion of a recently signed lease in Wan Chai in Hong Kong, amidst report is looking to lay off 6,000 workers from its 12,000-strong workforce.
UBS said the issue is that co-working 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.
“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,”
In Australia, WeWork is opening its 15th location but in recent weeks it has halted further expansion and stopped signing new deals.
WeWork’s rapid expansion down under saw it sign a 12-year deal for 11,000 sqm at 320 Pitt St in the Sydney CBD on a 12-year deal. Last year, its 10-year lease commitment spurred Sydney developer Philip George to undertake a $50 million upgrade of the 7,300 sqm heritage-listed 66 King St office building. Its other Sydney locations include 4,100 sqm of Sumner Capital’s 50 Miller St, and the entirety of the 10,000 sqm office component of the timber Daramu House building in Barangaroo South.
Its first Perth location of 7,900 sqm will open in September. It recently signed another 12-year lease over 4,600 sqm at 260 Queen St in Brisbane from global real estate firm Hines.
UBS said the credit risk of co-working 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 co-working 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,”
In the case of WeWork, it occupiers more than 1.3 million sqm of office space globally, and owed $18 billion in rent, with a further US$47 billion in future rent payments due.
Having said that UBS said the co-working sector has fundamentally changed the way that office users and owners are utilising 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 co-working 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 co-working players in strategic partnerships to extract the premium from this structural change in how workspace is being redefined,”
UBS said the consolidation of co-working operators is something that will eventually happen across the industry, albeit gradually.
“That will allow for a few thriving and sustainable operators to stand out amid the currently fragmented landscape. Furthermore, 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.
“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,”
UBS said the bigger implication is that the pace of expansion by co-working operators is likely to slow from its breakneck speed.
“Office markets in APAC are likely to face a challenged demand picture, although this will be mitigated by tight vacancies in the region. More importantly, despite the rapid growth, co-working only accounts for about 2-5% of total office stock in the major cities in APAC; any fall out we see in the space will therefore likely be contained.”
