Never before have those of us in commercial real estate been the most interesting people in the room. Never before has office space been so centrally relevant to a worldwide health and economic crisis. Will companies need offices in the future? (Yes). Will the office of the future look completely different? (Just a little). Will companies significantly downsize, leaving offices vacant all over the world in favor of working from home? (No). And one of the most popular questions right now, what does this mean for the future of co-working?
Co-working v1.0 began with the shared office suite model, filled with long hallways and a multitude of doors to single private offices, similar to a creepy Halloween fun house. When the real estate market began to recover from the last economic downturn and FAANG (Facebook, Amazon, Apple, Netflix, Google) was born, these growing technology companies needed to solve for flexibility in office space, but not the way it looked in v1.0.
You could say co-working v2.0 began when WeWork was founded in 2010 and went on to build a company that was at one point valued at $47 billion dollars (or that is what they told the world) with approximately 850 locations around the world.
Why was WeWork and similar models so successful? Contrary to popular belief, it had little to do with the free kombucha and member perks. Outside of the communal draw, especially for many smaller companies, co-working v2.0 offered an office space solution that traditional real estate owners and lenders couldn’t: ultimate flexibility. At most co-working v.2.0 locations, you could sign a lease for 1 month, 12 months, or as long as you wanted. You could share space with other companies, or you could lease an entire space on your own. You could expand and contract, seemingly whenever you wanted. And, for many high growth companies, technology or otherwise, this offered a real solution to unexpected/unplanned growth and a preference to not get “stuck” in longer term traditional office leases.
In fact, WeWork increased its corporate clients by 90% between 2016 and 2017. Many bemoaned co-working as being too costly, but many companies felt like the premium for flexibility, not having to build out space, and to have someone else take care of your problems (office related, of course) significantly made up for those costs. As a result, between 2014 and 2018 the number of co-working locations increased by 205% and pre-COVID, the sector was expected to see annual growth of 6% per year in the US. 2
Nevertheless, this co-working model, just like v1.0, is about to be updated. In this pandemic affected world, very few companies are comfortable in any office plan built on extreme density, sharing space with many other people at many different companies who may adhere to different safety measures or protocols, or relying on shared lobbies, kitchens, conference rooms, and hallways. So, just like an old iPhone, goodbye v2.0.
But what next? The reason that v2.0 became so successful is still relevant, and even more so today when the world is changing every few weeks. Today, bracing for change and learning to deal with unpredictability has become one of the most important skill sets. The percentage of companies that would consider the flexibility provided by a co-working model has increased because of COVID, but not in the way that it previously existed. For many of us, it is like working from home. A significantly higher percentage would consider doing it on a longer term or more regular basis, but it can’t look anything like it did pre-COVID, in order to be successful.
Let us introduce co-working v3.0. It may not be called co-working, but this flexible office solution will allow companies to occupy their own spaces for lease terms that are more in-line with v2.0. In order to achieve this, many traditional landlords will allocate portions of their buildings (10% – 30%) for flexible lease terms. These spaces will be built out on spec, many will be furnished, and lease forms will be standardized.
Capital partners and/or lenders have always been the hindrance to this and have historically struggled to underwrite or lend on buildings with short term leases in place. The demand for this type of space, coupled with the premiums for these spaces (similar to v2.0) will limit downtime and exposure for landlords and lenders. With some tweaks to cap rates and underwriting methods, traditional landlords will finally be able to participate in a part of the market, which historically was off limits. Other asset classes, including hotels and multifamily have been able to do so, and finally, office buildings will be no different.
Co-working v2.0 was just under 3% of the Los Angeles office market, just under 6% of the San Francisco office market and just under 9% of the New York office market. Version 3.0 will expand upon that even more, and we suggest you get well versed in change; it is here to stay.
Jennifer Frisk is senior managing director with Newmark Knight Frank’s downtown Los Angeles office.