Cushman & Wakefield’s Coworking and Flexible Office Space report examines coworking and flexible-office trends and their implication for the commercial real estate industry and its participants.
Coworking inventory has grown substantially over the past three years. In fact, half of all current U.S. coworking space has opened since early 2015, with over 5 million square feet (msf) of new space coming online each of the past three years. Another 3 msf of new space has opened in the first half of 2018. Despite this growth, coworking still accounts for only 1%—47.8 msf—of the total 5 billion square feet (bsf) of office inventory across the 87 markets tracked by Cushman & Wakefield.
In the largest U.S. coworking market, Manhattan, coworking space accounts for less than 3% of office space. The other gateway markets are in a similar range with somewhere between 1% and 3% of office inventory in coworking space. Approximately half of all coworking inventory is in the six gateway markets: Manhattan, Los Angeles, San Francisco, Chicago, Washington, DC, and Boston. Non-gateway markets with over 1 million square feet of coworking space include Atlanta, Dallas/Fort Worth, Denver, San Diego and Seattle.
“Based on current near-term projections, coworking space could easily triple from its current share in gateway markets over the next decade,” said Revathi Greenwood, Cushman & Wakefield Head of Americas Research and the report’s lead author. “Total inventory could increase to over 5% of office space in many urban markets and as high as 10% in some markets.”
This growth is bolstered both by structural changes in the workforce and a changing profile of coworking users. Job growth in office-using industries—information, financial activities, and professional & business services—is also increasingly driven by small businesses. In 2017, small firms accounted for 89% of new job growth, up from 69% in 2000.
At the other end of the spectrum, coworking and flexible spaces are increasingly attractive to enterprise users, and providers are taking notice, actively promoting their locations and services to large occupiers. According to Emergent Research, the percentage of WeWork members who work for companies with more than 100 employees quadrupled from 2010 to 2017; they now account for 12% of members. Over the same period, freelancers/independent workers’ share of memberships decreased from 68% to 39%. In 2017, half of all members worked for companies with fewer than 100 employees. This matches the trend in the broader industry in which freelancers have moved from 55% of all memberships in 2012 down to only 41% in 2017.
“Occupiers’ demand for flexibility is not going anywhere,” said David C. Smith, Cushman & Wakefield Vice President and Head of Americas Occupier Research and co-author of the report. “The largest coworking providers continue to expand their portfolios at a dramatic pace.”
Questions remain about the ability of coworking operators to withstand a downturn. During a prolonged downturn coworking occupancy could potentially decline by up to 6%. Cushman Wakefield estimates that the largest coworking providers can withstand occupancy declines of this magnitude, as they are bolstered further by significant cash reserves and the diversity of their service offerings and, hence, income streams. Watch out, however, for increased M&A activity and consolidation along with bankruptcies as the market matures.
“While an eventual economic downturn may reduce the demand from coworking among freelancers, entrepreneurs and small businesses, it also will cause large occupiers to think even more seriously about the need for flexibility in their portfolios,” Smith said. “Occupiers will trim space from their traditional lease structures and augment the portfolio with coworking space on the margins.”
Over the last three years, the entry and growth of coworking operators—particularly WeWork—have driven real estate demand, measured by net absorption, in a variety of markets. For instance, in the Washington, DC, region, coworking accounted for 28% of net absorption in 2017 and looks set to repeat that performance this year, driving almost 23% of new space demand in the first half of 2018.
However, not all of that absorption is truly accretive. When coworking occupancy rates and the demographics of coworking members are layered onto leasing and net absorption figures, it is evident that only a proportion is truly new demand—for example, freelancers that otherwise would not be in office space of any kind. Corporate users, which are increasingly the targeted audience of coworking providers, typically cannibalize traditional office space in some shape or form.
“We estimate that approximately 30%-40% of new coworking leases account for new net absorption,” Greenwood said. “That is, every 1 msf of new coworking space leased adds 300,000 sf to 400,000 sf of new absorption that would not otherwise be in the office market.”
Coworking is not without its downsides. “There are considerable hidden costs that have not yet been fully quantified—particularly in terms of wear and tear on the physical building infrastructure and on soft services such as cleaning and security,” Smith said.
As for office property valuations, analysis of 17 building sales with coworking tenants from the past two years indicates a relationship between the reported cap rates and the proportion of a building’s square footage allocated to coworking. In those cases where 40% or less of the building was leased as coworking, the cap rate was within range or below other comps in the area. However, the gap between cap rates for comparable sales and the building(s) in question expanded as the proportion of space allocated to coworking increased. The initial results do suggest that investors seem to apply a discount as the percentage of the building that consists of coworking increases.
“The market currently seems to be comfortable with 15%-30% of an asset being allocated to a coworking provider with relatively strong credit,” said David Bitner, Cushman & Wakefield Vice President and Head of Capital Markets Research. “Anything above that may currently be viewed adversely. However, we expect that the range of comfort will increase over time as investors and lenders have more experience trading assets with significant coworking occupancy.”
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