Let’s Get Flexible: Coworking Companies Streamlining Portfolio After COVID-19

Coworking companies are refocusing on real estate fundamentals and their more profitable sites in the wake of COVID-19 and Adam Neumann.

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It seemed a week didn’t pass in 2018 without news of a coworking lease.

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Leasing activity for flexible office providers jumped by 200 percent between 2017 and 2018, leading Cushman & Wakefield to dub 2018 as the “Year of the Coworking/Flex Office Sector.”

The wheels started to wobble in the fourth quarter of 2019, in the wake of WeWork’s disastrous initial public offering attempt, but they completely fell off this year. The coronavirus pandemic has forced members out of coworking spaces and into their homes, and occupancy rates have plummeted.

Instead of going on a tear of signing new deals, most coworking and flex office companies have, instead, started to take a hard look at their locations to streamline their portfolios.

“Operators are using this time to revisit some poor decisions in the past,” said Francesco DeCamilli, vice president of flexible workspace at Colliers International. “They’re using this time to really reevaluate every one of their sites and rebalance coming out of COVID.”

Newmark Knight Frank’s “3Q 2020 Manhattan Office Market Report” found that 23 coworking locations around Manhattan have closed since the beginning of the pandemic, giving back 1.2 million square feet of space to landlords. The report estimated that another 1.1 million square feet of sublease space is expected to come back to Manhattan’s market, mainly due to coworking providers across the board closing locations.

In recent weeks, Regus has put more than 100 locations around the country into bankruptcy as it looks to cut 4 percent of its portfolio around the world, The Real Deal reported. But Regus has made sure to remain at its top-performing locations and, earlier this month, extended its lease at 136 Madison Avenue until 2031.

“Regus made it clear that they were identifying — as all the operators in their sector are — which are the successful locations and which aren’t as successful,” Colliers’ Michael Cohen, who represented Regus in the deal, previously told Commercial Observer.

WeWork has gotten out of the 115,000-square-foot space at 149 Madison Avenue it leased two years ago and recently announced it would close three of its oldest locations in Washington, D.C. WeWork sold a majority stake in its China division and CEO Sandeep Mathrani previously told analysts that the company wanted to exit or restructure 20 percent of its leases.

A spokeswoman for WeWork declined to comment but previously told CO that most of the decisions to close locations were made prior to the coronavirus pandemic as Mathrani tries to turn the company around.

Early in the pandemic, Knotel announced plans to give back about 20 percent of its 5 million-square-foot portfolio to landlords because of the pandemic. But it hasn’t been all smooth sailing. Knotel has been hit with numerous lawsuits from owners across the city for not paying rent, with owners claiming the flex office provider owes more than $6 million, according to court documents.

“Knotel is always evaluating and adjusting our portfolio to best meet the needs of our customers, through COVID-19 and beyond, and we have reached positive resolutions with many owners,” Mousa Ackall, a spokesman for Knotel, said in a statement. “We take our landlord relationships very seriously, and will continue to actively engage with them to achieve good outcomes during these challenging times.”

(Disclosure: Observer Capital, led by Observer Media Chairman Joseph Meyer, is a Knotel investor.)

While coworking companies’ rapid expansion helped them spread across the globe, boosted their valuations, and was a boon to landlords, it left some of the providers themselves with bloated portfolios filled with plenty of underperforming outposts. In WeWork’s IPO filings last summer, the coworking behemoth had more than 600 locations and was on the hook for $47.2 billion in future lease obligations.

“It’s clear that some of them expanded too aggressively in the past — WeWork being the poster child of this approach,” said Dror Poleg, a former adviser to WeWork competitor Breather, and co-chair of the Urban Land Institute’s Technology and Innovation Council.

Part of the issue was that many of these companies ignored the basics of the real estate industry in favor of growing at all costs, DeCamilli said. (Under former CEO Adam Neumann, WeWork considered itself a technology startup instead of a real estate company.)

“There have been criticisms about the underappreciation of real estate fundamentals by leaders of coworking companies and many of the operators,” DeCamilli said. “We’re starting to see the merits of that criticism.”

That was fueled largely by coworking companies trying to justify the eye-popping valuations investors were giving them. WeWork started 2019 with a $47 billion valuation after SoftBank Group’s $6 billion investment, while Knotel was crowned a unicorn that same year.

“That would’ve pushed me to do all sorts of things that would’ve killed my business,” Poleg said. “[WeWork] had an investor that basically pushed them to make these choices.”

That’s starting to change now, as the pandemic has forced coworking companies to really focus on the real estate portion of their businesses. WeWork replaced the bombastic Neumann with Mathrani as CEO, a legendary real estate figure credited with helping pull mall operator GGP out of one of the biggest real estate bankruptcies in history.

“There’s a lot more emphasis on traditional real estate experts being elevated internally to really right-size the operations,” DeCamilli said. “There’s also quite a bit of inbound inquiries from operators who are looking for us to help them restructure their portfolio.”

And, so far, Poleg said WeWork has made the right moves by cutting down on its billion in lease obligations, which will help it come out stronger.

“Everything [WeWork has] done over the past year, and over the past six months, is exactly what they’ve should’ve been doing,” Poleg said. “It’s definitely a good time for these companies to try and renegotiate.”

With leasing activity plummeting across the board, landlords are more willing to work with coworking companies to keep them in the property, because filling a vacancy would be extremely challenging amidst the pandemic.

“In a down market, where there’s not a ton of demand, it’s really in the best interest for both parties to come to some sort of compromise,” DeCamilli said. “For forward-thinking landlords and operators, this period is bringing them closer together and giving them more insight into each other’s businesses.”

Partnership agreements — which can include operators sharing revenues with landlords at locations — were gaining popularity pre-pandemic, but the idea is gaining much more traction now, DeCamilli said. In recent weeks, Industrious announced new deals to partner with landlords like EQ Office, LIWRK and Pedcor Companies, and open new outposts around the country.

While the flex office market hasn’t faced “a challenging experience where there’s been a hit on demand” before, operators are making moves to help become stronger in the future, DeCamilli said.

“Pressure makes diamonds,” he said. “I think this period of distress is really pressure-testing operators around the world. They’re going to rise from the ashes with a more optimized model.”

Aside from an increased focus on partnership agreements, operators like WeWork have started to roll out programs where companies and users can pay a monthly fee to be able to access all of the providers’ locations around the world. They’ve also started to focus on more private and dedicated offices — moving away from the hot-desking model — as fears of catching COVID-19 makes workers wary about packing into dense spaces.

Those efforts could help capture the increased demand for flexible leases many expect in the future, as companies won’t want to commit to long-term deals post-pandemic while others want to offer employees the ability to work closer to home but ditch their dining room table.

“There’s a number of high-profile, Fortune 500 companies that are working through significant portfolio changes that involve some portion of on-demand workspace,” DeCamilli said. “We’re still in the early stages of it.”

Even if the coworking market is expected to come out stronger, streamlining their portfolio could lead to some troubles for landlords.

Coworking companies lease a total of 14.7 million square feet around Manhattan, and occupy 3.1 percent of its office inventory, a Savills “NYC Coworking Review” report found. The top five coworking companies — WeWork, Knotel, Regus, Convene and Spaces — are committed to paying more than $755 million in annual rental income to landlords until 2030. If all of the coworking space went back on the market, it would increase Manhattan’s Class A availability rate by 48 percent.

DeCamilli said that coworking still only makes up a tiny portion of overall office occupiers, and their ditching space won’t “have an outsized effect” on the market. However, Poleg said that landlords are downplaying the dangers of flex office operators ditching space.

“Landlords are very reluctant to face reality, but now it’s being expedited and cemented,” Poleg said.

And with the case of WeWork, backer SoftBank proved it has the funds and desire to carry WeWork through this time and could easily fight it out in courts to get out of leases.

“Landlords are now in a much worse position than they were a year ago,” Poleg said. “WeWork is still alive and is owned by a $200 billion conglomerate that has shown its willingness to bankroll the company.

“This attitude of, ‘We’re going to dictate terms to all the people on Earth, and I tell them how to work,’ I think it’s time to move on,” Poleg added.