The start of a new year provides time for reflection and a look ahead. The start of a new decade even more so.
As the Founders of Co.RE, the Coworking Real Estate Opportunity Fund, we bring an interesting perspective to this process in that we have line of sight on two industries – Coworking and Commercial Real Estate. We focus on the intersection of the two and are very excited for what we believe 2020 holds.
However, before we begin our look forward we would be remiss if we didn’t speak to the biggest news story in our industry in 2019. Unless you’ve been under a rock, you’ve seen the endless stream of articles on the fall of WeWork. The situation has created a lot of questions about the viability of our industry and we regularly get asked if the WeWork crash indicates the end of coworking. Allow us to summarize what happened and what it means.
WeWork Didn’t Work, But They Will
WeWork tried an IPO at a highly inflated price with ridiculous governance. Their value was put over the top by Softbank, the largest private investor who stood to reap significant gains from a high value IPO. The markets’ rapid and vicious response showed they saw flaws and would not accept them. It’s a classic “The Emperor Has No Clothes” situation with public investors playing the role of the precocious child.
The IPO crashed and burned in spectacular fashion. Why? Despite the story WeWork told there was no innovation in their particular business model, just more risk and aggression than their competitors. They took a very simple and established concept – lease for the long term to secure a low lease rate and rent the same space at a high rate in the short term – and went all in. WeWork were great at lease arbitrage, that’s it. However, their inflated valuation was based on being perceived as a technology company. They were not a technology company. They were never going to “elevate the world’s consciousness” and they had no path to profitability. Hence the market’s overwhelmingly negative response to the IPO.
But what does this mean? In our opinion nada, nothing, zippo, a big nothing burger for coworking. It does not matter for two key reasons – the broad diversification within our industry and the incredibly strong and continuing demand for flexspace. These two facts are what really matter and are the best indicators of long term health and continued success.
We believe that with the removal of their mercurial CEO (and by mercurial we mean flakey), a much more moderate approach to growth and risk and a focus on their core business of coworking, not schools or fitness, WeWork will become a viable and profitable brand in the future. In the meantime we thank them for two things: Awareness of coworking is at an all time high and as WeWork recalibrates there is an opportunity for other brands to fill the void they have temporarily created. Demand is on the rise, with predictions that flexible space will occupy 15 to 30% of all office inventory by 2030. As WeWork pump the breaks on their reckless growth other operators can expand and meet the demand.
Now that we’ve got that out of the way let’s take a look forward.
It’s the Economy Stupid!
Nothing happens in a vacuum and while every industry is impacted by the vagaries of the economy both Coworking and CRE are highly influenced by changes in the financial markets. So what do we think is likely to happen in 2020?
The consensus forecast is that markets are expected to continue to eek out small gains. Most S&P forecasts call for gains up 5% in 2020 vs up 29% in 2019. Markets expect interest rates to remain fairly stable with US 10 year yields ending 2020 around current levels of 1.90%. The FED is expected to keep rates steady in the coming year after cutting rates three times during 2019. Okay that’s a pretty boring forecast. What’s really going to happen?
To answer that question we have to look at risk factors including geopolitical risk. Increased tensions in the Middle East will push oil markets higher and a rise of tensions with North Korea will create uncertainty. Both situations will impact economic growth and likely have a negative impact on consumer confidence.
Another area of risk is in the political arena. Right now the markets are not factoring in who may win the Democratic nomination or who might win the election. Depending on the outcome the markets will be tested.
Increased Sino US tension is another risk factor. The markets are happy with the US and China signing the Phase One Trade Deal. If there is a perception that either side is not honouring the agreement, if the talks don’t progress positively or there is indication that tariffs are coming back the markets will respond negatively and potentially in an inflationary manner.
That’s a lot of peering into a magic eight ball and we have no definitive answers but overall we believe all of the above factors will cause the economy to slow in 2020. This will push interest rates lower. That said we believe the economy will remain strong enough to continue to drive demand for flex space. Lower interest rates will keep CRE investment activity, with its higher rate of return, strong and will translate into rising office building values. We expect to see lease vacancy rates remain low contributing to continued strong demand for coworking and flex space.
Coworking is Growing Up
Coworking has moved out of its infancy. Brands are evolving and pushing forward into uncharted territory. Convene, Ucommune and others have crossed oceans. Spaces are opening their first locations with 20,000 square feet or more, as opposed to 10,000.
This does not exclude the smaller spaces in remote areas which absolutely are part of this movement. Suburban and rural spaces are seeing plenty of traction and it would be ridiculous to enter a small town with a fancy 20,000 square foot space. We’re maturing and growing, getting smarter faster and more nimble. This evolution will attract new players, new investors and new types of partnerships and business models.
Let’s Get Healthy
We believe health and wellness will be the biggest trends in coworking in 2020 and for the balance of the decade for that matter. Coworking brands that are not designing their spaces with health and wellness in mind are going to miss the boat.
We’re not just talking about physical health, we’re talking about mental and environmental health, as well. It’s the health of the building. It’s the lights, the air, biophilia, nature, nutrition and more.
As far as mental health, the loneliness epidemic is staggering and the numbers are downright scary. We in the coworking industry are uniquely positioned to help move this ship. We have humans in our care for eight hours a day, they often spend more hours awake at work then at home. We believe the coworking industry can and will take a lead in addressing this issue.
Texas is Having a Moment
Yes! the Houston Texans did beat the Buffalo Bills in the NFL Wild Card Game but we predict the good news for Texas will extend beyond football. Not only have some of the most iconic coworking brands of the last decade emerged from Texas (think Link Coworking and Common Desk) but certain high-growth markets within the US, such as Texas, will see outsized economic performance in 2020. CBRE is predicting the top three cities for office absorption in the US will all be in Texas: Austin, Dallas, and Houston.
Community is Critical
From international relations to domestic cultural politics to the environment the future feels unsettled and uncertain. America is divided and fractured and moving into the new decade we believe folks are fatigued with division and will increasingly look for ways to connect and unite.
Community, long the secret sauce of coworking will become more appealing and attractive to exhausted, isolated and lonely workers. Community can’t be bought, it has to be built.
Other industries are discovering community. Just look at how Peloton is building a community for their brand, and pop-up shops are often a brand looking to connect and engage their community. Since coworking is a place of work and a community we need to better be able to grow it and excel at it or others will take our place.
Green is the New Black
Full disclosure, I stole that line from Forbes Europe, and they are not wrong. In 2019 Greta Thunberg made us all sit up and take notice and increasingly companies and workers are starting to take climate change seriously. Sustainability is no longer a fringe issue. Conscious consumers are now demanding sustainable fashion and food and we believe this demand will extend to their workplace in 2020.
Coworking brands are ideally placed to take the lead here particularly those brands that invest in buildings and leverage adaptive reuse to breath new life into old structures.
Consolidation or Diversification
Fun fact, 85% of our industry is comprised of independently owned spaces. The big players like WeWork, IWG (Regus/Spaces), Knotel and Servcorp only control 15%. While WeWork had the biggest piece of the awareness pie, people were surprised to learn it had the smallest piece of the supply pie.
Eventually we will see some consolidation in our industry although the finances of consolidation are not as compelling in coworking as they are in more traditional industries.
However, as the industry strengthens in secondary and tertiary markets including suburbs we believe we will continue to see growth in market share owned by small independent players throughout 2020 and beyond. We will also see regional players expanding and growing and the continued rise of niche operators. For now its diversification.
As we look forward to 2020 we are positive about the direction of both coworking and commercial real estate. All factors indicated continued strong demand and growth for the coworking industry and this bodes well for thoughtful, effectively managed brands, both big and small. We are excited for expansion away from a concentration in major urban markets into tertiary and secondary markets and the suburbs.
A much larger portion of the population are choosing to work independently or being sent home to work. The growth of this distributed workforce including freelancers, gig and remote workers, will drive significant growth for coworking as will the continued adoption by corporations. Corporations are eager to minimize their real estate costs and attract top talent. Coworking presents a unique solution to these two problems.
Commercial real estate will remain a solid investment through 2020 and we believe investors looking for surprise free returns will increase allocations in this asset class. Furthermore, smart real estate investors looking to take advantage of positive trends will increasingly focus on coworking.
The Founders at Co.RE believe the sweet spot where coworking and commercial real estate intersect is the ideal place for investment in 2020. A preferred investment is one anchored in a tangible, cash flow generating, appreciating asset. Cash flows can further be increased and returns maximized when coworking is an anchor tenant in a building.
Our industry leading coworking expertise allows us to cherry pick the best coworking operators to bring onboard as tenants and our legacy in commercial real estate, representing over $12 billion in transaction volumes allows us to quickly and efficiently identify and acquire optimal buildings. Interested in learning more? Contact us.