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Why WeWork didn't work - the demand for co-working spaces

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The ‘writing has been on the wall’ for some time for with regards to WeWork’s need to restructure its business model. That likelihood issue predates Covid and the impact that has had on office occupancy levels and therefore WeWork. Rather the issue relates to the business model itself.

Looking at the UK's history of service office operators, there have been periods of expansion with growth in the number of suppliers and the amount of office space available, which has been followed by a contraction in both as the economy and/or have retrenched. WeWork is no different. In effect it is a serviced office operator, albeit with a different label, different marketing approach, a different target market and possibly more open co-working space than others. But the model is the same.

WeWork's risky business model

It is that model itself that is the problem, namely renting office space from landlords, adding services plus a mark-up and then selling on the space in small units to a myriad of occupiers. At the start of the 1990’s a number of serviced office entrants came into the sector looking to take advantage of the depressed office market. There as a flourishing of the sector but then, as now, demand declined and costs increased. The simple issue is that to be viable, both per scheme and as a business, occupation levels need to be maintained at a high level, generally over 70%. Below that profit margin gets eroded and at lower levels it is costing the business money. Rental levels in places such as Central London rise and fall which changes the attraction of serviced space, but it also means that the likes of WeWork can get caught with rent rises.

They are also caught in the trap of writing off capital costs of fit out which drives longer leases from an occupier’s side as well as landlords seeking longer terms when the demand side allows it. The primer a building or location, the more susceptible to significant rent increases and longer terms landlords can command for the space.

Covid's hit to demand for working spaces

Covid was a big hit to demand but could have been a springboard for higher occupancy. However, the move back into offices in the UK has been and remains slow. On-going research at Henley Business School into offices and Covid is indicating current levels of occupancy peaking at 60% each week. Hence overall use levels of offices are down.

Larger occupiers sought to reduce space over the last three years with exercising break clauses and not renewing leases. That has continued as they look to create the right type of space that attracts talent. During that period the easiest space to exit was space with the shortest lead time and fewest risks and costs. That means serviced space, because a key selling point of such space is that it is flexible in contract terms. If a firm holds space on longer leases that it cannot exit, then it will retreat from space on flexible terms to the space it cannot exit. A large part of the UK economy is driven by SME’s, for these firms switching to home working through Covid and spending money on fitting out home offices means that their demand for space in central locations has changed.

Now what is sought is meeting areas and touch down space rather than a desk. There are many other options available that provide that. For some firms they will not look at serviced offices because of security issues and the cost of installing their own starts to change the profile and standard leases become more attractive.

The future of co-working spaces

Demand remains for co-working space. For many the home environment does not offer ready opportunities for working. Short term project space is always a need and hence the WeWork offering will work. However, from an economic point of view the business model needs to change. Taking conventional leases creates too much of a risk for the operator. A much better approach would be partnerships with landlords on specific buildings with a profit share or turnover rent model. That would provide the landlord with a low base rent and then a share of the performance of the operation.

The office sector is not immune from what is happening in the business world and the economy. Growth of offices based on simple projections has been shown to create models, with the likes of Cisco Systems at Green Park in Reading taking space driven by projections not actual demand. That also illustrated the need for lease flexibility so that change can be managed without the need for the likes of Chapter 11. The period of the financial crisis and the recession illustrated the issues around firms not being able to right size easily.

Howard Cooke

Lecturer of Corporate Real Estate
Published 9 November 2023
Topics:
Leading insights Flexible working

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