Co-working and the rise of workplace-as-a-service may be the dominant real estate story of 2018.

With real estate firms like Boston Properties, Tishman Speyer, among others, starting to offer their own co-working brands (or planning to launch them), this market will continue to be scrutinised in 2019.

There are other entrants, too. Office Depot has started converting some of its retail floorspace to workspace. And, some market observers believe there will continue to be room for independent co-working spaces, too. For example, there are even co-working providers with niche offerings, such as wellness and mindfulness.

Overall, the model is experiencing significant growth, but is still very nascent. Moreover, technology could further impact tenant-landlord-broker relationships beyond what co-working has done thus far. Regardless of what happens, co-working is here to stay because occupants realize significant benefits from the flexibility.

Setting The Stage

Co-working started as an offering that targeted small companies and freelancers in search of flexibility in their office space. These firms and freelancers didn’t want to enter into long leases, but sought smaller square footage to house their workers, and didn’t want to worry about office operations. Co-working solves all these issues at the same cost of a traditional lease (and in some cases, it is less expensive).

Many co-working spaces simply gave tenants smaller desks, packed into small offices, and increased space utilization - they didn’t utilize much technology to squeeze more value out of the square footage. But the ability to utilize space, even in low-tech ways, is what drives company valuation. Regus, the biggest flexible workplace vendor, has 5x the space of WeWork, but only 3x the workstations. And WeWork has a 10x valuation compared to Regus.

In search of growth, now co-working firms serve large companies, too. This includes building office spaces from scratch or providing flexible satellite offices. Co-working has gone mainstream, indeed. Globally, about 40 percent of space is leased but unoccupied so companies large and small can benefit from a smaller office space that can be more highly utilized. This aligns well with the co-working business model. And, even larger companies recognize that outsourcing their office space is not so different than outsourcing their cloud computing infrastructure to Microsoft or Amazon - it enables them to focus on their core business.

Headwinds On The Horizon?

The emerging dynamic for 2019 will be the brewing conflict between the building owners and the co-working providers. The conflict will be based on what each firm wants to own and what can be provided via a partner (outsourced).

Co-working firms vary on how much of the value chain they seek to own. WeWork certainly is seeking to disintermediate traditional FM providers and in some cases even architecture firms, but their competitors seem to be more focused on managing space more flexibly.

Real estate owners increasingly see WeWork as a threat, not a partner, which is driving them to invest in this business model on their own. Some market observers don’t think co-working will emerge as a real threat to the real estate owners, because while it is growing fast, it is not a huge share of leased space. This may mean that co-working providers aren’t actually going to be huge companies.

There are some signs of cooperation. All of the primary co-working firms have started to enter into partnerships with real estate owners. Industrious, a workplace-as-a-service firm that competes directly with WeWork, models its business on hotels, in which a management company and hotel brand share revenue. Their co-founder Jamie Hodari notes of the traditional co-working model: "It’s the wrong relationship for both sides. It’s wrong for tenants, and it’s wrong for landlords."

In addition to owners, other incumbents are making moves. CBRE, has launched its own take on co-working, called Hana, which is being led by a former Zipcar executive. As new brands and offerings are launched, which type of firm will be most appealing to tenants? Co-working startups or real estate owners with flexible spaces?

While later to the workplace-as-a-service game, owners may be able to offer the same experience, with flexible terms, at a more attractive price. They can cut out the workplace-as-a-service provider, eliminating one entity that otherwise would take margin. Disintermediation could hurt the co-working providers, too.

Another potential headwind is the fundamental business model. The short term leases offered to occupants are subject to far more price volatility than the traditional long-term leases. As the co-working firms enter into long term leases with owners, they may find that an economic downturn reduces their rental revenue, making it more difficult to cover these leases. If this does not happen, building owners may decide that the risk/reward calculus is more in their favour if they operate the flexible spaces on their own.

Additionally, as more firms enter this space, it will commoditize and drive prices down. This is good for renters, but the impact on traditional service providers (facility management vendors), co-working providers, and building owners is still to be determined. And, the relationships between these service providers also may change. For example, if building owners, who typically have class A office space in prime locations, decide to stop leasing space to the co-working providers and attempt to lease space through their own flexible workplace brands, what reaction will the office seekers have?

Where Is This Market Going? How Will Technology Impact It?

In addition to this market becoming more crowded, commoditized and technology-enabled, how else will it change? Goldman Sachs wrote an interesting white paper on advanced mobility that may be illustrative of what could happen in real estate. The report states:

"Ride hailers [Uber, Lyft, etc] are first and foremost technology companies, whose technical strength is deep pools of data and predictive algorithms. Their core business model is to match supply of mobility with passenger (or goods) demand in the most efficient way possible. To this end, they have developed consumer-facing brand identities."

and then continues:

"Ride-hailing companies and their drivers make uncomfortable bedfellows: Ride-hailing companies take a 20%-25% cut of drivers’ fares, and thus depend on drivers to make money. Conversely, however, ride hailers need to recruit drivers to grow, and need to subsidize (or even occasionally fully pay) those drivers to attract new customers."

Substitute “ride-hailing company” for “workplace-as-a-service company”, and “driver” for “real estate firm”, and we have a similar concept in the co-working industry. This white paper highlights the key role of the ride hailing companies as optimisers of supply and demand, rather than owners of the supply. This model is less capital intensive and less threatening to other value chain participants. And it’s not totally foreign in real estate. Liquid Space, primarily used to book very short term space (within co-working facilities, in many cases) is perhaps the most neutral of any startups in co-working, but they are much smaller than co-working firms. (Liquid Space has raised about $25m.)

Open Questions

The workplace-as-a-service space will continue to move fast. It may become the leading entry point for smart building technology vendors who find that it is easier to sell larger deals across many co-working spaces operated by one entity. Additionally, these co-working providers may quickly realize the value of these emerging technologies. That said, there are a variety of open questions:

• What offering model makes sense - who should provide co-working space, and what capabilities are core vs. peripheral?
• Similarly, what vendor partnerships make the most sense - will real estate owners partner up with facility management providers and compete directly with the venture-backed workplace-as-a-service firms? Or, will all of them partner together?
• What is the role of technology? The optimal outcome for a tenant is to have wide availability to where he/she can work, across many sites, with the ability to quickly modify a space to fit that individual’s preferences (light, temperature, specific amenities, etc). This is more like a hospitality operation than a traditional office offering. As open floor plans have become less attractive based on new research, can advanced technology provide the same space utilization benefits without impacting productivity? What do these solutions look like?
• Similarly, can smart building technology be used to differentiate co-working spaces from peers? Does this lead to increased adoption of smart building technology?
• Moreover, could a unified technology solution lower the barriers to entry to provide co-working space? If the co-working providers themselves become the global optimizers, like Goldman Sachs describes Uber and Lyft, could they offer an out of the box technology solution (hardware plus software) that enables quick conversion of an office to a co-working space? With a revenue share business model, this looks more and more like an advanced AirBNB for offices. A rudimentary version of this model is on display in restaurants, offered by Spacious.

We’ll continue to monitor these developments through 2019 and beyond. To the extent that developments in co-working proliferate smart building and office technology, it will be a win for occupants and innovative vendors seeking to scale.

This article was written by Joseph Aamidor from Aamidor Consulting.