Coworking Concerns: The Office ‘In-Crowd’ In Doubt?

LOS ANGELES—There is no question that the coworking industry has both impressed on the street and transformed the office sector. However, doubts on the balance sheet have many experts questioning what this will look like in the future. GlobeSt.com spoke to Scott Unger, office specialist and SVP in the Pasadena/Tri-Cities office of Kidder Mathews, the largest independent commercial real estate firm on the West Coast, to get his views on coworking ups and downs, how investors are reacting, and what landlords should be focused on.

“Time will tell if the coworking industry can become profitable and remain profitable, but for now, office owners should be mindful of the reports of major losses as they consider leasing space to coworking tenants,” said Unger. “We will see how investor sentiment shifts during and after the next economic downturn as the market observes how the coworking industry performs.”

A recent American Realty Advisors report on office investor sentiment revealed the appetite for assets containing coworking tenants. If an asset has a coworking tenant that occupies 20 percent or less of the building, investors perceive on average an increase in the value of the building. When a coworking tenant occupies 20 to 40 percent of a building, investor sentiment is more varied. And the perceived building value is reduced when a coworking tenant occupies 40 percent or more of the property.

Coworking is not a new concept, but the growth in this cycle is unprecedented. The sector offers tenants the advantages of shorter-term leases, less upfront real estate capital requirements (e.g., tenant improvements, data/phone networking, etc.), and increased spatial flexibility with the ability to scale up and down as business may dictate. Meanwhile, the coworking operator enjoys the benefits of varied business types and sizes, as well as higher per-square-foot rental rates.

Also, FASB’s new corporate accounting rules, which require companies to report office space obligations, equipment and other items on balance sheets, could be a boon to coworking operators by making shorter-term leases more favorable.

“A strength of the coworking industry and benefit to the ownership of the office asset is the potential for increased demand in the building as a coworking occupant requires additional space for its operations,” said Unger. “The weaknesses and risks posed to the ownership of the office asset include a potential lack of lease securitization, short-term commitments from coworking occupants and the potential for less occupancy within the coworking space during an economic downturn, which would put pressure on the coworking operator’s payment of rent.”

Like most investments, balance is key. Coworking companies are catering to industries beyond just the tech and startup sectors in an effort to diversify tenant rosters and mitigate risk, according to Unger. Landlord due diligence must assess the coworking operator’s experience and ability to weather an economic downturn, how the lease is securitized, and whether or not the operator has “skin in the game” or is seeking a partnership with the landlord.

All CRE players can stand to benefit from a tightening of the proverbial ship late in an economic cycle. Whether it’s a reaction to current concerns or preparation for tomorrow’s storms, an ounce of prevention today can be worth a great deal more down the real estate road for the coworking industry.