As the commercial real estate market continues to evolve, there has been a fundamental and generational shift in office demand trends. Leasing activity to coworking tenants continues to expand, bringing about a transformation within the office market. Coworking space offers a more flexible alternative to traditional offices, in that multiple workers can share a single location while working independently. Leases tend to be short-term and size-adjustable, depending on how many workers need space. According to Jones Lang LaSalle (JLL), the sector has grown an average of 23% each year since 2010. The flex space office market is quickly becoming an integral part of commercial real estate and portfolio strategies.
This week’s chart highlights the industry’s top operators as a percentage of total leased space in 19 leading U.S. office markets. WeWork dominates the flexible office space and is currently the biggest coworking space provider in the U.S. as well as the largest office tenant in Manhattan with 5.3 million square feet as of September 2018. While flex space inventory currently accounts for less than 5% of U.S. office stock, JLL anticipates this will increase to 30% by 2030. Coworking providers leased more than 23 million square feet in 2018, JLL reports, proving that flexible space providers are quickly becoming a dominant driver of occupancy growth in the office market.
A major catalyst for this growing trend has been a result of increasing mobile and tech-enabled employees with the need for greater flexibility and ability to work remotely. Technological advancements in the workplace have enabled more online collaboration than ever before. Employers are increasingly offering remote work opportunities as coworking becomes more mainstream. Coworking solutions can benefit all industries, and have become attractive to traditional corporations looking to both reduce long-term lease obligations and maximize the use of their space.
Office fundamentals have been largely solid in recent years with positive rent growth and a steady decline in the national vacancy rate. As the commercial real estate cycle continues to age, conditions may become more challenging in the years ahead. A slowing economy could put pressure on both vacancy and rent growth rates. Office properties with coworking tenants may feel these impacts more strongly as this business model has not been tested through a downturn. Short-term leases can usually be terminated with a one-month notice, which can lead to volatile income streams.
The coworking industry could continue to be a disruptor in the traditional office space market. While coworking and flexible workspaces currently represent a modest share of overall office occupancy, their footprint is growing. Property owners are rethinking how to best utilize office space and are exploring opportunities to attract both small and large tenants.
For investors in this space, it is important to monitor overall portfolio exposure. In the event of an economic slowdown, operational and financial challenges could arise; however, coworking exposure in stronger markets could reduce this risk. Given the short-term nature of the leases, vacancies could rise quickly, leaving office owners scrambling to find new tenants. Investors should analyze their exposure at the property and market level and be cautious of exposure to speculative-grade coworking operators, which may increase credit tenant risk.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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