The future of real estate in the shared economy – Part 1

Regus pioneered the workspace-as-a-service concept in the 1990s, first in Europe and later in the Americas. The original idea was to provide space for self-employed workers and for the small number of corporate employees that were traveling or working remotely. However, the proliferation of technology in today’s market has enabled a fresh approach to this concept termed ‘space as a service’, based around three key principles:

• efficiently employing spare capacity;
• minimising the cost of a transaction;
• and adding attractive benefits beyond space.

Spare capacity is an economic term which describes the potential for utilisation of an object, service or space that is not currently being used. It describes the unrealised potential of an unused resource through its inefficient allocation. Co-working has been associated with reduced vacancy rates in the US; it is likely that this is driven by the efficient employment of spare capacity achieved by co-working operators.

The cost of a transaction determines how efficiently a resource can be allocated and reallocated based on market demand and supply. These costs can be further divided into three separate categories:

• search and information costs, expended to determine that the required good is available on the market, its lowest price, etc.;
• bargaining costs, required to come to an acceptable agreement with the other party to the transaction, drawing up an appropriate contract and so on;
• policing and enforcement costs, to ensure the other party sticks to the terms of the contract, and if necessary, the cost of taking appropriate action.

The rise of space as a service has been enabled both through the emergence of smart building technologies, allowing for an accurate measurement of real estate spare capacity, and the development of financial technologies able to reduce the associated search, bargaining and enforcement costs of a transaction, facilitating a more efficient allocation of unused space.

The ability of a landlord or operator to shorten leases and subdivide real estate spare capacity has created a social shift within the commercial real estate occupier market, driving it closer towards a hospitality model, where a strong user experience is essential.

With much shorter contractual obligations comes an increasing frequency of choice. The end user of the space is now able to leave without penalty if that space does not meet expectations or requirements. Accordingly, managers of flexible space have begun to include as many luxuries as possible as a part of their service offering. These include WeWork’s famous ‘free beer’, and the classic Google ping pong table.

The demand for space as a service is driven by increasing choice and flexibility, required by SMEs and corporates alike, as they both scale and outsource, and also by the opportunities for collaboration that these shared spaces present. Collaboration is defined as the sharing or exchange through peer-to-peer based platforms of such intangible assets as skills, expertise, innovation and user experience.

In a 2016 JLL poll, 74% of respondents indicated that “thinking, talking, and brainstorming create the most value for an organisation. In response, companies are turning to alternative workplace solutions such as co-working to encourage collaboration.”

To retain existing customers while attracting new occupiers is increasingly being built around creating an experience within any space, and companies such as Convene are helping to drive this movement by taking and operating communal space within multi-tenant buildings such as 22 Bishopgsate in London.

New job titles such as ‘Head of Workplace’ or ‘Community Officer’ are increasingly being designed to allocate accountability for these functions. The rise of space as a service will not only enable vacancy rates of buildings to decrease, but should also allow the desk utilisation rates of individual offices to increase.

The average workstation in Central London costs £17.5k per annum, yet the average desk utilization rate is only 45%. In an office containing 500 workstations, a system of enabling 100% desk utilization could generate close to £5m a year.

With low barriers to entry in the flexible office market, as most co-working space involves small areas, competition among the plurality of small landlords is likely to grow, looking to capitalise on this £5m opportunity cost. Comparing the newer space-as-a-service office sector to the relatively mature hospitality sector, it is highly likely that a desk brokerage platform will emerge through which prospective tenants will be able to book the spare capacity in participating landlords’ offices on a short-term daily basis. Such a system is currently offered by JLL-backed start-up Hubble, although at time of writing their minimum lease term is one month.

JLL predicts that 30% of all US office space will be operated under a space-as-a-service model by 2030 – currently, the proportion is 5% – and Deloitte suggests that over 50% of surveyed professionals are looking to increase property investments with a flexible lease.

It is highly likely that a desk brokerage platform will emerge through which prospective tenants will be able to book the spare capacity in participating landlords’ offices on a short-term daily basis.

The shifts in real estate markets that this growth would facilitate would be game-changing, with the following implications:

1. Net promoter scores (customer satisfaction ratings) will be used to compare various commercial spaces and ultimately drive tenant demand. Building owners and occupiers will, like hospitality operators, begin to think about their business in terms of B2B, B2C and platform channels (think TripAdvisor).
2. The collection and analysis of space utilisation data will allow for the dynamic pricing of spaces, increasing in price at peak times and decreasing in price when demand is low, thus enabling a fuller occupancy at all times, and maximising the value of the asset.
3. Building values will no longer be calculated universally, based on the strength of the tenant’s covenant and the terms of the lease, but increasingly on the basis of earnings before interest, tax, depreciation and amortization (EBITDA), or revenue per available desk.

While leading space-as-a-service brand WeWork may not continue to grow at its previous rate, it is clear that this particular unicorn’s early success has created a chain reaction which will have a lasting impact on the market for commercial real estate.

Since Saïd Business School’s 2017 report PropTech 3.0: The future of real estate, the smart real estate and shared economy verticals have converged. The customer-first approach of space-as-a-service operators has led to changing expectations for a modern office and begun to make occupant wellbeing a financial imperative. Subsequently, major landlords are now producing their own flexible working spin-offs. Examples include CBRE’s  Hana and Savills’ Pivot, as well as service offerings for new generation flexible office operators such as CBRE Host.  

The major risk facing all space-as-a-service providers is how they will maintain revenue during an economic downturn. While tenants value short-term flexibility, long-term leases protect the landlord. Small businesses and start-ups, the most common occupiers of co-working spaces, are the first to fail during recessions, while successful entrepreneurial workers can opt to work from home. Large corporations would also likely opt to terminate co-working leases when belts need to be tightened.

The industry has grown during the long economic recovery and certainly will be tested the next time the economy dips. WeWork kicked off 2019 with over 400,000 members at 425 locations in 100 global cities.  In 2018 the supposed $47bn company's losses and revenues both doubled, to $1.9 billion and $1.8 billion respectively, signalling troubled times ahead. WeWork acquired shared economy platform Spacious in August 2019, shortly before a failed IPO in September 2019 dealt a severe blow to its growth plans. 

Meanwhile, WeWork’s parent company, We Company, has started to buy buildings that it intends to occupy through the creation of a new $2.9bn fund. WeWork’s original success came through managing offices under a space-as-a-service model. This process has been described by some as ‘space arbitrage’.

As WeWork become landlords, their opportunity for arbitrage is even greater. They will now be able to drive ROI through increasing the cash flow on underperforming assets – increasing building value as a result.

This convergence of the high-risk start-up and the conservative property company has always been inevitable.

• This piece is an excerpt from PropTech 2020: The future of real estate, produced by Said Business School as part of the Oxford Future of Real Estate Initiative. Read the full report here.
• Learn more about the Oxford Future of Real Estate Initiative here.

 

References

1. Dahlman, C. J., 1979, The Problem of Externality, Journal of Law and Economics
2. JLL, 2016, A New Era of Co-working
3. Stanton, Y., 2019, Using sensors to measure workplace occupancy (MIPIM PropTech Online)
4. Fiorilla, P., 2018 Shared Space: Coworking’s Rising Star (Commercial Property Executive Online)
5. JLL, 2019, Flexible space evolves: Markets that are flexing their muscles in 2019
6. Deloitte, 2018, Blockchain in commercial real estate: The future is here
7. Fiorilla, P., 2018 Shared Space: Coworking’s Rising Star (Commercial Property Executive Online)
8. Fearn, N., 2019, WeWork Files Confidentiality for IPO (PlaceTech Online)
9. Aydin, R., 2019, WeWork isn't even close to being profitable — it loses $219,000 every hour of every day (New Haven Register Online)
10. Byrne, N., 2019, WeWork Launches $2.9bn to Become Landlord (PlaceTech Online)