The recent publicmayhem at WeWork, the largest coworking company in the US, has not only left WeWork’s future uncertain, but it’s also prompted questions about the viability of the whole coworking industry.
If a company once valued at $ 47 billion stumbled so spectacularly when investors gave it a closer look, how will it and the rest of the industry, which uses a similar business model, fare if and when a recession hits?
While it’s impossible to predict the exact timing or scale of an economic downturn,most economists believe a recession is comingwithin the next two years. Whenever it is, it will certainly be a test for coworking spaces, especially newer entrants like WeWork and its smaller competitors Knotel and Industrious.
WeWork is especially vulnerable. The companywithdrew its public filing papers earlier this weekamid deep financial losses, poor corporate governance, and reports of an unprofessional corporate culture.
“Property markets rise and fall with economic cycles,” Julie Whelan, head of occupier research at real estate services firm CBRE, told Recode. “The same will happen with flexible space. Clients will determine if it’s worth it or not. ”
Real estate experts say that while coworking spaces will surely see customer losses as businesses go under and individuals and startups opt for cheaper overhead, they also stand to gain other customers in a recession, as companies downsize and look for flexible office space. It’s not clear yet how exactly that balance will shake out, but the stronger a company’s current operating model the better likelihood they’ll survive a downturn.
Since the last recession, coworking space in the US has grown to 71 million square feet, a 600 percent increase since 2010,according to data from CBRE, which tracks the top 40 US office markets. But though this year is expected to see a record 36 percent growth in coworking office space, this growth is expected to slow down next year, Whelan said.
“When a recession hits, it will slow down more,” Whelan said.
The coworking business model
Overall, coworking office space makes up just 2 percent of all commercial office real estate in the US, according to CBRE, so any slowdown in this industry won ‘t have a big impact on the overall real estate industry.
It will, however, affect the success of the coworking industry.
One way to predict how a downturn would affect the coworking industry would be to consider IWG (formerly Regus), the sole major coworking company that has faced a recession. The company, which provides fully equipped offices and coworking spaces through its subsidiaries like Regus and Spaces, survived the dotcom bubble,filing for bankruptcy, and the Great Recession. It’scurrently thrivingas itsbiggest competitor, WeWork, faces an existential crisis.
“In our industry, you always need to be prepared for any major swings in the market,”
Michael Berretta, VP of Network Development at IWG, told Recode. “However, the good thing about the current demand for coworking is that companies will continue to look for flexible workplace options, regardless of market swings.”
He added, “One of the biggest factors to be mindful of during downturns in the economy is the ability to minimize risk. There is a lot of risk involved in trying to grow too quickly. ”
WeWork has been growing rapidly in recent years. It more than quadrupled its number of locations, now 528, from 2016 to the first half of 2019. And newer locations are inherently less profitable. WeWork says 30 percent of its open locations are mature.
Coworking companies generally take on long-term leases for buildings that they then refurbish and lease out piecemeal to individuals and businesses on a month-to-month basis. That means that coworking companies are still on the hook to pay rent to building owners even when their tenants might decide to leave at any time.
“Shorter term lease tenants can disappear almost overnight,” Paul Leonard, a managing consultant at real estate information firmCoStar Group, told Recode.
That doesn’t mean the model will fail.
Jim Costello, SVP of real estate data companyReal Capital Analytics, says banks manage a similar situation – taking short-term leases in order to make long-term loans – and can be very profitable.
“They make a living playing off the differences,” Costello said.
Importantly, he notes, banks also keep a reserve of cash to help them stay open through tough times.
“The key issue is that you have reserves, a lot of capital in the background, to help you through time periods when the market isn’t cooperating. ”
At current spending rates, WeWorkcould be out of money by early next year.
Companies choose coworking spaces because they’re fast and flexible. Businesses are willing to pay a premium for real estate that can be gotten – and disposed of – quickly. To survive a recession, coworking companies will have to focus on delivering what makes them valuable to consumers in the first place.
“Experiences, amenities, aesthetics – that is important to a certain point, ”Whelan said. “But what’s really driving people to the space is flexibility, speed to market and capital deferral,” or not having to make huge investments in leasing and outfitting office space.
“Those with very sound operating principles, governing structures, and that are very careful with how they’re operating their businesses, those are the ones that will end up coming out of the recession stronger. ”
Critics have lambasted WeWork for its losses , itsunclear unit economicsand its monstrous corporate governance issues.
And a recession will bring a lot of consolidation to the coworking industry.
CBRE estimates that there are 700 individual coworking operators in the US , 80 percent of which only have one location. “Those are going to disappear or be acquired,” Whelan said, because their scale is too small to remain profitable.
For all its other liabilities, WeWork does have size.
As Costello put it, “Recessions are about working the imbalances out of the system. It’s like a massage from a giant Swedish guy working out knots in your shoulder. It hurts a lot, but it helps. ”
How will WeWork, specifically, fare in a recession?
WeWork is a bit of a special case.
The future of WeWork, which, according to CBRE, represents one-third of all flexible office space in the US, will have a big impact on the coworking industry. And the company is facing daunting circumstances.
It has the best coworking brand recognition, but it has been burning money to fuel its rapid growth. Many of its recent leases were signed when rent prices were as high as they’ve ever been in major cities. Additionally, the company’s aggressive growth has meant a lot of new locations, which are expensive to refurbish and fully lease out – so many of its locations aren’t yet be as profitable as its locations that have been around for two years or more.
ASanford C. Bernstein analyst told the Wall Street Journalthat at current spending rates the company would run out of cash after the first quarter of next year. Having pulled its public filing, at which WeWork hadhoped to raise up to $ 4 billion, the company is now jettisoning extraneous businesses, cutting costs and laying off staff.
“We have decided to postpone our IPO to focus on our core business, the fundamentals of which remain strong,” WeWork’s co-CEOs Artie Minson and Sebastian Gunningham wrote in a joint statement Monday. )
Though WeWork declined to comment on the record, in itsnow-defunct IPO filings, it makes a case for why it will survive and potentially thrive in a recession.
“In a downturn, we expect that businesses will search for more flexible and lower cost alternatives. We believe our flexible workspace solutions provide organizations of all sizes an opportunity to avoid long-term lease obligations in favor of short-term alternatives tailored to the specific requirements of their business, ”the S-1 reads.
As of Q2, 40 percent of WeWork’s memberships came from companies with 500 or more employees. Still, like other coworking spaces, the majority of WeWork’s members are smaller startups, which can be more volatile. And like WeWork,tech companies have been prioritizing growth over profits, a practice that is especially vulnerable in a recession, when spending is scrutinized and profitability is more important.
So far WeWork has been deeply unprofitable. It lost $ 1.6 billion on $ 1.8 billion in revenue last year.
“Obviously you’re going to have a problem if you’re not profitable in a great market,” Leonard said. “If you’re not profitable now, I think you’re not going to be profitable when people are losing jobs.”
WeWork, in classic WeWork fashion, also saw a recession as a chance to grow its business, while real estate and construction costs are cheaper.
“Not only do we believe our business model mitigates the pressures of an economic recession, we also believe that our model could position us well in a downturn. An economic downturn may provide us an opportunity to further scale our platform at more attractive unit economics. ”
If a bull market hasn’t been kind to WeWork, a recession won’t be either.
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