Co-working startups face fresh challenge of winning over landlords

AFTER a tough time during the pandemic and months of financial instability, Indonesian co-working startup CoHive finally reached the end of its rope and was declared bankrupt in January.

The fall of CoHive, once Indonesia’s largest co-working operator, sent chills throughout the industry. Some observers might be quick to declare the co-working business model unviable, but the event is just one sign of how much the co-working landscape has evolved and remains in a state of flux.

The pandemic changed working styles for good, to the benefit of flexible workspace operators. But it was also a stark lesson about the risks of getting locked into long-term leases when times are bad and office demand plunges.

It’s sped up the shift towards the asset-light management contract model, which takes a page from the hotel industry. Instead of renting real estate, co-working operators manage spaces for landlords for a fee, ensuring landlords have skin in the game.

For years, operators have used a fairly straightforward model of renting spaces from landlords, fitting them out with swanky amenities and shared spaces, and charging members for the use of the place.

In theory, it works because some companies want the flexibility of short-term agreements – 12 months on average – while dodging the costs of renovation and office equipment.

It’s also a subletting model that’s been tested before. Co-working shares many similarities with serviced offices, a real estate offering that’s been around long before venture capitalists became enamoured with WeWork.

The main difference is that co-working has the added feature of community-building. Still, operators are discovering that a genuine sense of community is difficult to create at scale, and not as valuable as it was first hyped up to be.

And while general office designs have trended towards more open, shared spaces, the jury is still out on how much of a premium customers are willing to pay for peer collaboration.

The next evolution of the co-working sector towards management contracts is therefore crucial, and could act as one validation of such business models. If operators can prove their worth to landlords, more of the negotiating power will finally shift to them.

Tough road

There are variations of management deal structures seen in the industry. A co-working operator could purely earn a management fee, with the landlord charging no rent and bearing the costs of fitting the space out.

Operators could also bear the cost of furnishing, and have a profit or revenue-sharing agreement with the landlord. Profit-sharing agreements could be performance-based.

The landlord, particularly those with more premium properties, could decide to charge the operator a “minimum guaranteed rent” below the market rate. Joint ventures have also been formed between operators and landlords, to redevelop real estate that focus on co-working.

The management contract model has gained popularity as co-working companies attempt to shed the weight of lease liabilities. New York-listed WeWork is taking on more management agreements and participating leases, where the build-out of the space is paid by the landlord and rent is determined based on revenues or profits from the space.

Meanwhile, its Asia competitor, Singapore-based JustCo, is aiming to grow the proportion of management contracts in its landlord deals from 10 per cent to 50 per cent in the next three years.

These co-working operators have a difficult task before them. For years, landlords have relied on the stability of rental payments from long-term leases. Operators would need to convince these traditional real estate companies that they can add more value by helping to increase yields.

This comes as major developers are themselves becoming operators as well. With the shift towards flexible work arrangements, companies such as GuocoLand have entered the co-working arena. Some, including CapitaLand, have launched their own branded spaces.

Buzzing market

The industry is beginning to come under pressure amid rising interest rates and a growing number of companies reducing their real estate spend. WeWork in January said it plans to cut about 300 roles across countries as it prepares for a potential recession.

But even with economic headwinds, the co-working market could get hotter as more operators join the fray and companies embrace the value of flexible workspaces.

In Singapore, occupancy at flexible space centres recovered from 50 to 60 per cent during the pandemic to 80 to 90 per cent in Q3 2022, according to CBRE Research. As of Q3 2022, the flex space market has more than quadrupled since 2013 to 3.71 million square feet across 176 centres.

Leasing volume by operators amounted to 0.15 million square feet in just the first nine months of 2022, overtaking 2021’s full-year volume of about 0.12 million sq ft, the real estate agency found. Prices at spaces within the core Central Business District were deemed competitive, as office rents continued to rise.

New models of co-working are emerging as well. Some operators are experimenting with on-demand offerings and decentralised spaces. Startups like Workbuddy give customers access to a large network of co-working spaces from different operators with just one pass. New entrant Staytion turns MRT stations into co-working venues.

Market watchers also expect more competition in the sector as operators from the US, Europe and Australia begin to eye Asia. Similar to the hospitality business, co-working is a model that makes sense only at scale, which could lead to more consolidation in the sector.

Already, operators are exiting markets they have struggled to succeed in. CoHive and JustCo’s Indonesian businesses shut down, for instance, largely due to the oversupply of office spaces in Jakarta.

Companies will have to be more selective about which markets to expand to, especially as funding for expansion becomes harder to raise.

So as much as co-working operators say their business model is proven and sustainable, the reality is that there is a long way to go and much to watch out for.

Now that some operators have won over white-collar workers and company management, it is time to see whether they can do the same for landlords.