WeWork Vancouver is one of the company's 849 locations
For a long time, it seemed as though the flexible office market could do no wrong, with rapid expansion and new companies entering the market seemingly on a weekly basis. Then cracks began to show, and people began to question whether the market had become overheated.
The big story, of course, was, and still is, WeWork. The flexible office behemoth had been lauded for its rapid growth and its charismatic leader, Adam Neumann. However, having filed the papers for its initial public offering (IPO), in August last year, the company abandoned its plans after failing to attract sufficient investor interest.
It was a huge climbdown and led to Neumann's resignation. Analysts suggested that the company was running out of cash, but at the end of October it was announced that Japanese investor Softbank had agreed to stump up $5bn in new financing in exchange for an overall 80% stake in the business (it already owned a third).
"Wework wasn't the only flexible office operator suffering in late 2019"
WeWork's latest financials appear to justify investor hesitancy: in November last year it revealed an unadjusted loss of $1.25bn in the third quarter of 2019, up from $497m in the same period in 2018. The figures also showed that its occupancy rate was 79% – the lowest since mid-2017.
However, WeWork wasn't the only flexible office operator suffering in late 2019. In October, Central Working fell into administration, joining The Clubhouse, which was bought up by Regus owner IWG. And there was Second Home, the company set up by Rohan Silva, a former adviser to David Cameron, which had to seek new funding after suffering cost overruns on its first US development.
What this means for the flexible office sector divides opinion. At a glance, it might appear that the whole market is suffering growing pains, but Giles Fuchs, chief executive of Office Space in Town, thinks there is a pattern in the companies that have hit trouble: the leasehold model isn't viable.
What this means for the flexible office space sector divides opinion. At a glance, it might appear that the whole market is suffering growing pains, but Giles Fuchs, chief executive of Office Space in Town, thinks there is a pattern in the companies that have hit trouble: the leasehold model isn't viable.
"Serviced offices only work when you own the building or you have a management contract with the landlord," he says. "The interests of the operator and the landlord have to be aligned. When you have a lease, and you have a hard ceiling of rent in the way, it can be a case that the operator isn't making enough money to pay the rent."
Fuchs says that this has been obvious for 40 years, but it still isn't well understood by landlords or investors, who tend to view the flexible office sector as an amorphous mass, rather than interrogating individual firms' business models.
Landlords in particular, Fuchs adds, need to understand that companies operating under a leasehold model are vulnerable.
"Landlords need to have a Plan B in case the operator goes bust," says Fuchs. "If a client can't get in one morning and they have 50 employees, it's a nightmare and they will have to just go somewhere else. If you own the building, there is no reason why you can't just pick it up and run it yourself even if your operator has gone out of business, but you need a plan."
Douglas Green, director at flexible office advisory firm GKRE, takes a different line. He points out that Regus' business model isn't based on signing up to a management contract or holding the freehold, and that, despite ups and downs over the years, it is still very much an industry stalwart.
"Ideally, our clients would prefer to have a business backed by an asset, but actually it can preclude expansion because it is an expensive way to grow," he says. "Ultimately, you tie up too much money in the property. On the lease model, clients feel that you can expand quicker and still get the benefit of incentives from landlords that can carry you over the initial fill-up voids. Also, an operator-client with a mix of freehold and leasehold centres recently said to me that he doesn't need to get a valuation done on acquiring a leasehold business which says an awful lot."
All this has a bearing on how landlords and investors view having a flexible office operator as part of the mix in a building. Charles Golding MRICS, tangible assets valuation associate director at RICS and author of the Valuation of Flexible Workspace insight paper, says that one problem is there isn't enough data showing how flexible office operators have performed through economic cycles.
"In the hotel market, which has been established for some time, there are pretty good metrics and data out there," he says. "There is a level of expertise about looking at that income over the longer term. With the flexible workspace sector, it perhaps hasn't been through enough cycles in its current form for people to know how secure that income is going to be going forward. That's where some of the risk lies."