Recent media coverage has called into question the long-term viability of flexible office space and its potential impact on real estate markets. Despite this, CBRE believes that the structural shift to flexibility is here to stay and that real estate markets are not threatened by it.
Here are some facts supporting why flexible office space is a durable trend in the real estate market:
- Penetration levels are modest. Under 2% of total U.S. office inventory is dedicated to flexible office space and there are only a handful of submarkets that have more than 5 million sq. ft. of total office inventory with a flex-penetration rate of 5% or more.
- The operator base is diversified. Approximately one-third of the flexible office space in the U.S. is provided by WeWork. Nine other operators account for 35% of total flexible office space. The rest (32%) is scattered across 690 more operators.
- Office demand remains strong and broad-based. Over the past year, traditional (non-flex-operator) tenants have leased, on average, 55 million sq. ft. per quarter. Flexible office space accounted for only 6.5% of all leasing activity nationally in H1 2019, compared with 26% of leasing activity directly to technology companies.
- Landlords have been conservative in leasing to flexible operators. In Manhattan, the 10 largest landlords on average have less than 2% of their portfolio leased to flexible space operators and none of the top-10 landlords has more than 5% exposure.
- The demand is clear. Market data provider Statista estimates that more than 1 million people in the U.S. will work out of flexible office space by 2022. There is enough demand to meet the existing supply of flexible office space and we see that continuing.
Proven Concept Evolved for Today’s Tenant
The concept of flexible office space has existed for decades and is a proven, successful model for operators like IWG (formerly Regus). The rapid growth of a new generation of entrants has brought a renewed interest in the flexible office model. The size, location and design of the space, along with the quality of amenities, are what sets this new generation of flexible space apart from the legacy models. These new hallmarks of flexible office space are key to attracting and retaining a modern workforce and, in turn, the sought-after enterprise tenant.
Landlords, investors and lenders of course must pay attention to the risk profile of any unknown credit tenants, including flexible space operators. To date, landlords that have engaged with these operators have done so with cautious optimism, generally placing limits on how much space they are willing to dedicate to this model. Landlords likely will scrutinize the risk profile of operators more closely and exercise more caution when leasing to these operators in Q4 2019 and beyond.
To the extent that landlords are seeing occupier demand in their markets for flexibility, they will continue to embrace new space models to provide it. A risk vs. reward equation is part of every landlord decision. If landlords believe their reward will be greater by engaging with new models, such as partnership arrangements, then these will proliferate in the market.
As with any transformational phenomenon, the flexible space road is not smooth. There are bound to be bumps, twists and turns before things settle. The short term could be a tumultuous time for flexible office space, but landlords, investors and lenders will become more educated over time. This wisdom of experience will eventually create a flexible space model that fits the needs of all parties, most importantly the consumer.
The model may shift from where we are today, but the fundamentals of speed, flexibility and low capital outlay will remain staples of occupancy decisions.
For more information on the flexible office market, please see our recent Let’s Talk About Flex report.
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