Are Management Contracts The Future Of The Flexible Workspace Industry?

Published on May 11, 2018 - By Cecilia Amador de San José

• New opportunities are opening for coworking operators to enter into management agreements with real estate owners.
• The “perfect serviced workspace business model” is split three ways: own one-third of your locations, manage another third, and lease the rest.
• Operators should seek to create a business model strategy that will allow them to be flexible enough without exposing their brand to economic cycles.

A few weeks ago, following WeWork’s sale of ‘junk’ bonds, CB INSIGHTS published an in-depth article titled “What Big Real Estate Is Saying About WeWork”.

WeWork’s debt financing, which raised a total of $702 million, meant that the coworking giant “revealed a view into its internal finances, showing substantial growth in revenue, and potentially alarming growth in costs.” Yet, even though WeWork’s finances are on the negative side, CB INSIGHTS found that “WeWork is increasingly coming up in conversation among real estate incumbents on earnings calls.”

What’s interesting is that while some real estate companies view WeWork in a positive light, others “tip-toe around the company as a competitor, expressing reserved skepticism for the coworking model.” The coworking model can be successful, as has been proven by executive suites and business centers that have been around for a long time. WeWork’s specific fast-growth model has been a source of skepticism even among industry experts, especially as there is no way of knowing how it would turn out in an economic downturn.

Still, real estate companies view WeWork as a potential competitor, and for good reason. Last year, we saw some of the first property companies enter the flexible workspace industry. British Land launched its own coworking brand, Blackstone bought a majority stake in The Office Group, and real estate agent Savills also launched its own coworking brand.

Similarly, last year we also saw WeWork dive into the real estate industry by purchasing buildings. By purchasing real estate assets, WeWork is  hoping to better protect itself should any downturn come around in the current economic cycle. For this reason, real estate companies have started to see WeWork as a potential competitor.

Yet, at the same time, some see it as a potential ally. WeWork didn’t only invest in real estate last year, they also dived into the world of management contracts by securing a management deal with IBM; much as Regus and others have been doing for years, if not decades.

So what’s going on here? WeWork is edging into real estate, while real estate is edging into flexible workspaces. What is the flexible workspace industry doing about all of this?

A few days ago, Bisnow reported that “Blackstone Thinks It Can Make A Killing As Others Rush Into Coworking Too Late.” According to the article, during a CRE event, James Lock, Blackstone Managing Director in the U.K. said that:

“There are a lot of (property) firms potentially coming to the sector late who haven’t got the insight around how you operate and run these businesses. They (coworking spaces) are like hotel businesses. It’s about the bottom line, it’s about efficiency of management, it’s about practical management and people can get caught out”.

Property companies have access to a necessary element of the industry: physical space. Yet, there’s more to the industry than location and space; it’s about hospitality, community, and services. WeWork was able to pick up on the fact that not every company is capable of fulfilling all of the above, which is why they began to make inroads into managing space as opposed to only subleasing it to short-term tenants.

Property companies will continue to edge into the industry, and Blackstone does make a valid point in stating that these companies don’t know the ins and outs of operating a flexible workspace. This means there is a huge opportunity for workspace operators to grow and increase their revenue and impact by entering into management agreements with real estate owners.

There’s an added benefit to management contracts; in the case of an economic downturn, the consequences are likely to be less than if operators had gotten into a long-term lease by themselves. Management contracts, to a certain extent, protect operators as they don’t have to make an investment in the property; they generate revenue by splitting the earnings with the landlord from the operations and management of the space. On the other hand, management contracts can be shorter term, and offer less overall revenue opportunities.

Frank Cottle, industry expert and Chairman of the Alliance Business Centers group of companies, believes that “the perfect serviced workspace business model” includes owning ⅓ of the locations, managing another ⅓, and leasing the remaining ⅓.

In an interview with Bisnow last year, Charlie Green, co-founder of The Office Group,  gave insight into the kind of revenue declines flexible workspace companies could expect in a recession depending on how they manage their portfolio, stating that “good asset management had limited the decline in turnover to 12% in the last recession.”

Green’s argument supports that of Cottle, who argues that “each ⅓ contributes in the aggregate to a higher company valuation, were the positive balance sheet of the owned ⅓ helps to offset the negative balance sheet of the ⅓ leased, while the pure fee income from the managed ⅓ gives the company a higher revenue to debt ratio than a typical company in our industry (one that focuses mostly on leasing space).”

Management agreements pose a great opportunity for operators, especially as property owners increasingly show interest in adding coworking spaces to their current and upcoming portfolios. WeWork’s financial model was highly criticized for relying too much on signing long-term leases that left them without protection in an economic downturn. The coworking giant has already taken important steps into protecting itself by purchasing properties and entering into management agreements. Still, their fast-paced growth doesn’t allow for their numbers to add up yet, and WeWork is yet to be a profitable company.

And while Blackstone believe that other property companies are coming in too late into the industry, this will depend on their ability to find strategic partners that will allow them to understand the nature of flexible workspaces and what makes them work.

In the end, it all boils down to creating a business model strategy that will allow you to be flexible enough to provide short-term space, without exposing your brand too much to economic cycles.