IllinoisOffice Bend but not break: Flexible office spaces react to the pandemic Matt Baker May 20, 2020 Share on Facebook Share on Twitter Share on LinkedIn Share via email WeWork's flexible office space at 1 W. Monroe Street, Chicago. Since we’ve all been in lockdown for the past two months, there’s been plenty of time to wonder what comes next for office real estate. How do we actually return, for example, and what does the office of the future look like? It’s also fair to ponder what impact the pandemic will have on the heretofore ascendant coworking sector. It’s not a frivolous question, at least in Chicago. Six years ago, there were 38 coworking locations in the Chicago CBD, comprising 788,898 square feet of office space. Now, the number of locations has tripled and the total coworking space has ballooned to nearly 3.5 million square feet, according to new data from Colliers International | Chicago. The very nature of coworking has changed in that short time too. Once the domain of startups and freelancers, the sector has matured to focus more on flexible offerings to enterprise users. “The industry is shifting from almost exclusively catering to traditional users such as small financial services firms and boutique law firms to providing dynamic, flexible workspaces in amenity-rich environments that are attractive to a younger workforce,” said Robert Patterson, associate in the Chicago office advisory group and author of the report. Back in 2014, Regus owned more than half of Chicago’s coworking market share with 425,007 square feet of space. Since then, a number of larger players have entered the market. Convene, Industrious and Novel Coworking now combine for more than 20 percent of the market; smaller providers, including Amata, MakeOffices and Spaces, have also set up shop in the Central Loop, Fulton Market, River North, West Loop and other neighborhoods. The monster of the market, however, is WeWork. The company—which ran into trouble last year with an IPO that sputtered out of gas and an eventual bailout by SoftBank—controls 1,081,787 square feet of space in Chicago. That crowns them as dominant in the flexible office arena with 31 percent market share, but the company also commands more general office space in the city than any other non-governmental tenant. Right up through the beginning of 2020, coworking had been the most dynamic segment of the office market. The current health crisis has turned it on its head, however, and there are many unknowns for the short- and long-term stability of the sector. “Today, the coworking industry finds itself particularly hard hit by the COVID-19 pandemic, as many coworking occupiers have implemented work from home policies and have subsequently ceased paying month-to-month rental payments to their coworking providers,” Patterson said, “while the providers remain liable to pay their landlords market rental rates on their direct leases.” Once the lockdown hit, companies started looking for ways to immediately cut costs. Those with a monthly rent (that they can’t even make use of) had an obvious line item to cut out of the budget. Since contracts vary from tenant to tenant and provider to provider, it isn’t immediately clear how many flexible office users have monthly rather than annual terms. WeWork’s failed IPO provides some context, however. When the coworking provider was preparing its offering last year, paperwork filed with the SEC indicated that 28 percent of its tenants had signed month-to-month deals. Extrapolating that out to the rest of the sector, many providers may have already seen more than a quarter of their tenants opt not to renew in April and May. The larger challenge may be what occurs in the months ahead, as office employees start to return to work. The business model for flexible office spaces—as defined by later entrants, and WeWork in particular—relies on higher density for maximum margins. Will individuals feel safe returning to an environment designed around close proximity to others? That could be a costly consideration for coworking firms, from both an income and operations standpoint. “If these providers elect to reconfigure their spaces to reduce the number of people occupying the space, they will reduce their revenue under their current cost-per-head model,” said Patterson, “while also incurring immediate capital commitments required for space reconfiguration.” The density question may be answered for them, however, if companies allow their workers to continue working from home, either full or part time. If that happens, the demand for flexible space would likely fall. There are so many unknown variables, however, that the very opposite could be true as well. Demand for coworking space could actually rise as users try to offset the risk of a company-wide outbreak via distributed workforce. The state of Chicago’s flexible office sector is a reliable indicator for the health of the metro’s overall office market. Coworking demand accounted for more than a third of total positive net absorption over the past six years. If these providers default on their leases, the market could see an oversupply of high-quality, built-out space throughout the CBD.