By John Arenas | August 24, 2017

Say Adios to the Office: Are Office Assets Going the Way of Retail?

Why Shifting Workforce Needs Demand New Investment Strategies

The term Retail Apocalypse would have seemed like hype just a few years ago, but a mere 5% shift in consumer buying behavior to online purchases since 2013 has taken revered retailers to their knees or worse, including 9 prominent bankruptcies, all during a period of economic expansion. This spring, Credit Suisse Research predicted that 25% of existing US Malls will close within the next 5 years. US Consumers have turned conventional retail asset investment and management strategies to dust as they decided to change where and when and how to shop.

Office Apocalypse?
Feeling safe as a commercial office investor? Not so fast. First, consider that companies are reinventing their workplace to support a more mobile and digitally connected workforce. These newly empowered workplace consumers are demanding ‘workplace experiences,’ not just space. To compete for top talent, tenants are seeking more amenity-rich buildings that include shared work lounges, coworking, event space and high walkability scores. At the same time, companies are seeking more lease flexibility and shorter terms to match their shorter product cycles. To many, signing 10 year leases is a costly and unnatural mismatch during most of the term of the lease providing little or no business resilience.

A January 2017 Morning Star Research report on underwriting office assets, “Sharing the Experience-As Co-working Grows, the Office Isn’t Necessarily the Office Anymore” predicts that a shift in worker demand for flexibility will leave traditional workspaces in the minority by 2030. The report goes on to say that coworking will present new underwriting and valuation standards as the coworking business evolves. With coworking taking just under 1% of all office space today, it may seem too early to adjust office asset investment strategies. However, coworking is projected to double to 2% of all office space in two years according to Emergent Research, and at the current 41% annual growth rate, coworking market share could reach 5% of all office space within the next 5 years. That’s equivalent to 600 million square feet of coworking leases. This 4% change in workplace consumer demand for office space approaches the same magnitude as the change in consumer behavior that has redefined retail investment.

Satisfying Tenant Demand and Investor Returns
Asset managers, developers and operators of commercial office buildings are taking steps to serve the changing nature of office demand while improving investment returns. Offering coworking and shared tenant amenities in collaboration with a leading shared workspace company can allow owners to participate in additional rent streams, while maintaining competitiveness of the asset. This can take several forms, including entering into a management contract, a joint venture or a participating lease with an established coworking company. An established provider can operate the shared workplace and offer access to all building tenants as an amenity and make the building a more vibrant destination, adding to financial performance of the entire building. In the management scenario, the landlord designs and delivers the facility and hires an operator to activate and run the location for a fee or a share of the revenue from the operation. A joint venture approach involves setting up a partnership with a coworking company. The partnership entity serves as tenant and signs a lease, with both parties investing capital for the opening and operation of the location. Profits are then distributed according to ownership interest. Another approach is to sign a lease with the coworking operator that includes a profit participation for the landlord or a revenue share as additional rent. This is similar to the approach commonly used when attracting restaurants and other retail tenants to office projects.

The ongoing shift in office demand from tenants, and newly empowered consumers of workplace call for new office investment strategies. Delivering competitive office product will require more than it used to. Collaborating on new strategies with the coworking industry can be an important part of ensuring office asset investment returns.