Co-working Spaces. A Bubble in the Making?

For decades business centres were the only option available to firms looking for fully-fitted out, serviced offices with high flexibility. Many large multinationals, on entering India in the 1990’s, set up their first office in a business centre. The trend continues even today.

The current flavour of the season is Coworking spaces. Millions are dollars are being invested in creating such spaces in office buildings. In theory Coworking spaces should be used by freelancers, start-ups, SMEs and large corporate firms. Surprisingly both the high-end Coworking spaces and business centres are affordable only to large firms. There is disconnect in the offering and needs of the market.

Current frenzy raises several questions. Will demand for such spaces go beyond the tech industry? Will large firms do away with old-style offices and opt for a more vibrant new layout? Is too much money being spent on a depreciating asset? How and will such Coworking spaces make money?

Is There a Bubble in the Making?

Several studies have been carried out by various professional firms in the recent past on Coworking spaces. A quick glance at some of the findings highlights the following:

1.   About 25 mn sft of office space is expected to be leased by Serviced Office firms by 2023

2.   The industry would receive about $ 400 mn in investments by 2018. It is predicted that by 2020, Coworking spaces would outgrow traditional serviced offices model

3.   Softbank has invested $ 4.4 Bn in WeWork, currently the fastest expanding Coworking space operator. In all, they have raised close to $10 bn.

4.   It is also estimated that there are about 200 high-end business centres in India currently and their numbers are expected to double by 2020. At the same time there are about 100 formal Coworking spaces and their numbers are also expected to increase significantly in the near future.

5.   One consultant estimates that the potential area leased, just by Coworking space firms, could be around 7-9 mn sft over the next few years.

These are big numbers. As is the case with all large numbers, they can easily deceive. To make sense of how this would impact corporate real estate, we need a dispassionate review.

Serviced Offices Classification

Traditionally a business centre was synonymous with high occupancy costs, however in the recent past, its business model has evolved. Globally and in India. We can now classify Serviced Offices (SO) in three broad categories:

1.   Business centres (BC): this is the traditional SO which continues to grow. Established international and Indian operators such as Regus, Vatika Business Center, and Executive Business Center etc are still expanding their footprint across India. They have refined their operation model over years of experience and are using innovative transaction structuring to grow further.

2.   Incubation centres (IC): explosion in start-ups and the need for an ecosystem to support and nourish them was the key reason behind establishment of incubation centres. These are usually cheaper to use, have large common areas that are accessed by all occupiers and also provide expert advice to users by facilitating meetings with CA, Lawyers and investors etc.

3.   Coworking spaces (CS): offered at prices similar to a BC but with several amenities that are present in an IC, CS is the latest product offering in the SO domain. Having evolved after and from the above two models, it tries to offer best of both the worlds and has witnessed impressive fund raising stories in India and globally.  

All the above business models together create a new segment of occupiers in corporate real estate. Some operators try to use these terms (BC, IC, CS) loosely or interchangeably. Others are making changes in their existing models to come-up-to-speed with latest developments.

But how is this business changing? More importantly how will it look like in the near future? What can be impacts of these changes on various participants? I will focus just on the journey of such offices in India. 

What prompted an increase in Serviced Offices?

The office space needs of any start-up or a new company entering India, should be the least of their worries. SOs have met this need successfully over the years across all key cities of India.

The spurt witnessed in start-ups, new companies entering India, unwillingness or inability to make capital expenditure in office furniture and fixtures and the need to have someone take care of basic office/ administration chores, have been the main reasons behind increase in SOs across India.

1.   Several large multinationals, post the sub-prime crises and during the current Great Recession have avoided incurring capital expenditure wherever they can avoid it. Focus on the bottom-line has rarely been greater. For many such firm, investment in office interiors is a “wasteful and unnecessary expenditure”.

2.   Unpredictable economic conditions also prompt many firms from shying away from making high investments. Such circumstances are expected to continue in the near future as well so we can assume demand for SOs would remain consistent. 

3.   Start-ups are either bootstrapped or funded. In either case, the smart Founders don’t want the core team to be saddled with operational issues and smart investors prefer their money is invested in the core business and not office furniture. This trends is also expected to continue.  

4.   Traditionally, Delhi and Mumbai have witnessed city specific demand for SOs. Liaison offices and touch-down office in the CBD have been in demand in Delhi and Mumbai respectively. The former is the first step towards setting up a full-time operation in India and the latter is to ensure operational efficiencies for large firms considering the challenges faced in Mumbai.

5.   Bengaluru over the years has become the most-favoured destination on this planet to hire software developers. Even the start-ups in the US now prefer to have a development centre in Bengaluru once they reach a reasonable size. This has resulted in a very specific and regular demand from small and medium sized firms from the US and Europe. When they set up a footprint in Bengaluru, many of them prefer SOs.

I should highlight that in several instances, landlords/ developers have invested in fit outs and have leased their office space as a “fully-fitted” out premises. Sizes of such leased spaces could vary from 1,000 sft to 30,000 sft. Such office space acquisitions don’t always eat-into the SO demand but in many cases firms graduate into independent, fully-fitted out offices from the SOs.  

The Case against the Current Trend

Co working is supposed to provide individuals/ free lancers, boutique firms, start-ups a unique physical space along with a community. However the per seat costs of many of these new spaces can only be afforded by global giants. Therein lies the concerns.

Critics would argue that a CS is essentially a new design for a BC. On examination of several new and operational Coworking/ incubations spaces, several observers have commented that:

1.   A Coworking space has a larger area dedicated to common areas, lounges etc but also has dedicated cabins/ workstations. In many cases, it’s just a better designed business centre with large common areas.

2.   Both the incubation spaces and Coworking spaces don’t have the traditional corporate feel to the office environment. Standard modular workstations have given way to completely open layouts. Visual appearance of the space is livelier with the intent to make them more attractive to the millennials.

3.   When a Coworking space becomes as expensive as or more expensive than a business centre, then it automatically gets out of reach of start-ups and most small/ medium firms with restricted budgets.

4.   Only when per-seat costs are below Rs 7,500/month (inclusive of basic services) and there is high flexibility, does the space make sense to most start-ups. Anything over this figure makes it challenging to make the case, even for a start up with Series B funding. 

5.   Large common areas may also result in larger attrition amongst the occupiers. Based on review of plans and services of such Coworking spaces, it is clear that quality of office interiors is above average. It encourages a vibrant workspace. At the same time the Founders of start-ups evaluating them have mused about ability to hold attention of their team on tasks at hand.

Conclusions

The largest business centre operator in the world, Regus, set up in 1989, runs 3000 Centres in 900 cities across 120 countries. Wework, founded in 2010 is already in 16 countries and 160 locations.

One can try to point out several drawbacks and risks in the Coworking spaces. Fact remains,

It’s a reality and it’s fast changing the landscape of commercial real estate. Any rapid change, in a short duration, prompts the question regarding its longevity.

A.   Oversupply: in all likelihood there would be an oversupply of serviced offices at city or micro-market level if all the above projections are correct. The result should be reduced prices for occupiers. Then and only then SMEs and start-ups would evaluate them.

B.   Consolidation is a logical next step for some of the existing players. Considering the rapid changes in the marketplace, the current operators would have to rethink many of their strategies. However it is doubtful if they will have access to capital for such consolidation.

C.  Some Centres will shut down, in fact some have already shut down or are on the verge of closure. Most current operators would rationalise their footprint. It is critical at this stage that each centre becomes and stays profitable on a stand-alone basis.

D.  Fitted out space will remain in favour of most occupiers even in the short to mid-term. It is advised to all landlords and Developers that, in case they are able to then, remain open to investing further in fit outs to attract the right tenant.  

E.   High costs: claim of 20%-25% saving when it comes to traditional offices doesn’t seem to add up especially for the mid and high end Coworking spaces and even the business centres. Operators at the bottom-end of the market would continue and would remain the preferred option for all start-ups.   

It is easy to conclude that disruption is taking place in the serviced offices segment. However, will an office decision be taken by its “coolness” quotient and not hard facts? Perhaps in some cases, large firms (and only large firms) may give a higher weightage to it but most others would think twice.

At the current speed and direction, the Coworking revolution will miss and pass by the freelancers/ entrepreneurs/ Start-ups and SMEs. At least in India. Office interiors are a depreciating asset and that would pose noteworthy challenge to all these operators 5 years from now. Serviced office is dead! Long live the serviced office!