Seismic shifts in the flex-office market

Montreal-based Breather, a company that rents workspaces by the day, made a bold announcement last month that reverberated throughout the world of flex-office operators.

“Breather, in its current form as an operator, doesn’t make sense. And, to be frank, I’m not sure it ever made sense,” CEO Bryan Murphy told the Globe and Mail as he announced the startup would close all of its locations in the U.S., Great Britain and Canada.

Flex-office companies emerged from 2020 bruised and battered. But they say that whatever doesn’t kill you — and, to be sure, some companies were dealt a fatal blow — only makes you stronger.

The year of Covid was a telling one for the fast-growing commercial real estate sector that critics and supporters alike have long asserted had to prove it could survive through an economic downturn.

And 2020 proved to be the ultimate test for some of the biggest players.

Regus — the largest and longest-running company in the space — filed for bankruptcy in the United Kingdom in September 2020 and threw more than 100 locations in the United States into Chapter 11.

The five-year-old startup Knotel drew the ire of many of its New York landlords who claim the company has stopped paying rent, even though its members are still paying their dues. More than a dozen owners have sued to collect and a few have even filed to evict Knotel. A handful of smaller co-working companies have folded up or tried to reorganize themselves through bankruptcy.

“The flex sector is going through a vast change as it’s been heavily impacted by the shutdowns — even potentially more so than conventional businesses,” said CBRE research manager Mike Slattery.

One of the big questions looming for short-term rental companies, co-working firms and other flexible-space providers is how their business models will be affected by shifting work patterns brought on by the pandemic.

Critics argue that with companies allowing employees to continue to work from home, there will be less demand for their spaces. But those who are more bullish say the new realities of office culture mean companies will shift employees from traditional offices into flex spaces with less restrictive terms than more traditional office leases.

The co-working correction

The onset of the pandemic certainly represented a big shift for flex-office companies, which had gobbled up space in Manhattan and other markets over the past few years, driven in large part by WeWork’s ambitious expansion.

Flex-office firms leased just 300,000 square feet in Manhattan in 2020, according to CBRE, down from 4.7 million square feet in 2018.

And while office leasing across all industries was down due to the pandemic, flex office took a much bigger hit. Those 300,000 square feet accounted for just 3.5 percent of Manhattan’s leasing total, compared to 2018 when the sector accounted for about 18 percent, CBRE’s figures show.

As for public sentiment toward the flex space, one can look to Regus’ parent company IWG, run by founder Mark Dixon, which is publicly traded on the London Stock Exchange.

The value of the company’s shares has made a significant recovery after taking a sharp dive in March 2020 along with broader stock market turbulence when the pandemic first hit. IWG stock was trading at about £360 (about $485) in early January, recovering about 70 percent of the value lost in March, when it bottomed out at £160 (roughly $215).

In response to the pandemic, the company accelerated its plans to shutter about 4 percent of its portfolio of nearly 3,400 locations worldwide. In the U.S., part of that strategy involved putting many of its locations into bankruptcy.

“We predict dramatic changes in the fabric of how and where people work will continue to accelerate as employees look for solutions that offer a mix of working from home, satellite office and HQ,” a spokesperson for IWG told The Real Deal in a statement.

Regus, which first launched in Brussels in 1989, is no stranger to bankruptcy. The company filed for Chapter 11 in 2003 after the dot-com bubble burst. At the time, the flex-office market was much younger than it is today, but the industry really started growing and maturing in the years following the Great Recession.

WeWork opened its first location in Soho in 2010 and famously ballooned to a valuation of $47 billion with heavy backing from SoftBank before the co-working giant’s failed IPO effort in 2019. Following that debacle, the company changed leadership — replacing its co-founder Adam Neumann with mall industry veteran Sandeep Mathrani as CEO — and drastically cut back its growth plans.

In August 2020, WeWork got a $1.1 billion cash infusion from SoftBank, and that month its executive chairman Marcelo Claure told the Financial Times that the company was on track to be profitable by the end of 2021. SoftBank removed Claure from WeWork’s board just a few months later.

Even with the cash infusion, Fitch downgraded WeWork’s rating to CCC in October 2020, saying there was concern over the viability of its business model if the pandemic led to less demand for office space.

WeWork’s success inspired a new generation of co-working firms, many of which were aimed at niche audiences.

But that trend appears to be going in reverse now, as companies in weaker financial positions struggle and those with stronger models become more entrenched.

Industrious — one of the few firms that has shown little sign of pulling back or changing course — is teaming up with landlords to operate their office properties as private offices. Developer Sioni Group recently signed an agreement with the startup to debut its recently developed 53,000-square-foot office building at 44 West 37th Street in Manhattan as Industrious Herald Square this winter.

Industrious CEO Jamie Hodari recently told TRD that smart landlords are trying to take advantage of the “work from anywhere” trend.

Survival of the fittest

Many see the pandemic as weeding out the weaker players. When workers do finally return to the office and the market bounces back, they say, the playing field will be much more consolidated with fewer players.

In June 2020, the wellness-focused co-working firm The Assemblage reportedly shut down all three of its Manhattan locations. Primary — a small co-working firm founded by former WeWork employee Lisa Skye Hain with two locations in Manhattan near Penn station and in the Financial District — filed for bankruptcy in July. And Serendipity Labs, a co-working firm founded in 2011 by former Regus president John Arenas, filed for bankruptcy in December 2020.

“Only the strong will survive,” said Ryan Simonetti, CEO of the shared meeting-space startup Convene.

“There’s no question for me that when the pandemic ends, businesses that survive will desire these amazing experiences,” he added about the perks of flex office, which doesn’t require companies to commit to long-term leases. “And if anything, there will be [fewer] competitors around.”

Simonetti, who said his company cut about 85 percent of its expenses in 2020 as a survival measure, noted that “strong” could be defined in a number of ways: a deep pocket of cash to dip into or an asset-light business model that spreads around the risk, for example.

He said Convene was able to get through the pandemic due to the fact that it mostly partners with landlords instead of doing conventional leases. The company also recently pivoted by transforming some of its shared-meeting locations into mini broadcast studios as part of its new virtual meetings business.

Simonetti said he believes his segment of the flex-office market will bounce back quicker than others. “I think the meetings, events and conference business recovers faster than the co-working business,” he said.

For others, the pandemic has exposed fatal flaws in their business models.

Breather, which is shutting down all of its 400-plus on-demand locations in an effort to repay creditors, has also laid off most of its staff. The company is now pivoting to an online membership model that lets users rent flex-space operated by other companies.

“I want to be like Airbnb,” Murphy said in December 2020.

Revolving doors

To be sure, the challenges of 2020 have put many operators in adversarial relationships with their landlords.

WeWork filed a lawsuit this month against its landlord at 404 Fifth Avenue, the Chetrit Group, claiming the owner threatened to illegally draw down on a multimillion-dollar letter of credit at the location.

And Knotel is facing a mounting pile of lawsuits from property owners and vendors claiming the company owes them roughly $10 million in rent and fees. Knotel CEO Amol Sarva said he was working to resolve the “shared economic situation with our landlord partners” and argued it was in everyone’s best interest to come to mutually beneficial agreements.

“We’re trying to do it in a civil and cooperative way, because we will be doing business in the future,” he said in a recent interview. “They all know that customers want to do flex.”

Knotel reportedly secured a recent funding round, which he announced to employees in an all-hands meeting this month. Sarva declined to comment on the funding or whether any new cash would be used to pay rent, but a source told Business Insider that it’s a restructuring type of deal, including debt and equity financing.

Sarva told TRD his big takeaway from last year is that the flex-office model can survive a once-in-a-lifetime crisis. “The big news is, this is the way it works now,” he said. “Flex platforms are real.”

To that end, 2020 wasn’t all a retreat. In November, for instance, IWG opened its first Williamsburg location under the company’s Spaces co-working brand.

The new flex office opened in 79,000 square feet at Meadow Partners’ 109 South 5th Street, which had previously been a WeWork location.

—Akiko Matsuda contributed reporting.