BROOKFIELD PUBLIC SECURITIES GROUPi | GLOBAL REAL ESTATE 4Q 2019

The Next SaaS (Space as a Service): The Impact of Coworking on Global Office Markets & Landlords

Coworking, also known as flexible workspace, is a rapidly growing industry that is changing the way that employers, employees, service providers and office landlords think about workspaces. In the last year alone, the number of coworking spaces rose by 16% in the U.S. and 36% internationally.ii Will the current boom end in an equally impressive coworking bust or is this just the beginning of a fundamental change of the office workplace? In this paper we discuss how we view the coworking industry and its growth opportunities and its impacts on the office market as we move forward.

AN OVERVIEW OF COWORKING EXHIBIT 1: THE HISTORY OF COWORKING WHAT IS COWORKING? THE MOBILE

The official definition of coworking 2007 REVOLUTION is “the use of an office or other working environment by people who are self-employed or working for different employers, typically so as to share equipment, ideas, and OmniOffices C-Base Founded “Coworking” WeWork knowledge.” The concept of shared Group Founded One of the first Catches On IPO A privately held hackerspaces, The first official office space has been around since Pulled on executive suites an early form coworking valuation the early 1960s, when “executive company and of coworking space opens in concerns suites” were established across early pioneer in San Francisco the country primarily for traveling salespeople. Coworking, as we think of it today, took off shortly after the financial crisis. Vacancies were high Regus Founded “Coworking” WeWork and office landlords allowed coworking Now operating Coined Founded companies, particularly WeWork, to 3,000+ locations Work clubs Now 430+ in 120 countries begin popping locations in rent this available space to help fill as “IWG” up in NY 86 cities these vacancies (Exhibit 1). The industry is defined by its flexibility and the services it provides, particularly design and hospitality. 1962 1989 1995 1999 2005 2010 2019 Source: Brookfield Public Securities Group LLC and The History of Coworking in a Timeline, deskmag 2013.

1 EXHIBIT 2: THE SCOPE OF COWORKING SERVICES: DESIGN, HOSPITALITY, FLEXIBILITY

■■ Economical for the tenant to reduce space

■■ DESIGN Attractive layout facilitates employee collaboration ■■ Data-enabled platform learning, giving the operator the ability to know “what works”

■■ Onsite food and beverage COWORKING ■■ Flexible meeting/conference facilities for entire building HOSPITALITY OPERATION ■■ Concierge ■■ Content/social programming

■■ Short-duration leases (1 month – 2 years) allow for TECHNOLOGY FLEXIBILITY quick scalability ENABLED ■■ Onsite coworking desks for employees and contractors

Source: Brookfield Public Securities Group LLC.

Coworking’s flexibility gives it an “on-demand” and service- Technology companies, driven by their startup-like culture, like feel. Employers and entrepreneurs have embraced this have for years been at the forefront of workplace flexibility movement, with inventory increasing by 29% since 2010 and “amenitization.” This has been a key driver of their (Exhibit 3). ability to attract and retain top talent, particularly among . Coworking models offer non-tech companies WHAT HAS DRIVEN THIS GROWTH? the ability to quickly and easily replicate some of these Tenant expectations for office spaces have evolved in recent cultural aspects, particularly with regard to flexibility, years, driven primarily by millennials who look for more amenities and socialization. flexibility and amenities. This cohort of workers, who are expected to make up 35% of the workforce by 2020, seek workplace environments that promote work-life balance.

EXHIBIT 3: U.S. FLEXIBLE OFFICE SPACE HAS GROWN SIGNIFICANTLY 84.9 Flexible Office Space Inventory (Million Square Feet) Flexible Office Penetration (%)

70.9 2.1 62.4 1.8 1.6 44.7

34.3 1.1 27.7 22.2 0.9 18.2 14.5 0.7 11.3 0.6 9.5 0.5 0.4 0.3 0.3

2010 2011 2012 2013 2014 2015 2016 2017 2018 H1 2019 YE 2019* Source: Let’s Talk About Flex, CBRE Research, Q2 2019. * Expected

BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 2 TYPES OF COWORKING MODELS We divide the industry into three types of models: Serviced Offices, Traditional Coworking and Enterprise Solutions.

■■ Serviced Offices: The first iteration of the coworking model, these companies essentially offer a ready-made office space marketed toward either small businesses or large companies that DECLINING need a temporary space during moves or renovations. Serviced Offices have the feel of a DEMAND traditional, professional office, rather than the social, community-oriented atmosphere that more traditional coworking spaces are known to have.

■■ Traditional Coworking: The “space as a service” membership model offers individuals and organizations the flexibility on how they choose to consume space. Individuals or organizations SATURATED select a membership model that best suits their space and timing requirements. Membership MARKET offerings can range from a private office with access to shared amenities or conferences rooms to a “hot desk” within the space that is used only when needed.

■■ Enterprise Solutions: The newest model has coworking operators partnering with larger to bring the look and feel of a coworking space to their offices or to move certain teams or departments to a coworking location. Often entire floors or whole buildings are GROWTH configured to a company’s particular needs, including specific designs, brand customizations A R E A and other amenities.

HOW COWORKING CAN BENEFIT TENANTS coworking operator is the sole source of all services, which In the traditional office leasing model, the tenant handles is often more efficient for the tenant from both a time and everything, including the lease and rent, while also working cost perspective (Exhibit 4). From the landlord’s perspective, with external service providers in terms of the design and the material change is the loss of a direct tenant relationship, hospitality aspects. However, in a coworking model, the as the coworking operator is now the middle person.

EXHIBIT 4: IN THE COWORKING MODEL, THE TENANT’S RELATIONSHIP IS CONCENTRATED ON THE COWORKING OPERATOR TRADITIONAL MODEL COWORKING MODEL EXTERNAL SERVICE COWORKING OWNER TENANT PROVIDERS OWNER OPERATOR TENANT Rent per Square Foot Occupancy Design Cost/Employee Rent Rent

Long-Term Lease Long-Term Lease Flexible Lease

Space Space Space Hospitality Shared Amenities

Design Source: Brookfield Public Securities Group LLC. Hospitality

BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 3 TRADITIONAL COWORKING EXHIBIT 5: COWORKING REDUCES TENANT’S COSTS BENEFITS FOR TENANTS Rent Tech Costs Office Services & Amentities ■■ Reduces Costs for Employers: While the rent per square foot is 100SF/EMPLOYEE COWORKING EXAMPLE more expensive, the overall cost $17.9 While cost reduction per employee may be lower. This $3.0 is good for the tenant, is partly due to smaller spaces, $15.1 we question the but also because the coworking $8.0 $3.0 ability of coworking operator can procure amenities at operators to make lower costs, compared with tenants’ $8.0 $10.8 money at this price purchasing power in the traditional $0.9 point. IPO filings model (Exhibit 5). $4.0 for WeWork made ■■ Flexibility and No Up-Front poor economics $6.9 Capital: The tenant has the ability $5.9 visible to the market,

to scale up or down as space needs Cost Per Employee ($000's) which caused the $4.1 change. Rather than dedicating eventual withdrawal resources to an office buildout of the IPO. under the traditional model, space in the traditional coworking model 100SF/employee 60SF/employee 60SF/Employee is ready-made. As of August 30, 2019. Source: Brookfield Public Securities Group LLC and WeWork. Uses Rent at The National quoted on WeWork Website for 125 S Clark St.

WHAT DOES THE CURRENT EXHIBIT 6: FLEXIBLE WORKSPACE FUNDING ($ MILLIONS) LANDSCAPE LOOK LIKE? WeWork Other The operating landscape is quite concentrated with the $6,000 SINCE 2013 We Company (WeWork) and WeWork $10,735 5,821 IWG (Regus and Spaces) as the Other $3,337 dominant players. Within the 5,032 $5,000 U.S., these two names hold 50% Total $14,072 of all flexible-office inventory.iii WeWork has dominated the amount of funding that has $4,000 been raised (Exhibit 6) and has 4,400 3,916 the largest presence in the two biggest coworking markets in the world: and New York. $3,000 Since WeWork’s first New York location was established in 2010, the company’s footprint has grown $2,000 approximately 30% annually across . In London, Brexit 1,367 has actually been a positive for 1,253 WeWork, with flexible workspace $1,000 1,184 absorption increasing since 539 the referendum. 690 505 60 Notably, the vast majority of the $0 40 capital raised by WeWork (and the 2013 2014 2015 2016 2017 Nov 2018 rest of the industry) over the last couple of years has been done Source: Flexible Workspace Report, Art Invest Real Estate, March 2019. at ever higher valuations and with one investor – SoftBank.

BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 4 IS COWORKING HERE TO STAY? some employers might be drawn to coworking, given the lower cost and the flexibility. On the other hand, WHAT MIGHT HAPPEN DURING A RECESSION? we believe other companies will use their coworking One of the key questions around the coworking model is footprints to reduce their space quickly during a its profitability. To date, these operators haven’t been able downturn. Individual LLCs, generally the structure to turn much profit despite being 10 years into a bull market. that is found on the leasing agreement, make it easier This begs the question: What will happen in a recession? In to walk away from a lease during tough times, something the last two downturns the impact was limited (Exhibit 7), that is much harder to do in a traditional model. and there is good reason to think that during a downturn

EXHIBIT 7: OPERATING PERFORMANCE DURING RECESSIONS HAS BEEN MIXED

REGUS AMERICAS NUMBER OF WORKSTATIONS CONTRIBUTION MARGIN FOR REGUS AMERICAS Recession Recession

100,000 40%

30% 80,000 +3.0% 20% 22% in 2009 60,000 10%

0% 40,000 -1.4% -10% 20,000 -20% -21% in 2002 0 -30% 0 1 3 4 5 2000 2001 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 200 200 200 200 200 2006 2007 2008 2009 2010 2011 2012 2002* 2002* Source: Company filings as of 2012. * As Restated.

OUR EXPECTATIONS FOR INDUSTRY EVOLUTION providers to build out office spaces to meet both employer Enterprise Solutions Is the Source of Future Growth and employee demands. We would expect consolidation among these providers, as scale will be necessary to provide In the current landscape, we think the serviced offices the best economics for tenants. model is a thing of the past and see the traditional coworking model as fairly saturated. The real growth opportunity, Coworking Operators Become Partners with Landlords in our opinion, is the enterprise solutions model, as we As coworking operators focus on offering enterprise believe the “amenitization” of the office space is here to stay. solutions for larger organizations, the expectation would With millennials (and generation Z after them) continuing be for the relationship between coworking operators to increase their presence in the workforce, the ability for and landlords to shift. Our expectation is for the industry companies to offer these types of workspaces will become to gravitate toward a participation model—one in which more important. Enterprise solutions has already seen the coworking operator would receive a management fee growth – WeWork’s enterprise solutions business now for the space, while transferring some of the up-front capital accounts for ~40% of its business – and we expect large costs to the landlord (Exhibit 8). companies to continue to engage with these types of

EXHIBIT 8: THE POSSIBLE EVOLUTION OF THE COWORKING BUSINESS MODEL TODAY: TRADITIONAL LEASE TOMORROW? PARTICIPATION LEASE Lease Term 5 – 10 Years 5 – 10 Years

Coworking Operator’s Ownership of the Management Co. None 0 – 50%

Management Fee N/A 0 – 3%

Participation for Manager Upside/Downside Unlimited Significant

Breakeven Occupancy for Manager 70 - 80% 70 - 80%

Up-Front Capital Cost Borne by Coworking Operator $200 – $300/SF $100 – $150/SF

Source: Brookfield Public Securities Group LLC research and estimates.

BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 5 OUR VIEWS ON THE FUTURE IMPACTS However, the loss of direct relationships between TO THE OFFICE MARKETS landlords and tenants may result in unintended negative consequences. Coworking does give the landlord the ability Coworking, particularly as enterprise solutions grows, to rent to smaller tenants, but less space may be rented will likely have a permanent spot in the office landscape. out, as these tenants use less square footage per employee. We expect long-term impacts to the office leasing ecosystem We’ve already seen some compression within the office and building values, with both positive and negative market, and we could see more as coworking continues outcomes for both landlords and tenants. On the tenant side, to increase its presence. Office brokers, however, may suffer there is the previously discussed flexibility, cost reduction the most as landlords work directly with coworking operators and amenities. From the perspective of the landlord, they to rent out space (Exhibit 9). will be able to rent to tenants that they wouldn’t have been able to access through a traditional model.

EXHIBIT 9: COWORKING – WHO WINS? WHO LOSES?

LANDLORDS BROKERS TENANTS Higher Revenue/SF Shorter-Term Lease ✕ Tenants Can Lease Directly Through Significant Space Absorption Coworking Provider Focus on Core Business

Direct Tenants Desire Flexible Space Solutions Easier To Expand/Contract

Ability to Move Smaller Tenants in Larger Spaces Wider Range of Services/Amenities

✕ Further Compression of Space/Employee Lower Occupancy Cost/Employee

✕ Competition for Direct Leases ✕ Higher Rent/SF

✕ Loss of Direct Tenant Relationship ✕ Loss of Direct Landlord Relations

Source: SL Green Realty Corp and Brookfield Public Securities Group LLC.

Valuation Impacts on Office Real Estate Buildings that have 20% to 30% of coworking space While we have limited transaction data so far, coworking trade at a higher valuation (i.e., lower cap rate) than operations (in a limited capacity) may actually increase comparable buildings with no coworking operations a building’s valuation. Investors view up to ~20% of space (Exhibit 11). However, the recent failed IPO of WeWork occupied by a coworking operator as a positive for a building may change this view, as the implied risk premium has (Exhibit 10), and cap rates seem to support this narrative. likely risen significantly.

EXHIBIT 10: INVESTORS SEE VALUE IN SOME AMOUNT EXHIBIT 11: EXHIBIT 11: COWORKING IMPACT ON CAP RATES OF COWORKING IS POSITIVE FOR OCCUPANCY LEVELS < 30%

% of space 125 occupied by 100 % of investors that think coworking % of investors that think coworking space will coworking space will 75

reduce property value increase property value 50 -72% 80%+ 10% 25 0 -71% 60% - 80% 8% -25

-57% 40% - 60% 14% Difference in Sales -50

Cap Rate vs. Benchmark -75 -29% 20% - 40% 20% -100 0% 10%20% 30%40% 50%60% 70%80% 90%100% -6% 0% - 20% 34% % of Building Occupied by Coworking Space Provider (at time of sale) Source: “The Property Value Implications of Flexible Space,” CBRE, Source: Capital Analytics, Cushman & Wakefield, HSBC, July 10, 2019. January 2019. Circles represent individual sales. Benchmark developed by Cushman & Wakefield and represents sales in the same submarket.

Proactive office owners can use coworking to optimize the building’s appraisal value as amenities are added certain assets. The addition of a coworking operator that benefit all tenants, not just coworking tenants. to a building that may not be best-in-class can improve

BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 6 Our Closing Perspectives

We think the industry will continue to evolve, as some parts partner more with landlords; sharing both the upside and reach saturation. We see the “amenitization” and sharing the downside. However, while current pricing levels are an of office space as here to stay and foresee coworking attractive value proposition for tenants, we do question the operators playing a significant role as the service providers. ability for operators to make sustainable returns through Winners and losers will emerge among brokers, tenants and a cycle, given these aggressive economics. The evolution landlords—with the proactive office owners using coworking toward the alignment of interests between landlords to optimize certain assets. Rather than simply occupying and coworking operators should make the model more space as a tenant, we expect coworking operators will sustainable for all involved.

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The Brookfield Investment Funds are distributed by Quasar Distributors, LLC. INVESTMENT PRODUCTS: NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED BROOKFIELD OVERVIEW FACT SHEET THE NEXT SaaS: THE IMPACT OF COWORKING ON GLOBAL OFFICE MARKETS & LANDLORDS 8