BEYOND COWORKING How Flexible Space Solutions Became Manhattan’S Fastest-Growing Industry VIEWPOINT FLEXIBLE SPACE SOLUTIONS

VIEWPOINT FLEXIBLE SPACE SOLUTIONS

BEYOND COWORKING How Flexible Space Solutions Became Manhattan’s Fastest-Growing Industry VIEWPOINT FLEXIBLE SPACE SOLUTIONS

Nicole LaRusso Director, Research & Analysis Mike Slattery Research Manager Chris Donofrio Senior Research Analyst

EXECUTIVE SUMMARY While traditional long-term leasing models are—and will remain—the preferred operational model for business and the foundation of the commercial office market, the rapid growth of coworking and other third-party flexible space (FS) solutions provides occupiers with a wide array of options for leasing office space. CBRE’s Viewpoint examines the evolving flexible space landscape and its impact on the Manhattan office market, where flexible space operators continue to rapidly lease space.

Historically, flexible space operators—third-party providers that lease space to others at a premium—supplied executive suites; Regus and others have been in that business for decades. Then, in 2010 on the back of the financial crisis, WeWork was born, propelling coworking to the forefront. This drove a sea change in the flexible-space industry, and inspired a long list of competitors to test their mettle in Manhattan. As the operators move beyond freelancers, start-ups and small businesses, leasing activity by third-party flexible space operators has picked up considerably and become an increasingly noticeable part of the Manhattan market. Today it continues to accelerate:

• While flexible space leasing averaged only about 3% of total annual leasing activity between 2013 and 2017,1 the sector’s leasing in 2018 seems to be on track to exceed this, with over 900,000 sq. ft. of flexible space leases closed in Q1 2018 alone, and many more transactions in the pipeline for the year ahead. (See Figure 1)

• While currently only 2.5% of overall Manhattan office occupancy, the flexible space sector occupies 9.2 million sq. ft. and has grown by approximately 600% since 2009. There are now 65 different flexible space companies operating 260-plus locations.

What are flexible space solutions? Coworking, accelerators, serviced offices, enterprise solutions and turnkey environments that solve for requirements that are uncertain, transient or short-term in nature.

1 In order to accurately portray the flexible space sector in Manhattan, this report documents all flexible space leasing in Manhattan south of 65th Street, including those leases signed both within and outside of CBRE’s Manhattan building statistical set. However, total Manhattan leasing activity includes only leasing within CBRE’s statistical building set, as is consistent with ongoing research practice.

Figure 1: Manhattan Flexible Space Solution Footprint (Cumulative)

RSF (Millions)Comparison (Millions) 10 9.2 8.2 8 6.8 6 5.6 4.4 4 3.7 1.9 2.2 2 1.3 1.6

0 2009 2010 2011 2012 2013 2014 2015 2016 2017 Q12018 Source: CBRE Research.

# Since 2013, when third-party flexible space expansion began to accelerate, the sector has 1 averaged an annual growth rate of 22%.2 If this rate continues, the footprint of flexible Manhattan is the space operators could reach 15 million sq. ft. by the end of 2020, or approximately 4% largest FS market in North America of Manhattan’s total occupied office space. By comparison, the law, media and entertainment, and technology sectors each account for between 8 and 10% of total occupancy, while financial services, the largest sector, accounts for 28%. (See Figure 2)

Growth of the flexible space model continues, even as it evolves. What started as a 9.2 MSF service for small tenants is quickly pivoting to account for larger companies, including FS footprint in many in the Fortune 500 who are exploring ways to leverage flexible space solutions as a Manhattan piece of their larger portfolio strategy. As companies of all sizes look to build greater flexibility into their real estate portfolios, there is mounting momentum for flexible space providers to expand their footprint in Manhattan and beyond. % 2.5 Figure 2: Manhattan Occupancy By Industry FS share of total Manhattan occupied space Feie Space 2.5% Education 2.7% Arts & Recreation 1.6% Real Estate 2.9% Non-Profit 3.3% Health Care 3.5% Financial Services Govt. 28.2% 65 4.7% FS operators in Manhattan Mar./PR 4.8% Q1 2018 Prof. Services 5.1% Law Other 9.7% 5.8% Apparel/ Media & Retail Entertainment Tech 9.5% 7.6% 8.0% 260 Source: CBRE Research. FS locations in Manhattan 2 Annual growth begins with percent change from 2013 to 2014.

WHO’S PAYING ATTENTION TO THE FLEXIBLE SPACE SECTOR? Large leases make news and financial market valuations are mindboggling, but the real reason to pay close attention the flexible space sector is because landlords and tenants across the spectrum are increasingly engaged:

• Small users. According to CBRE Research, as the amount of flexible space in Manhattan has grown in recent years, leasing among tenants of under 5,000 sq. ft. has fallen off dramatically, dropping 41% from 1.45 million sq. ft. in 2013 to just 0.86 million sq. ft. in 2017. This suggests that these small users are migrating to flexible space solutions.

• Large users. 75% of corporate occupiers anticipate including coworking or flexible space in their occupancy portfolio over the next three years, according to CBRE’s 2018 Global Occupier Survey.

• Landlords and investors. According to CBRE’s 2018 Global Investor Intentions Survey, approximately 45% of landlords and investors say that flexibility of use is the most important occupier trend for real estate in 2018.

• Brokers. Real estate advisors are responding to tenant needs for quick, turn-key space by showing them flexible space options alongside pre-builts, sublease and other traditional lease arrangements. Flexible space operators are courting brokers to “find and fill” their spaces by paying commissions.

HOW HAS THE FLEXIBLE SPACE LANDSCAPE EVOLVED IN MANHATTAN? As of Q1 2018, more than 65 flexible space operators occupied 260-plus locations across Manhattan. Some obvious distinctions in the flexible space operator mix are apparent, but those lines blur quickly as providers evolve their brands. In the early 1990s, third- party flexible space providers made their first foray into the market as executive suite or serviced office providers. That model began as a pure real estate play, with companies offering individual entrepreneurs, start-ups and small businesses short-term lease opportunities within larger offices, as well as access to shared services like receptionists, conference rooms and mail service. Regus, the dominant operator, and several others have been in that business for decades.

That sector existed relatively unchallenged until the Great Recession of 2008, when the market experienced a rapid uptick in unemployment. Displaced workers turned to self-employment and sought new work spaces, as well as opportunities for networking and collaboration. This dovetailed with the rise of the millennial workforce and the growing embrace of mobile technology. These conditions sparked the coworking trend, which brought community and collegiality to the serviced office environment. At the time, WeWork championed the coworking movement and established itself as the driving force behind “workplace as community.”

It did not take long for larger tenants to discover the appeal of coworking. In response, many operators adjusted their offerings to provide enterprise-level solutions. Knotel and Industrious are among this new crop of flexible space operators who are, along with WeWork and Regus, expanding to service larger users. And finally, in this ever-evolving landscape, another provider type has emerged with a focus on meeting, conference and event space. Taking a page from the hospitality and office market playbooks, these operators, most notably Convene, represent a fast-growing part of the landscape.

Figure 3: The Flexible Space Solutions Continuum MOST FLEXIBLE MOST PERMANENT

SHORT-TERM MEETING/ INCUBATOR/ SERVICED ENTERPRISE TURNKEY LONG-TERM COWORKING EVENT SPACE ACCELERATOR OFFICES SOLUTIONS LEASE/SUBLEASE LEASE/OWN

Entrepreneurs, Sales Offices/ Freelancers/Start-Ups SMEs*, Large Start-Ups/ Regional Offices/ SMEs*, Start-Ups & SMEs*, Start-Ups & SMEs*, Start-Ups & SMEs* & Large Entrepreneurs Large Enterprises Large Enterprises Large Enterprises Enterprises CLIENT Enterprises Small Business SEGMENTS

Convene, Industrious, Breather, BetaWorks, Corporate Suites, Industrious, Spaces, WeWork, Convene Grand Central Tech, Jay Suites, Regus, Industrious, Knotel, Knotel, Liquid Space, Traditional Owners/ Traditional Owners/ The Yard TechStars Servcorp, Virgo Regus, WeWork Regus, Spaces, Large Corporates Large Corporates SERVICES & PROVIDERS WeWork

*SME = small and medium-sized enterprises

WHAT DOES THE THIRD-PARTY FLEXIBLE SPACE FOOTPRINT LOOK LIKE? The third-party flexible space sector has now reached a level of scale that gives it discernible market status. In fact, 2017 saw 45 separate flexible space lease transactions3 and was the third consecutive year in which the flexible space sector leased more than one million sq. ft. in Manhattan, nearly all of which was net growth. While flexible space leasing averaged only about 3% of annual totals between 2013 and 2017, 4 the sector’s leasing in 2018 seems to be on track to exceed this, with more than 900,000 sq. ft. of flexible space leases closed in Q1 2018 alone, and many more transactions in the pipeline for the year ahead.

Figure 4: Manhattan Leasing By Flexible Space Operators MSF Deal Count 1.40 45 48 1.20 42 1.00 36 27 0.80 26 30 22 24 0.60 19 18 16 19 18 0.40 11 12 8 7 12 4 5 0.20 2 6 0.00 0.07 0.17 0.14 0.06 0.33 0.13 0.34 0.37 0.52 0.82 0.70 1.26 1.01 1.23 0.92 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Leasing Deal Count Q1 2018 *Data excludes renewals Source: CBRE Research.

While the flexible space sector accounts for just 2.5% of overall Manhattan office occupancy, it is the fastest-growing market segment. WeWork’s growth is clearly driving the market, but another major driver of the sector’s growth is a proliferation of competing operators. Combined, these players have pushed the total flexible space footprint to over 9.2 million sq. ft. by Q1 2018, more than doubling in scale since 2013 and growing approximately 600% during this economic cycle. Since 2013, when flexible space growth kicked into high gear, the sector has averaged annual growth rates of 22%. If this rate continues, flexible space operators could reach a footprint of 15 million sq. ft. by the end of 2020, or approximately 4% of Manhattan’s total occupied space.

3 This number has been revised since it was originally reported in the CBRE 2017 Manhattan Office Market earY in Review, based on receipt of additional information on flexible space leasing transactions in 2017. Also, the term “flexible space” is synonymous with coworking and shared space providers, which is the term used in the 2017 Year in Review report. 4 See Footnote 1.

Figure 5: The Rise of Third-Party Flexible Space Operators Footprint (MSF) 12.0 Rise of Enterprise 10.0 9.2 Birth of Coworking 8.2 8.0 6.8

5.5 6.0 Executive Suites Market 4.3 4.0 3.7

1.9 2.2 2.0 1.3 1.6

0.0 2009 2010 2011 2012 2013 2014 2015 2016 2017 Q1 2018 Other IWG Knote l Convene WeWork *International Workplace Group includes Regus, HQ Global Workplaces, and Spaces. Source: CBRE Research.

As flexible space operators move beyond the world of freelancers, start-ups and small businesses, their appetite for space is accelerating, making them an increasingly noticeable part of the Manhattan market.

WeWork is the largest flexible space operator in Manhattan, with 4.1 million sq. ft., or 45% of market share as of Q1 2018—more than the next 10 operators combined. And they continue to grow; in Q1 2018, WeWork closed five transactions for approximately 562,000 sq. ft. As of Q1 2018, WeWork ranked sixth among Manhattan’s largest occupiers. And if considered a landlord—given its business model of leasing space to other tenants—WeWork would be Manhattan’s 31st largest landlord.

International Workplace Group (IWG) has the next-largest share, with 48 locations across its brands, among them Regus and Spaces. Together these IWG-owned brands account for about 1.52 million sq. ft. of space in Manhattan, about 16% of the total.

The third-largest operator is newcomer Knotel, which had the fastest growth of all flexible space operators over the last two years. As of Q1 2018, Knotel had reached 26 locations totaling 570,000 sq. ft., and recent additional investment will fuel further expansion. Convene ranked number four; they have grown 53% since year-end 2016 and also have future expansion plans, signing two additional leases alone in Q1 for over 57,000 sq. ft. Additionally, Convene is growing its presence by managing spaces on behalf of tenants—such as Condé Nast at 1 WTC—and owners, including the Durst Organization at 4 Times Square.

Figure 6: Third-Party Flexible Space Operators | Manhattan Market Share

Total Market | 9.2 MSF Q1 2018 Rank Tenant Occupancy (MSF) Locations Other 1 WeWork 4.1 43 Live Primary 1% 18% The Yard 1% 2 IWG* 1.5 48 YC Office Suites 2% 3 Knotel 0.6 26 Virgo Business Centers 2% 4 Convene 0.3 10 WeWork Corporate Suites 2% 45% 5 Jay Suites 0.2 7 Jay Suites 2% 6 Corporate Suites 0.2 8 Convene 4% Knotel 7 Virgo Business Centers 0.2 5 6% 8 NYC Office Suites 0.2 5 IWG 16% 9 The Yard 0.1 5 10 Live Primary 0.1 2

*International Workplace Group includes Regus, HQ Global Workplaces, and Spaces. *Other includes 55 additional flexible space solution companies. Source: CBRE Research.

Beyond these four, the remaining top 10 operators are relatively small and have exhibited less ambitious growth. Jay Suites, Corporate Suites and Virgo Business Centers are all serviced office space providers with fairly stable footprints, while another serviced office provider, NYC Office Suites, recently added a fifth location. The Yard, a coworking firm that leased a flurry of spaces several years ago, seems to have cooled activity, while Live Primary, a relatively new coworking concept with a wellness-in-the-workplace bent, recently expanded to over 100,000 sq. ft. And although not in the Manhattan top 10, Brooklyn-based Industrious is worth watching, as they have recently secured funding to expand their presence.

Figure 7: Manhattan Flexible Space Providers | Recent Growth

YE 2016 Q1 2018 Rank Tenant Occupancy Occupancy % Change 1 WeWork 2,609,000 4,111,000 +58% 2 IWG* 1,293,000 1,518,000 +17% 3 Knotel 17,000 573,000 +3,271% 4 Convene 217,000 332,000 +53% 5 Jay Suites 186,000 202,000 +9% 6 Corporate Suites 198,000 198,000 - 7 Virgo Business Centers 172,000 196,000 +14% 8 NYC Office Suites 129,000 196,000 +52% 9 The Yard 97,000 125,000 +29% 10 Live Primary 25,000 101,000 +304%

*International Workplace Group includes Regus, HQ Global Workplaces, and Spaces. Source: CBRE Research.

DOES TRANSACTION SIZE MATTER? One noticeable factor in the growth of this sector is the size of flexible space transactions. Across the sector, the average deal size for flexible space operators is 40,000 sq. ft. Notably, WeWork is driving the average and has been taking larger spaces than its counterparts; its average deal size is 95,000 sq. ft.

Since 2013, WeWork has expanded its own footprint, completing 14 transactions larger than 100,000 sq. ft. Among the other operators, there has been only one deal of this size: Spaces signed a 103,000-sq.-ft. lease at 424 West 33rd Street in December 2017. Other operators are taking down space at an average of just 21,000 sq. ft.5 Many operators have recently pursued larger leases, including Spaces, Convene and Virgo Business Centers, whose latest transactions have ranged from 40,000 to 100,000-plus sq. ft.

Figure 8: Flexible Space Operator Average Deal Size | WeWork vs. Other Providers

95,000SF Average WeWork Deal Size

21,000SF Average Deal Size of All other FS Providers

Source: CBRE Research.

5 Average deal size for new leases only. The averages do not include expansion leases. Also, the average is somewhat skewed by the prolific leasing activity of meeting room rental company Breather, which has signed 21 leases since 2015, all but one for less than 5,000 sq. ft. Without Breather, the average of all other non-WeWork flexible space transactions would be 25,000 sq. ft.

WHERE IS MANHATTAN’S FLEXIBLE SPACE? FOLLOW WELL-PRICED AVAILABILITIES... While the major tenant groups in Manhattan’s office market—including financial services, as well as technology, advertising, media and information (TAMI)—have been directing much of their leasing activity to the newest and best product on the market, the third-party flexible space sector is taking a decidedly different tact.

The economics of the flexible space business dictate that operators seek prices at the lower end of the market, so there is room to improve the space and then rent it out to others at a premium. Therefore, value is a significant factor in most operators’ leasing decisions, and they typically sign deals at taking rents that are noticeably below the market averages and often take space in older commodity buildings.

That said, there has been a significant uptick in flexible space transaction taking rents of late. Before 2015, few deals were signed above $50 per sq. ft., but since 2016, the average taking rent has jumped to more than $61.50 per sq. ft. This is even more notable given that taking rents among all Manhattan transactions have remained relatively flat since 2015, hovering between $65 and $70 per sq. ft. This suggests that the flexible space sector’s aggressive growth trajectory is pushing it into more expensive space.

Figure 9: Flexible Space Operators | Historical Average Taking Rent Average Taking Rent ($PSF) MSF $80 1.40

$70.13 Millions $70 1.20 $61.54 $60 1.00

0.80 $50 0.60 $40 0.40 $30 0.20

$20 0.00 2011 2012 2013 2014 2015 2016 2017 Q1 2018 Q1 Annual FS Leasing Activity Average FS Taking Base Rent (PSF) Manhattan Overall Taking Rent *Data excludes renewals. Source: CBRE Research.

Figure 10: Manhattan’s Flexible Space Footprint WHERE ARE THE FS OPERATORS? Flexible space providers have spread throughout Manhattan. With 4.9 million sq. ft., Midtown hosts the most flexible space on the island, accounting for 53% of the Manhattan total. Yet, given the size of the market, flexible space only accounts for 2% of Midtown’s total inventory. The Grand Central submarket Midtown has Midtown’s highest concentration of 4.9 MSF third-party flexible space providers, with approximately 939,000 sq. ft. and 33 locations as of Q1 2018. Midtown South Flexible space providers have been 2.6 MSF particularly active in Midtown South, where they occupy a combined 2.6 million sq. ft., or 3.4% of the total market inventory (at least 140 basis points ahead of the share in either Midtown or Downtown). Flexible space operators have found very strong demand for their services in Midtown South, fueled by growth of TAMI tenants who often have a need for rapid expansion and built space. For many, third-party flexible space is seen as a more convenient option to meet aggressive growth demands.

Downtown has also seen an influx of flexible space in recent years, though the total footprint accounts for less than 2% of that market’s inventory. The Financial District submarket has the highest Downtown amount of flexible space of any 75K RSF 1.7 MSF Manhattan submarket. At just under 1.4 25-75K RSF million sq. ft., flexible space operators 10-25K RSF have been attracted by some of the city’s <10K RSF most affordable rental rates as shown by the average asking rent of $57.40 per Source: CBRE Research. sq. ft. as of Q1 2018, compared to $73.00 per sq. ft. for overall Manhattan.

HOW HAS FLEXIBLE SPACE GROWTH IMPACTED THE MANHATTAN OFFICE MARKET? For one, the growth of flexible space has boosted leasing activity. Unlike other tenant segments whose leasing activity reflects the combined effect of expansions, contractions, consolidations and relocations, flexible space leasing is, at this point, almost exclusively growth. Every new flexible space lease is net growth, and thus a gain for the overall market’s performance.

Flexible space operators leased just under one million sq. ft. of space outside of the available office stock tracked by CBRE (either because it occurred in non-statistical buildings or within space that was not activity marketed). However, approximately 5 million sq. ft. of that leasing in the last several years contributed positively to net absorption, particularly for lower-priced, less-desirable space that had otherwise dragged down parts of the market.

Flexible space operators’ footprints function much like “shadow space,” or space that flies under the radar of official availability metrics, but nonetheless competes with space being marketed on behalf of landlords.

That said, once a flexible space operator leases the space, it then has to be filled by end users, the true occupants. As a result, the flexible space operators’ footprint functions much like “shadow space,” or space that flies under the radar of official availability metrics but nonetheless competes with space being marketed on behalf of landlords.

While the scale of this competition is hard to measure, there is evidence of an impact: the expansion of the flexible space footprint in Manhattan has coincided with a steady decline in the amount of direct leasing activity among the smallest tenants.

Between 2013 and 2017, the amount of flexible space grew by 119% to reach 8.17 million sq. ft. This coincided with the amount of annual leasing activity by tenants of 5,000 sq. ft. or less falling 41% from 1.45 million sq. ft. per year to just 0.86 million sq. ft. in 2017. This strongly suggests that the abundance of flexible space has attracted small-user leasing activity away from the market of for traditional available direct and sublease space.

Figure 11: Manhattan Leasing Activity vs. Flexible Space Footprint Cumulative FS Occupancy (RSF) Total Leasing Activity among Tenants

Among larger users, the impact is unclear, yet WeWork’s recent public disclosures provide some insight. WeWork stated that its portfolio-wide occupancy level increased from 76% to 81% in 2017, with its enterprise clients (companies of 1,000 employees or greater) growing to approximately 25% of its total memberships.6 This suggests that the increasing share of large users has propelled greater occupancy. Just like traditional landlords, WeWork, and likely other flexible space operators, are finding that it is easier and more efficient to fill a space with larger users than it is to do so with several smaller tenants.

Commercial real estate experts are playing an important role as intermediary for occupiers up and down the size spectrum, offering guidance to clients as they consider short-term flexible space options alongside traditional direct and sublet lease availabilities. Experts are also offering comparisons on quality of the flexible space service and viability of the provider. Flexible space operators are increasingly courting brokers to “find and fill” their growing portfolio of spaces, and have been negotiating commission agreements with various firms in the market.

6 Bryant, Chris. “WeWork’s Junk Bond Adventure Raises $18 Billion Question” Bloomberg.com, 25 April 2018.

WHAT DOES THE FUTURE OF FLEXIBLE SPACE LOOK LIKE? The third-party flexible space industry is incredibly dynamic. Twists and turns are inevitable, but what remains certain is that the industry will continue to grow throughout 2018. In Q2 2018, several significant flexible space leases have been signed in Manhattan, and flexible space operators are out in the market today with more than a half a dozen large requirements. Other markets across the U.S. and around the world are undergoing their own flexible space transformations, fueled by investor capital that is spurring rapid expansion.

So the question remains: where is the flexible space trend headed? While the answers are uncertain, the path forward includes some likely milestones:

Milestone 1: Small, medium and large businesses continue to test the opportunities afforded by flexible space as they pursue increased agility in their commercial real estate portfolios and overall operating strategies.

Milestone 2: There is consolidation across the third-party flexible space operator landscape, as the biggest, most well-capitalized players displace or acquire smaller competitors.

Milestone 3: Traditional landlords develop strategies to offer flexible space solutions to occupiers, whether by getting directly into the flexible-space game, or through partnerships with third-party flexible space operators.

Milestone 4: The flexible space industry’s viability is stress-tested by an economic downturn and the ever-dynamic real estate market.

Milestone 5: Shake out and further consolidation occurs across the flexible space landscape, as weaker players fall to operating and financial pressures.

CBRE is closely tracking this rapidly evolving industry and its impact on the Manhattan office market. At the same time, our sales professionals will continue to compare and contrast flexible space offerings for their customers. As the third-party flexible space footprint grows in Manhattan and beyond, the business model will undoubtedly mature and evolve, bringing both new opportunities and new considerations for occupiers, landlords and investors.

FOR MORE INFORMATION, PLEASE CONTACT:

Nicole LaRusso Director, Research & Analysis Tri-State +1 212 984 7188 [email protected]

Michael Slattery Manager, Research +1 212 656 0583 [email protected]

Chris Donofrio Senior Research Analyst +1 212 895 0928 [email protected]

To learn more about CBRE Research, or to access additional research reports, please visit the Global Research Gateway at www.cbre.com/researchgateway.

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