CREJ

September 2019 — Office Properties Quarterly — Page 13 www.crej.com A s the emergence of shared office space begins to take hold throughout the nation, investors, businesses and individuals are questioning Denver’s capacity for the new trend. We know coworking space to be a shared workplace where individuals and small businesses come together to work on independent activi- ties under one roof. Typically, these coworking companies are renting office space on long-term leases with the intent of profiting from short-term subleases. Coworking is designed to mini- mize the square footage a company needs per employee. The typical office employee uses just under 200 sf of space, while aWeWork subtenant operates in approximately 50 sf of space. Ideally, each coworking facility opti- mizes space, ensuring none is left unused, which provides significant cost returns to the owner. NVC sur- veyed several Denver coworking facili- ties and found that many are operat- ing near capacity. Culturally, the trend seems to have been accepted in progressive cit- ies throughout the nation, including Denver. Since 2016, Denver’s supply of shared workplaces has exploded and reached all corners of the core metro area. Denver’s coworking facilities have exceeded 25 independent operations. Employees at large companies, start- ups and work-from-home employees are making up the subtenant base. In fact, coworking in Denver has gained so much popularity that The Pass- port Program, a marketing agency that sells tangible passport booklets for restaurants, music venues and bars, has created a “coworking pass- port” allowing indi- viduals access to over 16 of Denver’s coworking offices. WeWork (TheWe Co.) dominates the amount of cowork- ing space in the city. TheWe Co. has six current loca- tions in Denver with five proposed offices and will become the largest office tenant in the metro area. Brokers are capitalizing on the risk inherent with coworking and have secured some of the most expensive office leases throughout the Denver metro. The typical WeWork lease in the Denver office market is executed at $34-$36 per square foot triple net with tenant improvement allowances upward of $100 per sf. These spaces are “highly amenitized” and occupy the upper echelon of Class A space in the city. Landlords and investors alike are scratching their heads with questions about the fundamental risk inherent in coworking office space. Questions like, “Will its growth likely keep up with the demand for shared space?” or, “How risky are these leases relative to downturns and recessions?” are common of the investor pool through- out the underwriting process. TheWe Co. sets an incredibly high bar for success, though its initial public offering (valued at $47 billion) has been called “the most ridiculous IPO of 2019” by Sam McBride of New Constructs Investments Analyst. This claim is justified given that WeWork has accumulated net losses of over $1 billion in 2018 despite doubling its revenue from the year prior. 1 On the other hand, companies like IWG, the largest global workspace provider, have officially hopped on the coworking bandwagon. IWG is attempting to make a spinoff of WeWork’s model. As of March, IWG owns over 60 million sf of office space whileWeWork has about 45 million. 2 Also, Ivanhoe Cambridge, a global real estate investment company out of Montreal, Canada, announced a “strategic partnership” withWeWork. With so much big money backing the company, it becomes difficult to accu- rately assess the impact coworking has on property value. Jim Messina, MAI, senior vice presi- dent of NVC’s office division, indicated that between 2017 and 2018, inves- tors were ultraconservative when underwriting real estate transactions in Denver where 30% or more of the building was dedicated to coworking tenancy. During this period, capitaliza- tion rates were 50 to 100 basis points higher for buildings with significant coworking space. In 2019, rates appear to be only 25 to 50 bps higher. “Greater acceptance for this concept has surfaced, even when consider- ing the potential risk associated with coworking space,” said Messina. In current underwriting practice, investors are becoming more comfort- able with the model and the discounts attributed to risk are shrinking. Still, coworking tenants are far from being categorized as good credit tenants, and there is large speculation about what will happen to the mass accu- mulation of office space dedicated to the idea. During a recession or downturn, it is common to see increased vacancy throughout all asset classes, espe- cially office space. Many investors argue that this is the Achilles’ heel for coworking space. However, there is strong evidence for the counter argu- ment. We spoke with several cowork- ing offices operators in Denver who have reported that many of their subtenants are in the tech industry, internet business or startups. Many are full-time employees at large tech firms such as Google.While we do agree that vacancy in the Denver’s office market likely would increase in a recession, many existing firms likely will reorganize their exist- ing real estate holdings during this time frame. These firms may rely on coworking in this period, even if for a short time, which will sustain subten- ant occupancy within the coworking realm. Current underwriting practices are continuing to be bearish on properties with large portions of space dedicated to coworking. However, as general acceptance for coworking grows, investors may ease their heavy con- servatism on underwriting policies, normalizing coworking space in the m arket. 1. https://news.crunchbase.com/news/ wework-loses-1-9b-on-1-8b-in-revenue- during-2018 2. https://www.bloomberg.com/news/ articles/2019-08-24/iwg-mulls-spinoff- new-york-listingfor-u-s-business-sky- says. ▲ Is coworking working in Denver’s office market? Coworking Julian Factor Appraisal associate, National Valuation Consultants Inc.