The commercial real estate revolution – how co-working is disrupting the market

This article originally appeared on TwentyTwo (link below)

The demands on commercial property in New Zealand are changing, a real estate revolution is happening. Increased demand for co-working spaces and ‘space as a service’ is disrupting the traditional commercial office market offering and real estate investment sector.

Figures out of the UK show that by 2027 co-working spaces will account for 10 percent of their property market and I don’t see why NZ won’t be the same.

The growth of co-working & shared space

Co-working or shared spaces are not new. You could argue serviced-offices like Regus and Servcorp for example were the first to adopt this business model.

Co-working providers offering ‘space as a service’ however have only become prevalent in NZ over the last 10 years. They provide a more contemporary and funky solution, targeted at small businesses in growth mode - providing a buzzy environment that allows small businesses to feed off each other and create a sense of energy that they couldn’t create if they were working on their own.

In Auckland, the most successful example is arguably Generator, established in 2011 in Britomart. They now have four sites around the Auckland CBD and provide a range of options from casual lounge only memberships, through to individual workpoints and dedicated offices of all sizes and shapes. They even have a staffed reception, meeting room, function and café facilities to boot. Other examples include the B:Hive, CoLab, The Icehouse, GridAkld and many others keep popping up all the time across Auckland and other parts of NZ.

To date many these offerings have been generally pioneered by under-capitalised entrepreneurs or not-for-profit initiatives seeing an opportunity for a new business model or providing an extension to their core activities. As a result, the facilities have sometimes lacked the level of investment needed to compete with a business leasing traditional office space. Consequently, the property market has generally viewed these offerings as ‘boutique’ and suited to small businesses or starts-ups, and not any real threat to the traditional property investment market, developing and leasing commercial office space.

That all changed last year when NZ’s largest listed property company, Precinct Properties, brought 50% of Generator giving some credibility and horsepower in NZ to the latest ‘real estate revolution’.

How co-working works - the SaaS business model

Most people are familiar with software as a service (SaaS) – where you subscribe to a technology platform based on the number of uses and the features you need – Xero being the quintessential NZ example. Business models like Generator and others are founded on a similar principle – ‘space as a service’ (or SaaS)

Occupiers don’t sign a lease, they enter into a service agreement, whereby space, desks, IT, telephony and other services are provided for a monthly fee on an as needed basis – generally per person rather than per square metre or some other property-centric metric. Businesses are not locked into a long-term lease, don’t have to fund fitout and furniture up-front and can vary their needs as and when their business changes.

As an occupier of Generator’s foundation site in Customs Street East since 2012, TwentyTwo has first-hand experience of SaaS. When we re-established our Auckland presence in 2012 we took up residence in Generator’s relatively new Customs Street co-working space. This provided a professional basecamp for our team commuting backwards and forwards from Wellington, and a high-energy environment to help stimulate our business growth. Once we recruited staff we upgraded to a workpoint within a shared open office area and recently we’ve taken over a dedicated office area within Generator where we can have our own branding and create a team culture.

For us, this flexibility has been critical. We’ve been able to upsize our presence as our business has evolved. The other key benefit is the environment. As commercial property advisers, we could have easily leased some office space in the city and set up our own workplace. However, while our team is still small it is vital they are around other like-minded people rather than being isolated. I’m sure this is a key reason for many of the businesses who are based there.

The Commercial Real Estate Revolution and its effect on Commercial Investment

Over time real estate investment has evolved but the underlying principles of having an interest in land/buildings against which money is lent has remained at the heart. Land and buildings are security. Leases create a secure income stream. Over time income increases, debt reduces and capital value increases.

The models for property investment have responded to the demand for new investment products, not necessarily to the demand from businesses for a new solution or business model for office space (or any other space for that matter).

Private investors and developers buying land and buildings, taking long term view, building a portfolio and wealth over time remains the cornerstone model.

Institutional investment (using trust, insurance and superannuation funds) was driven by the introduction of superannuation and savings schemes. Insurance companies, banks, pension funds, and trusts took in money and needed to find a home for this money that would earn a return and provide a safe investment. Institutions like insurance companies and banks became long term investors and owners of significant portfolios.

More recently, institutional funding has focused on long term annuity investments giving rise to public private partnership funding and similar hybrid models.

The emergence of listed property companies signalled a move away from using superannuation and savings income to invest in property. While many of the current players have emerged from former structures, like major companies such as Precinct and Kiwi for example, these businesses are now property-specific entities investing in property. They are increasingly more sophisticated and appear to be able to weather the markets ups and downs. Their business model is based on buying stock, upgrading, managing and reinvesting. More recently some of the larger owners are moving from a pure investor mindset to becoming more of a developer/investor to create the appropriate quality of investment product/buildings sought by the market. A key example is Precinct developing Commercial Bay to maintain their market share as a landlord of premium space as their current portfolio ages and tenants looking for new offerings.

The disrupter effect

Not only is SaaS disrupting the traditional office market, it is also disrupting the real estate investment sector. The key differentiator is that SaaS is not founded on the same traditional real estate principles as typical investment, requiring an ‘interest in land’.

SaaS is about a business on-selling space, rather than an investor leasing space. As a result, the business model changes from real estate led to business led. The value of a business like Generator for example is more about the value of the income stream of the business (generated by occupation, service agreements and up-selling support) not about the value of the bricks and mortar.

To date this investment model has been applied to co-working spaces that generally suit smaller businesses. However, overtime I can see this model being applied to larger solutions whereby whole buildings or campuses are used as part of a SaaS solution. This would allow businesses to upsize and downsize their needs on a larger scale.

Overtime, this could effectively mean the traditional lease (which is archaic at best) being ripped up and replaced by a service agreement!

Is this fanciable? Maybe or maybe not? With a major listed company like Precinct buying 50% of Generator clearly they see this model as part of the future. In Precinct’s case it makes good business sense. They get a feeder pipeline for their traditional office product as smaller businesses within Generator outgrow this solution they are migrated into more traditional solutions. And overtime, as Generator grows and offers SaaS on a larger scale they get a partner to build and manage space for, while Generator manages the day to day interface with businesses. Sounds smart to me.

My admission

I’m embarrassed to admit that I predicted some years ago that this type of model would flourish! I first heard about this concept in the late 1990’s when a US property company used it as a strategy to back fill space in a market downturn period. I’ve also mused over the idea with NZ based developers in the past, with barely an eyelid raised!

My interest has partly been in response to the demand from our clients for new offerings and partly out of frustration with the inadequacies of the traditional lease we continue to use.

To date this type of solution has lacked scale but the 2017 announcement by Precinct to acquire 50% of Generator brings this model into the forefront of thinking and will continue to grow. I predict other larger providers will step into this space. Let’s wait and see!

Read the original article on TwentyTwo

Story by: Dean Croucher