NEW YORK CITY—A small space occupier (less than 5,000 square feet), historically and practically, has always been at a disadvantage for leasing space in major urban markets. More often than not, they lack exposure to the business of office leasing, including an understanding of their own occupancy requirements, market conditions, and appropriate lease terms. Typically, the opportunity they offer a broker to collect a small leasing commission fails to keep a broker's attention for any period of time and limits their access to listings to the “classifieds.”

On their own, the small space user effectively wanders the internet and usually works directly with the landlord of an obsolete class B or C building with no amenities, who accommodates them essentially on the landlord's terms. In Manhattan, small space rental rates have continued to increase despite a 90% average occupancy rate for small spaces. Meanwhile, the supply of New York City class B and C office space is expected to continue a steady decline from a peak of approximately 237 million square feet in 2003 to approximately 220 million square feet in 2025. Considering small business (10 or fewer employees) represents approximately 80% of all business enterprises and approximately 87% of new business start-ups, this is not good news for a small space occupier.

Co-working space has emerged as a permanent solution to this dilemma by offering small space occupiers a simple and flexible leasing opportunity combined with “big office” amenities and a social environment to satisfy the needs of the millennial workforce. A “pay-one-price per seat” approach plus credits for office services and a month-to-month term offers small space occupiers cost certainty and no upfront capital expenditure, along with the flexibility to easily scale their space use up or down as they see fit. The occupiers' fully loaded cost is usually equal to or slightly less than the cost of leasing and occupying space in a traditional manner.

Class B buildings with deep floor plates once large enough to accommodate the “typing pool” and large companies are now accommodating co-working operators. These operators lease in bulk on a long-term basis and effectively re-trade the space monthly utilizing a vertically integrated licensing model with scaled pricing that takes a sole proprietor or small business from the lowest cost lounge seat to a shared desk, to a cubicle, and finally to a higher-priced private office, which constitute the bulk of the revenue producing space.

In all, a typical co-working facility has minimal improvements, averages 85 square feet per person and a stay in excess of 24 months with the ability to reprice vacant seats on a daily basis like an extended stay hotel. An attractive margin combined with steady demand from the underserved small business segment positions co-working space as a sustainable operating business model and worthy of class B building owners' consideration and investment.

In New York City, Midtown South has developed as a hub of the technology, advertising, media and information sector (“TAMI”) and co-working space followed suit with 17 locations and approximately 500,000 square feet of space capable of accommodating almost 6,000 workers. This submarket offers convenient access to Manhattan's East Side residential neighborhoods and lifestyle amenities in the adjoining “Flatiron” district to the south.

As media companies (Time Inc., Conde Nast, McGraw Hill and more) relocated to Lower Manhattan and the district became the second largest TAMI hub after Midtown South. Class B office buildings on lower Broadway that once accommodated the likes of American Express, ATT, and Standard Oil beckoned to co-working operators. This submarket, with rents typically 25% lower than Midtown South, is now home to approximately 600,000 sq. ft. of co-working space and growing as Lower Manhattan offers an expanding residential community and efficient mass transit access to ever-popular Brooklyn, Hoboken, and Jersey City.

Class B office buildings, in addition to deep floor plates capable of accommodating an open plan space program, require large blocks of contiguous space and sufficient infrastructure to successfully compete for the tenancy of co-working operators. Built in a time when 275 square feet or more per employee was the norm, today's class B owners need to be prepared to accommodate the demands of a co-working operator's “dense pack” space plan with investments in adequate vertical transportation and utilities to service the facility in recognition of the value co-working space brings to a property.

Increasingly, co-working operators are recognizing the value they can bring to an underutilized and/or obsolete office property and are seeking ways to structure leasing transactions in partnership with owners. The opportunity exists to create participation agreements that incentivize both parties to invest and improve capital efficiency and share equitably in value creation. The continued growth of small businesses and independent workers in support of the TAMI sector will create opportunities for owners of class B office space that may be largely empowered by the entrepreneurship, occupier experience, and marketing expertise offered by co-working operators focused on value added solutions to meet the needs of small business.

Glenn Brill is a managing director in the real estate & infrastructure solutions practice at FTI Consulting Inc. He may be contacted at glenn.brill@fticonsulting.com. The views expressed herein are those of the author and not necessarily the views of FTI Consulting Inc., its management, its subsidiaries, its affiliates, or its other professionals.

Instant Insights /

Co-working Is Here to Stay

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