Office space race: WeWork seeks to keep up with Toronto demand

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WeWork has turned an old office-sharing idea into a hot commodity.

The young U.S. company leases office space and then subleases it at a premium to tech startups, big firms, entrepreneurs – anyone who needs space for anywhere from a few hours to a few months or longer.

So far, the strategy has worked wonders. Valued at US$20-billion, the privately held company is now one of the largest corporate occupants in Manhattan and London.

In eight years, WeWork has expanded from one co-working office in New York to more than 300 in more than 20 countries. It plans to reach 400 locations by year end.

Toronto is one of WeWork’s fastest-growing cities; it opened its first space in Toronto last summer and its second in December. Both locations quickly filled up and have a waiting list, the company said.

Inside its first Toronto location just west of the financial district, people work elbow to elbow in rooms with glass walls. There are spotless desks, soft couches, coffee tables and bars stocked with fruit water, beer, coffee and tea.

WeWork plans to open a third location in Toronto this fall and a fourth early next year.

“We look in Toronto and we go ‘Wow,’ this is just extraordinary by any measure in terms of the reception for the business,” said Dave McLaughlin, a WeWork general manager in charge of Toronto, Montreal and the northeastern United States.

The company currently has two locations each in Montreal and Vancouver; it wants to have 20 spots in Toronto by 2020.

Demand for office space in Toronto has been insatiable, with financial-services firms widening their footprint and tech firms clamoring for space. The city’s office vacancy rate is the lowest in Canada and the United States. It is expected to fall further this year, well below Manhattan and San Francisco.

That has made it hard for any businesses to find office space, including WeWork.

“It’s not a market conducive for WeWork to find space,” said Aly Damji, senior vice-president with Hullmark, which was the first Toronto property owner to lease to WeWork.

Mr. Damji said he initially had concerns about WeWork because its valuation had grown “very, very quickly.” But Hullmark “believed in what they offer” and gave WeWork what it wanted: a long lease and more than $100 per square foot to renovate the space to its liking, also known as “tenant improvements.”

That is more than triple the going rate in the financial district, where a top tenant can get a landlord to pay between $30 and $40 for every square foot for building renovations, according to leasing agents.

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Co-working grows

Although office sharing has been around for decades, WeWork’s high profile has made it popular and the number of co-working offices is multiplying.

Mr. Damji said he started noticing that many of his tenants wanted shorter leases in part because they did not know how much space they would need in the future.

“They would rather pay a lot more on a per-square-foot basis to get on a month-to-month tenancy than to sign a two-year lease with a landlord that could handcuff them,” he said.

More contract work, technology, globalization and the growth in tech firms has helped fuel demand.

WeWork is now the second-largest corporate tenant in Manhattan and the largest private occupant in Britain’s capital, according to Cushman & Wakefield.

In Vancouver, WeWork and its office-sharing rivals dominate the business district, according to commercial realtor Cresa.

In Toronto, co-working space has increased about 11 per cent to 1.2 million square feet over the past year, Cresa said.

Swiss-based IWG, which has run co-working offices for nearly three decades, said there was a time when co-working was a foreign concept for landlords.

“There were questions around who’s going to be coming into my building, how is this going to operate. That’s not that long ago,” said Wayne Berger, an IWG executive vice-president in charge of Canada. IWG operates under the Spaces and Regus brands.

“Now the reality is Spaces and Regus are amenities in the building. They build vibrancy in the building. They become an amenity for all the other tenants,” he said.

High-risk proposition

While IWG and WeWork are both big players in the same business, their valuations couldn’t be more different.

IWG has operated shared offices for 29 years and has more than 3,000 locations in more than 1,000 cities. It is publicly traded and has a market value of around US$2-billion.

In contrast, WeWork is eight years old, has more than 300 locations in more than 60 cities and is worth around US$20-billion, as indicated by a recent financing.

Why is WeWork worth so much more? One of its biggest financial backers, Japanese conglomerate SoftBank Group, says WeWork has the data and technology to transform the way people work. WeWork, whose stated mission is to create a world where people work to make a life, not just a living, says its offices are where companies and people grow together and that they are “dynamic environments for creativity focus and connection.”

WeWork’s main business is co-working, although it has branched out into dorm living (WeLive); startup incubating (WeWorkLabs) and early childhood education (WeGrow).

Because WeWork is a private company, it is not known whether it is profitable, whether expenses are manageable or whether revenue − which the company says will double to more than US$2-billion in one year – is growing organically.

“WeWork is a high-risk proposition for a landlord,” said Michael Emory, chief executive of Allied Properties REIT, which owns offices across Canada and is credited with having the vision to restore and refurbish derelict industrial buildings into offices.

Mr. Emory believes WeWork, Spaces and other co-working offices are needed in Toronto. But he will not lease to WeWork.

“Maybe WeWork will go from success to success. I have no real rational way of evaluating it. It is a very high-risk proposition for a landlord and an investor. At some point and time, some investor may be holding the bag on WeWork,” he said.

Although WeWork started in the wake of the Great Recession with one co-working shop in SoHo in 2010, its global business has been expanding in other cities when their economies have been booming and has not been tested during an economic slump.

After the dot-com bubble burst at the turn of the century, the U.S. Regus business was forced to file for bankruptcy protection in 2003, when demand for short-term rentals dried up. (Regus emerged from bankruptcy protection about a year later.)

“It is a business model that can introduce some strain depending on how high your occupancy is,” said Rich Kleinman, LaSalle Investment Management’s head of U.S. research and strategy.

“[WeWork is] an unproven business model through a full cycle. That is the kind of thing that you look at when you are underwriting a tenant that you would be signing a long-term lease with,” he said.

WeWork’s general manager Mr. McLaughlin said co-working lowers tenant capital expenditures and does not tie them into long-term leases. “Regardless of economic backdrop, we’ve seen an increasing value placed on flexibility, moving real estate from a fixed asset to a more fluid one,” he said.

Flexibility could mean businesses and contractors choose co-working spaces during a downturn. On the other hand, it could mean businesses and contractors stop renting their co-working space.

No one knows if an economic downturn or simply the addition of new buildings will hamper the popularity of shared offices or whether the co-working glow will fade and leave landlords, their buildings and cities with vacant office space.

More critical are WeWork’s leases. It is not known whether WeWork’s U.S. parent company guarantees every location’s lease, which would help ensure that landlords are paid if WeWork does not have enough tenants to fill its space. A WeWork spokeswoman said the company does not comment on “the structure or content of our lease structures.”

Hullmark‘s Mr. Damji would not say whether WeWork’s parent company was backing up its lease. But he said Hullmark has a backup plan if WeWork fails.

“If they do fail, then their buildout is generic enough that we could lease each floor to a typical office tenant,” Mr. Damji said.