This article originally appeared in the Washington Business Journal.

Coworking definitely held some perks for Kelly Speakes-Backman.

Her nonprofit, the Energy Storage Association, spent nearly a year at WeWork’s Metropolitan Square location, a block east of the White House. The space was certainly easy enough for her 10 staffers to move into while the association searched for a more permanent home. A slew of office amenities were at hand, and the food and beverage options didn’t hurt.

But then that distracting disco music would waft in from the adjacent workstation at the wrong time.

“If I needed to have a conference call with my board, I would hear Donna Summer in the background,” said Speakes-Backman, CEO of the association. But as for the rest, “the coffee was awesome. The acoustics were not great. It definitely had a distinct vibe about it, which, in some cases, kind of works. If you’re looking for a place that encourages creativity and social interaction with folks of your ilk, that’s awesome. For us, it didn’t really work for all of us.”

The ESA, which advocates for the energy producer and storage industry and worked with Sam Heiber of Cresa Washington on its search, finally moved out of WeWork at the end of 2018. Much to Speakes-Backman’s glee, it had signed a roughly 2,000-square-foot lease in another building closer to Mount Vernon Triangle.

Her story is not uncommon, even if her particular experience about coworking may be — businesses, large and small, have increasingly turned to the rapidly growing flexible space industry while sorting out long-term plans. In the wake of the sinking ship that was the 2012 D.C. office market, coworking, and WeWork specifically, served as a sorely needed life raft as the city’s biggest tenants began opting for floor plans that did more with less space. In June, the District’s flexible office space jumped 66% year over year, according to CBRE Group, making the nation’s capital one of the fastest-growing markets. The number of local providers has ballooned tenfold from three in 2013 to 31 today, per Cushman & Wakefield, with another 2 million square feet of coworking space set to open in the next year or so.

But now that life raft is starting to take on water. In a saga that’s played out before a wary public, coworking’s biggest titan, WeWork, pulled out of its initial public offering plans 47 days after filing them. Its valuation plummeted by billions of dollars and lease obligations rose to $47.2 billion, sending its future into a murky fog. In D.C., WeWork has consumed more than 1.2 million square feet of office space, making it the city’s largest private office tenant and leaving the region’s real estate market vulnerable, uncertain of what happens next if the company buckles.

WeWork said it remains on a growth path. But regardless of what lies ahead for the goliath, industry observers say there’s a future to flexible office space. They expect a thinning of the coworking herd as dominant players gobble up smaller ones, similar to what we’ve seen in the hospitality industry. And they expect the model to shift, in some cases to where landlords themselves take more active roles.

“I think there are companies that only see the rosy side of the equation. There will be people who rush in, and their due diligence is not as strong,” said Michael Burke, vice president of real estate and development at shared meeting and workspace provider Convene, describing new entrants to the coworking market. “It takes a lot of capital to grow. And there will be consolidation.”

Will We survive?

This much we know: WeWork may require some reworking.

WeWork signed its first two leases in D.C. in 2013 — for nearly 54,300 aggregate square feet in Chinatown and Shaw. After that, its appetite for growth seemed insatiable, taking down whole floors and even, in the case of 1701 Rhode Island Ave. NW, a whole building. That 104,000-square-foot building is now owned by Exan Capital, which bought it for $119 million from developers Akridge and Alcion Ventures LP after the WeWork lease.

Today, the exposure of Greater Washington’s office market to WeWork spans from the University of Maryland’s College Park campus to Lerner Enterprises’ 1775 Tysons Blvd. The company has committed to blocks of more than 100,000 square feet in projects like Carr Properties’ The Wilson in Bethesda and Property Group Partners’ Capitol Crossing near Union Station.

While its footprint in New York and San Francisco is higher than in D.C. — totaling close to 8.9 million and 1.6 million square feet, respectively — WeWork said in its public filings that a majority of its U.S. revenue comes from five markets: San Francisco, New York, Boston, Los Angeles and, yes, D.C.

But then came the IPO from WeWork’s parent, The We Co. In mid-August, the company revealed a staggering gap: In the prior three and a half years, it recorded $4.7 billion in total revenue — and nearly an equal amount, $4.2 billion, in combined losses, 86% of that because of its WeWork business. A full 70% of its locations thus far weren’t seeing recurring revenue or positive cash flow, it said.

In the tumultuous months since, investors pulled back from the company, CEO Adam Neumann resigned and its biggest backer, Japan’s SoftBank, offered a much smaller recapitalization than its previous pledge. At the end of September, We Co. canceled its IPO and its one-time $47 billion valuation disintegrated. Critics have called into question its model of subsidized month-to-month memberships and steep real estate buildout costs for spaces it has leased but are not yet generating revenue, and certainly are a long way from profits.

It has already nixed earlier plans to open a new location in the Seattle area. Closer to the Capital Beltway, rumors are circulating about whether it may back out of at least two D.C. locations. Few are in agreement about its 2020 path. Industry observers such as Cushman & Wakefield expect WeWork to slow its expansion in 2020 with no new locations.

Ask WeWork, and they project more growth. “WeWork is the largest private tenant of office space in D.C., providing our members with well-designed, economic workspace that supports their growth. We expect to continue to grow our core business here, bringing members to newly opened buildings like 1701 Rhode Island NW and opening others in Q4 and the year ahead,” a company spokesperson emailed in a statement for this story, declining to comment further.

How big is the baggage?

Here’s what we know: WeWork could certainly get its financial house back in order. But if it collapses, it could tie up hundreds of thousands of square feet of office space across the region.

Some WeWork landlords say they’re watching and, if necessary, girding themselves for any impact. But so far, they say, their D.C.-area locations are still doing well. And, many assert, WeWork isn’t a big enough driver within their own financials to drag them down.

In all, coworking space providers made up 2.1% of the District’s office market in the second quarter, according to CBRE data, causing some to argue that any potential harm to local landlords will likely be minimal. Across the board, shared workspaces collectively represent just 1.6% of all office space in the U.S., though that percentage is higher in markets like New York, at 3.6%, and San Francisco, at 4%, according to CBRE.

Among the local landlords is Douglas Development Corp., which first brought WeWork to D.C. with leases at Chinatown Row and the Wonder Bread Factory. Those two properties, along with a third lease at Douglas Development’s Manhattan Laundry building, are tied to a balance of $93.26 million in commercial mortgage-backed securities debt, according to Trepp LLP. Though, that’s a drop in a $3.8 billion bucket of national CMBS debt slated to expire between 2024 and 2035 tied to office properties leased in part to WeWork, per Trepp. San Francisco, in comparison, carries $379.95 million in CMBS debt tied to the coworking company.

But Douglas Development hasn’t seen cause for worry. “For us, they’ve been very good tenants and have never failed to meet any obligation that they’ve committed themselves to,” said Norman Jemal, Douglas’ managing principal.

“There’s a lot of speculation about what might happen, but my three locations, they’re not full tenant users,” Jemal said. “They’re only a small part of the revenue in each one of them, and I would look at them as assets for the organization. We’ve absolutely seen tenants coming out of WeWorks moving into some of our spaces.”

For Boston Properties, WeWork is one of the real estate investment trust’s top 20 tenants nationwide, occupying large chunks of space in buildings like D.C.’s Met Square. At the same time, the Boston-based developer said, WeWork is responsible for only a little more than 1% of the company’s total revenue.

“Though we believe the shared workspace market has growth potential, we anticipate a pause given recent capital raising challenges in the industry,” Boston Properties CEO Owen Thomas said on an Oct. 30 earnings call with analysts. “WeWork has built an important market position in the industry and has the potential for further growth, assuming it executes well with the proceeds from its recent recapitalization.”

At Carr Properties, coworking represents less than 5% of the rent roll it collects from its roughly 4 million-square-foot portfolio, said CEO Oliver Carr III. And he said he has not received any indication that WeWork won’t move forward with plans to open at Carr’s Bethesda project or Midtown Center, where WeWork has committed to lease space.

Beyond its 66,500-square-foot lease with WeWork at 700 K St. NW, The Meridian Group went a step further, partnering with WeWork’s real estate arm to acquire 1333 New Hampshire Ave. NW, where WeWork has committed to leasing more than 100,000 square feet. The company has not given any signs of backing away from either of those commitments, said Katie Yanushonis, senior vice president at Meridian. At the same time, she said, WeWork is only one of several coworking iterations in Meridian buildings, including Cove and Spaces. The developer has also been weighing whether to establish its own in-house coworking brand.

“That conversation is constantly evolving,” Yanushonis said. “Our thought was we really like Cove and we’d like to expand that relationship, but that doesn’t preclude something that Meridian might do for ourselves.”

Warding off pain

Most landlords in the D.C. area are savvy enough not to lease too much space in a single building or across their portfolios to any one user or user type — that helps minimize the effects of losing a tenant to bankruptcy, said Vernon W. Johnson III, a partner at Nixon Peabody LLP who specializes in real estate and leasing issues. This wouldn’t be the region’s first rodeo, after all. It faced similar blows when law firm Dewey & LeBoeuf filed for bankruptcy and Howrey LLP’s partners voted to dissolve.

Additionally, landlords should thoroughly vet a prospective tenant’s financial position and business plan and, in turn, require a larger security deposit for higher-risk tenants, Johnson said.

JBG Smith Properties is one that exacts a higher burden on its seven coworking tenants, which have gobbled up a combined 525,000 of the Chevy Chase developer’s square feet across nine locations, including the combined WeLive-WeWork complex in Crystal City. Collectively, coworking comprises 3.5% of JBG Smith’s total operating portfolio by square footage and 4% of its rental revenue.

“Thus far, all of these locations have performed well, but as we do with any commercial tenant, when we sign leases with coworking and flexible space providers, we focus on lease security and downside protection,” JBG Smith CEO Matt Kelly wrote in a Nov. 5 letter to shareholders that accompanied its third-quarter earnings. “Due to their credit profile and relatively short operating history, we have required our coworking tenants as a group to provide us with significantly more lease security than noncoworking tenants in our portfolio.”

In a worst-case scenario, landlords can take legal steps to recover losses in the event of a bankruptcy, but that can be a drawn-out process and it’s no guarantee the tenant will have sufficient assets to pay out all of its creditors.

“You could get a large judgment that you can’t recover on, so these situations do create significant situations for landlords and could have a significant impact on their incomes,” Johnson said. “I think most landlords, on the front end, try to protect themselves by making sure that they’re not too much at risk with a single industry or a single tenant.”

An evolving industry

WeWork’s grand entry set the stage for other providers. And many of those spaces are likely not going anywhere, no matter WeWork’s fate. They just may operate a bit differently.

The industry has since spawned all sorts of niche players, including coworking brands catering to women, blue chip companies, and even suburbanites. That gets lost sometimes when people just focus on WeWork, said Mark Gilbreath, CEO of online flexible workspace LiquidSpace and president of the Global Workspace Association.

“There’s an underlying truth that, to some observers, may be precluded by the WeWork story, which is the story of one particular user in the larger flexible space market,” Gilbreath said. “There are thousands of operators that are delivering similar truths, similar value to the market.”

While WeWork grew by leaps and bounds, many of its competitors have opted for more of a slow-growth method. Among them is Carr Workplaces, a coworking brand founded in 2003 by real estate developer Oliver T. Carr Jr., the father of Carr Properties’ current chief executive. The business — part of the larger Carr Cos., which also operates Carr Hospitality and Carr City Centers but is separate from Carr Properties — has nearly 30 locations across the U.S., and 18 in the region.

The business has survived, and built a loyal base, by staying small and nimble, said Austin Flajser, president of Carr Workplaces and president and CEO of Carr Cos. The company’s sweet spot is a third of the average size of a WeWork location.

“We’re very much in growth mode,” he said. “We’re going to do it wisely, not just opening locations with landlords on every corner.”

These days, it’s not enough just to provide physical spaces. The 2.0 version of the flexible space industry is as much a service provider, engaging with tenants in a way that traditional landlords hadn’t before. Another key is to help foster a sense of community — think memberships on local boards and participation in neighborhood events — while remembering that members aren’t there to play, but rather to get work done, Flajser said.

“We’re not just marketing on a macro level. We ask our general managers and managers to get involved in the communities that we’re in,” he said.

Even longtime flexible workspace brands have come to this conclusion. While the days of dart boards and kitchen kegs are making way for a more professional atmosphere, coworking spaces say they can’t survive on just offering rows of office spaces anymore.

“One of the things we think is different this time around is the obvious quality and feel of the concepts,” Nate Edwards, senior director of research for Cushman & Wakefield’s D.C. region. “As opposed to being ‘shared offices,’ the focus is on the branding, the attraction and retention of employees.”

The parent company of Regus, which debuted in 1989 in Belgium, has more recently sought to step up its community outreach through its more contemporary Spaces brand, which launched in D.C. in 2008 with nearly 44,000 square feet at Douglas Development’s Uline Arena. IWG PLC acquired Regus in 2014.

“We recognized that the evolving customer did want a more collaborative work environment than a traditional flexible workspace such as Regus,” said Michael Berretta, vice president of network development for IWG, which operates about three-dozen Regus and Spaces locations in the D.C. area. “With Spaces, we created a more collaborative, open, contemporary work environment, but still to the same high degree of service.”

The landlord factor

The rise in coworking has spurred yet another player to get into the game: traditional landlords.

Take Carr Properties, which launched its WaveOffice brand in 2017 with a location in Clarendon, and Washington Real Estate Investment Trust with its Space+ concept rolled out last year. Boston Properties offers its Flex by BXP while Hines announced Hines Squared earlier this year.

WashREIT is beta testing a new program that will enable its tenants’ employees to do everything from getting cars detailed to reserving a spot in a fitness class with a smartphone app. Landlords are having to catch up, and technology is playing a big part of it, said Anthony Chang, vice president of asset management at WashREIT.

"We, as owners of assets, are changing our thinking about how those users are experiencing that space,” he said. “It’s not just a box-checker anymore. It’s how does it feel and does it help them with recruitment and business development?”

WashREIT has not signed on with any outside coworking providers as tenants, though Chang said that’s mainly because the right deal hasn’t come along yet. Many of the vacant spaces in its buildings are in smaller blocks than would accommodate a coworking mammoth like WeWork.

Other landlords are embracing coworking space providers as part of a larger mix of services they offer tenants. At Park Place, a Rosslyn office building at 1655 Fort Myer Drive that Altus Realty acquired in October for $66.5 million, there’s already a Regus. But Altus now plans to add a flexible space concept it is calling Framework as a short-term option of three to five years for tenants once they outgrow coworking spaces but aren’t ready for a long-term lease. It’s a concept Altus Partner Charlie Kehler anticipates will become more widely accepted in the coming years by federal contractors that need to take on additional space for short-term functions.

“What we’re finding is tenants are entering the market with less and less of a lead time to find new space,” Altus’ Kehler said.

Still other landlords say the best route is one of partnership with a coworking provider that’s better at incubating or interacting on a retail level with their smaller tenants. 

“That segment of the market was very poorly served by the real estate development community, and I think those coworking places that are coming into the market just opened up a door for organizations that really wasn’t available before,” said Bob Fox, founder and managing principal of Fox Architects. “You’re going to see that continue to grow and evolve. You’re seeing more players entering the mix. I think you’re seeing some stratification of the level of space that’s being provided.”

Startup finds fit in custom coworking

This was a big year for Arlington auto refinance company MotoRefi. It spread to more than 40 states across the country and completed a $4.7 million seed round with high-profile supporters.

Not bad for a company launched in 2016 and incubated in the Alexandria space of one of its backer, QED Investors. It subleased about 3,000 square feet in Ballston in 2018 before needing more room for its 30 people. But CEO Kevin Bennett didn’t want to lock into a long-term lease that didn’t take into account even its short-term growth.

This past summer, it moved into space specially designed for it at 1010 N. Glebe Road in Ballston by coworking provider Cove. It’s part of a new concept called coveHQ, which debuted early this year at 1730 Rhode Island Ave. NW. Under that model, Cove built out, furnished and manages 10,000 square feet for MotoRefi, handling everything from WiFi to printer paper — and more square footage as needed.

“Our space needs are going to continue to evolve,” Bennett said, “and as long as we’re evolving, we need a partner that can evolve with us.”

It’s an example of how coworking has gone beyond the millennials or one-person shops to serve larger employers. It’s shed its grown-up toys and taken on more of a professional flare. Coworking is also getting into the customization business — a trend Bennett said will draw more companies over traditional office leases.

“You’re seeing the market evolve into this kind of custom, flexible headquarters space,” Bennett said. “I really think it’s the future of the market and more and more real estate will look like this.”

In the case of MotoRefi, Bennett’s fifth startup in the D.C. area, he had ruled out a former haunt, WeWork, for several reasons, including its premium fees to take more space. He also wanted a home clearly branded as MotoRefi’s, not one shared by many users.

At One Ballston Plaza at 1010 N. Glebe Road, The Meridian Group also extended its partnership with Cove to offer Commons, a platform that offers coworking perks to all of the building tenants.

“We were looking for something that we thought would give us a competitive advantage,” said Katie Yanushonis, a senior vice president at Meridian. “It was not just space — it’s space plus service.”

Beyond Commons, Meridian serves as a landlord and joint-venture partner with WeWork at 1333 New Hampshire Ave. NW in the District and as a landlord to Spaces at The Boro in Tysons. It’s no wonder that building owners are taking these routes to help confront elevated office vacancy rates in the region and challenges in attracting and retaining tenants.

“I do think these owners are forward-thinking in terms of not just the next three months, but how do we plan for the next three years?” said Cove CEO and co-founder Adam Segal. “At the end of the day, it’s all about creating a very engaging tenant relationship that’s going to last you far beyond any lease renewal.”

The feds in coworking space? It could happen.

One of the country’s largest consumers of office space in the country, the federal government, has thus far held out from turning to coworking space providers.

But that could soon change, as the General Services Administration plans to issue a “Federal Workspace as a Service” solicitation in the first quarter of 2020 that would create an alternative to traditional leases. The national indefinite delivery/indefinite quantity contract would then enable the GSA to quickly take space to roll out new programs or initiatives without getting locked into a lease term of a decade or more.

The concept seems ripe for agencies that need space quickly, such as the Federal Emergency Management Agency when its personnel needs to provide hurricane disaster relief. The challenge, former GSA Public Buildings Service Commissioner Dan Tangherlini said, is getting buy-in from within the GSA and its partner agencies to embrace coworking as a valid option.

“I actually think it’s probably a better, faster entry point. The problem is going to be finding champions,” Tangherlini said during an on-stage interview at the Global Workspace Association’s September conference at MGM National Harbor in September.

The federal government typically lags the private sector when it comes to commercial real estate trends, including the current densification and open workspaces that are still playing out with new GSA space requirements. Tangherlini, who oversaw the GSA’s real estate portfolio from 2012 to 2015, said it’s been a heavy lift to just slim down the federal footprint, per an Obama administration mandate.

“I absolutely think it’s going to happen,” Tangherlini said. “It’s going to take a lot longer than a lot of people want it to.”

The four forms of coworking

While the predominant relationship between flexible space providers and commercial real estate owners has been one of tenant and landlord, several alternatives have emerged between those two parties, including coworking as a paid service. Here’s a look at four basic models:

  • Traditional: A coworking company leases space directly from a landlord and generates income from membership agreements to occupy smaller portions of that space. The model is often easier for a landlord to finance and creates the potential for members to graduate into direct leases with the landlord. But this holds some downsides for landlords, including limited transparency into the membership base and the loss of additional revenue if those members remain in the coworking space.
  • Partnership: A coworking provider and landlord form a partnership and share in any profits from the operation or loss of the coworking space. An example is the partnership between The Meridian Group and WeWork Property Investors to acquire 1333 New Hampshire Ave. NW, where WeWork preleased 30% of the 350,000-square-foot building. The model offers the landlord more say over how the space is used — and more risk if the location is not profitable or the coworking provider encounters financial challenges.
  • Operating agreement: A coworking provider is brought in to manage space for a fee, as is the relationship between Cove and Meridian for Commons at 1010 N. Glebe Road. This model offers tenants the same level of coworking service and amenities, but enables landlords to focus on other things. Though, this adds complications for certain owners, such as real estate investment trusts, because it is viewed as an added expense. Another potential concern is if the coworking company doesn’t share in the financial upside, then it lacks an incentive to operate it at the highest level of service.
  • Landlord as provider: An owner creates its own coworking brand, such as WaveOffices from Carr Properties on a local level and Tishman Speyer with its Studio brand or Flex by BXP at Boston Properties on a national level. This model gives the building owner full control over the coworking spaces and direct contact with its tenants. That can be a pro or con depending on the landlord’s resources and expertise.