Conceptual thinking

Alex Hayes, ‘Eurobuild CEE’: We are facing a probable recession, but will this be detrimental to the flexible office sector because of the subdued demand, or will it be beneficial due to an increase in the need for flexibility?

Hubert Abt, CEO of New Work and Workcloud24: Unfortunately, a recession is inevitable, but it will hopefully help us to get rid of inflation over the next two or three years. In a recession, the flex office sector ends up on the winning side, as due to the increased uncertainty and the need to adjust business plans to the changing economic environment more often, the demand for flexible solutions also increases. The trend for hybrid work after the lockdowns and the upcoming recession has accelerated the demand for shared office space. According to JLL, its market share will increase significantly from 3 pct today up to 25 pct or even 30 pct in the next few years. You can compare this with the dynamic growth of e-commerce over the last few years, which has been driving the expansion of the warehouse sector.

Has this changed your business model?

Our business model has changed very much. I would say, almost 180°. We started more than ten years ago as a serviced office operator. While we also gained some experience in the coworking business, 90 pct of our services and products have remained stable over time. With the lockdowns, we have been forced to think out of the box and started adjusting our model towards digital services and tools as well as a franchise concept and brick-to-business consultancy. Since then, we have not only acted as a tenant but more and more as a service provider for landlords where we can add value to the property. In today’s market, the transformation from space as an office to space as a service is inevitable, and we are also transforming towards being a space in the cloud operator. In 2020, we established Workcloud24, which operates a digital marketplace for space as a service and ESG compliance initiatives, where landlords can choose from different digital solutions and tools. The platform is available across Europe, which means we have increased the size of the total available market from 30 mln sqm of office space to 300 mln sqm.

How does consultancy fit with providing space as a service?

Actually, there are two sides to this coin. The client requires workplace strategy consultancy, while the landlord lacks knowledge of how to utilise regular office space for flexible demand. What has changed in the last two years is that 50 pct of the workforce requires hybrid work. They do not show up in the office five days a week anymore, and this has led to a significant decrease in office space demand. To be able to utilise office space, it needs to be adjusted to the new habits of workers, which is much more about collaboration, socialising and meeting than about private work. People don’t come into the office and drive an hour one way to get there to read their emails. Today, the office is about user experience and amenities that you don´t find when you work from home. We think that app. 30 pct of office space is no longer needed in the near future, and 80 pct of the existing stock needs to be adapted to the new reality. Hence, there is a lot of demand for consultancy.

You say that 30 pct of office space isn’t required, but we at Eurobuild have been writing that we expect an office shortage in Poland over the coming years.

Both statements are true. Offices that are lacking public transport connectivity and are not ESG compliant will suffer, while modern space, with excellent amenities, will be in high demand. 90 pct of the existing office stock does not comply with ESG standards, so there is a huge demand to adapt this space. I can give you a list of the Fortune 50 of each country and, by analysing their space requirements, we can discover that all of them have reduced their core space commitments by 30 pct to 50 pct. Today, the utilisation is even less. According to ABSL, the average utilisation of shared service centres in Poland is between 15 pct and 35 pct. Unutilised space doesn’t fit into ESG compliance, and because of the increased energy prices, no CFO is ready to pay energy bills for such space anymore, which is why they will reject it as soon the lease is due for extension and renegotiations.

You mentioned that you had set up a new company, Workcloud24. Could you tell us a little more about it?

We believe that the flex office sector is not yet developed to meet the future needs of the market for space as a service and ESG compliant products. On the one hand, there is the lack of supply to meet the demand in the future, as I mentioned before, only 3 pct of the stock is available while 25 pct is needed. And on the other hand, around 60 pct of the operators are single entrepreneurs or landlords who are not organised – in terms of having no information about ESG compliance, no digital strategy and with no global visibility or access to funding. The marketplace of Workcloud24 offers tools and services for landlords and operators who want to benefit from our twelve years of know-how, which we provide with different digital tools and services, such as, for example, a toolbox that helps to convert regular office space into flex space, a digital office pass that allows multi-location bookings, a carbon calculator to reduce the carbon footprint, or access to property assessed clean energy (PACE) financing to improve the energy performance of the space or building.

Is your sector going through a phase of consolidation?

Absolutely. Since the lockdowns, it has been two and a half years of suffering for the entire sector, and the fallout from this has been extreme. I would say, at a minimum, we lost 35 pct of our players over the last two years, and now, with ESG and digital strategies coming in, we will see a wave of consolidation, which is already on the way from the US. Knight Frank and Newmark have bought Knotel, the number three operator in the US, and are bringing them to Europe. CBRE acquired a significant share in Industrious, which is the number two operator in US. While we don’t know what’s happening with WeWork, we know that Cushman has a stake in it. Overall, we can see the big brokerage firms taking on this business, and this will lead to consolidation and greater professionalism.

Before we began this meeting, you told me that green certification for a building only goes so far. Could you explain this?

I think today we have around eleven certificates and seven building certificates in use. The sector seems to think that certificates allow them to forget about the need to comply with ESG. Like in the old days, when you went to a priest and gave them some money to forgive all your sins. This is what’s happening today, but only a fool believes that such a certificate assesses or replaces compliance with ESG standards. ESG is a process, and certificates only assess a building at a certain moment in time, normally pre-use. The certificate doesn’t measure what happens in use. It’s like you believe in a lease that reflects what happens in the property. A lease can reflect 100 pct occupancy while the space might not be utilised at all or abandoned and is 100 pct empty. So this is just the opposite of what the lease makes you believe. Now, if your next ESG valuation is due, you might be surprised about the value of the space as the valuator has to disclose that the space is empty. Another example might be PACE financing. With this tool, landlords can assess their investment in the property and offset it against the cash flow from the savings in energy. Certification won’t give you this knowledge. To properly assess this, you need to go way beyond the level of the certificate to understand your property, that is, to assess the clean energy investment in order to save energy and generate returns on your property. These two examples could serve to demonstrate the limitations of the value of certificates and where ESG compliance comes into play. ESG is becoming a question of life or death for the sector. According to McKinsey, a building could lose 40 pct of its value by the end of the decade, if the required action isn’t taken.

So you are saying that within seven years it will be completely untenable to have non-ESG compliant office space?

Not seven years, rather two. Corporate clients are already extremely sensitive to ESG compliance because they have to report it to their shareholders as well. Smaller clients will follow. And the capital market is flipping completely towards exclusively sustainable investments. Without being ESG compliant, in 2025 you will be out of business. This is what people don’t want to hear, but you will be barred from entering the capital markets, and the banks will follow the stranded risk analysis of rating agencies and forward the requirements to the landlords. They will either not finance non-ESG compliant assets at all or only with significant risk premiums.

But for many older buildings, the cost of insulating them is prohibitively high.

No, that’s not true. The truth is that you can’t afford not to do it! A solar panel on the roof with the old energy prices would take four years to pay back its costs, but with the new energy prices, it’s just two. You break even on your investment in a very short time and you get a premium on your rent because the user is prepared to pay more as he saves on energy consumption. You create a holistic ecosystem with the investment. This is the basis of worklcoud24´s Property Assessed Clean Energy financing. You assess the investment needed to save a certain amount of energy and make sure that the payback is done over time because of the savings.

Recessions tend to hurt small and medium-sized businesses disproportionately. Do you still see them as making up most of your clients, or have the corporates replaced them?

What has changed in the last two years is that the corporates have turned up. This was not the case before – we had almost 100 pct of what we call a flex basket. These are SMEs that need up to 20 workstations or 200 sqm. Today, 70 pct of our traffic is from these flex baskets, but it only makes 30 pct of our revenues, as we have 30 pct of traffic from corporate demand, which is increasing and already makes up 70 pct of our revenues. This represents a fundamental change in our revenue and client structure. It’s absolutely true, as you say, that smaller firms are more vulnerable. We expect a downturn in this segment of at least 20 pct over the first nine months of next year.

But do you expect that business to come back once the recession is over?

Yes, it always comes back. Growth in the economy is often driven from the root. And the good news is that clients who are using flex office solutions are already able to adjust and downsize their space, so they still have the opportunity to run an office but just on a smaller footing. You can say ok, I have five offices, let me give you back two, and I’ll keep three. When the business comes back, you can then say give me two more offices. But with a regular lease, you can’t do that – if you sign up for 200 sqm for five years, it stays 200 sqm for five years. We did the same in the lockdowns, and it worked perfectly, as we only lost 6–7 pct of our clients.

I assume you have a close relationship with landlords…

Yes and no. The truth is, we would love to have a much closer relationship. Most of the time this is because of the established structure. I’ll give you an example. For five years we tried to establish what we call 360° reception services, where we provide concierge service for all tenants of the building. Our motto is “you’ll never get a second chance of a first impression” – and that’s why we believe that it’s so crucial to establish proper services at the place of first contact. But we only partially succeeded, because a landlord signs up a property manager and those then sign up a facility manager and then the facility manager signs up a security company, who takes care of the reception. I guess everybody can see what the most likely outcome of all that is. We can see that the holistic concept of space as a service has still to be fully embraced.

But that’s changing?

I really hope so, but I’m not seeing much change. Now, with the need for ESG compliance initiatives, we have another reason to talk to landlords and ask them what their plans are. What has changed completely over the last six months is that landlords are bringing us to the table and asking us how we would approach these questions. Since we compare the usage and the energy consumption per sqm and per workstation within our portfolio, we can see the average, the peak worst and the peak best. Targeting the peak best, we state that this must be achievable for all of our properties, and to do this, we need to communicate with our landlords and ask them what their plan is for this. This kind of communication would never have happened over the last twelve years. We operated buildings, but we didn’t know what we were operating. We consumed energy, and then we were billed. Now we need to ask, where is the electricity coming from, what is the carbon footprint, and how can we reduce our consumption of it? The fundamental change ahead of us in the office sector is that we will need to think like a shopping centre manager. They do not get their money just from the anchor tenants. They make their profits by building an environment for the smaller tenants to improve their turnovers, and out of these higher turnovers, they pay a higher rent. We need to build an environment for the tenant, so they can save on core space but allow them to spend on services to increase the utilisation, which gives us a premium on headline rent. We need to stop thinking in terms of long-term lease contracts with maximum collateral and minimum incentives. We need to think of space as a service with maximum flexibility.

I’m surprised, because I thought two or three years ago landlords were doing all they could to woo flex office providers…

What happened before the lockdowns was that serviced office operators were bullish and grabbing market shares. We grew by 100 pct for three consecutive years and we tried to get as many properties as possible in our portfolios, because the name of the game was who could grow the fastest. This was only acceptable to landlords because we offered a lease with collateral behind it. Landlords didn’t buy into the service concept – it was only the lease they were interested in. But now we go for management and service contracts. New Work only comes by invitation. Recently we opened a service centre for one of our clients in Sofia. They want us to commercialise the space, they know that we can do it as we have done it many times over the last few years. They require a certain standard, not only for the fit-out and technical equipment, but also for the procurement management. The centre was up and running in time, met the budget, and was 100 pct occupied from day one. Another example is Tulipan in Warsaw, we tried to do business with Commerz Real for more than two years. The space was empty and not commercialised, as is almost all space in the entire Mokotów submarket. We are still operating under early access and the space is not yet fully ready for operation, but we have bookings for over 60 pct of the occupancy for the opening day. Nothing has changed, the submarket remains the same, and vacancy is still high, but the product is not space as an office anymore – now it’s space as a service.

Would you expect the coming recession to spur on the changes that you see as essential?

Yes, during recessions massive business opportunities always arise. And in combination with the need for ESG compliance, the current recession should trigger change for the better. For example, in the flex office sector two years ago, when a valuator noticed that you had space leased to WeWork in your portfolio, they would have discounted this particular space. Today, if there is no flex space, they will ask why you don’t have a flex operator and if you don’t have one, you get discounted. The same goes for PACE financing. Since energy is expensive, it allows such investments to be profitable. As the assessment triggers the need to implement an ERP system, it will improve the efficiency of the building and convince the management to implement a more holistic sales and service approach.

One final question – what do you see as the biggest risk to the sector over the next two or three years?

The disruption for those players who don’t hear the wake-up call in time. Albert Einstein once said: “If you always do what you always did, you will always get what you always got.” I guess everybody somehow feels that we can just go on doing what we always did. Flex covers 2–3 pct of the market, but it should be 25 pct to 30 pct – and, if you are lucky, you will find 2 pct of newly built properties with a functioning ERP system, but it should be 100 pct. We live in a digital world, but the sector is still stuck in the last century when it comes to such tools. This, put together with the need for ESG compliance, is leading to a transformation risk, while at the same time it offers huge business opportunities.

Hubert at the helm

Hubert Abt has been working in the real estate sector for over thirty years. He was employed as a developer and later in the land banking sector, providing equity and mezzanine capital for various real estate projects. In 2012, he founded New Work Offices in Budapest, which offers various flexible office solutions. Since then he has developed its business model further, growing the company to what it is today, with 16 locations in four countries with approx. 56,500 sqm. Hubert now leads the company as CEO and focuses on investor relations and developing new products for the Workcloud24 platform, of which he is also the founder and CEO.