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Denis Ma explains why he's overcome his scepticism of co-working concepts in Hong Kong
When I first heard that co-working was coming to Hong Kong back in early 2016, I thought that it would just be a fad. That's not to say that I didn't believe that co-working as a concept could work—it’s already been proven to be very popular in the US, Europe and even China—but I was sceptical about whether the start-up community in Hong Kong was large enough to sustain the demand for this type of office product.
Yet, co-working is now booming in Hong Kong and has been one of the few bright spots in the city's office leasing market where demand growth has remained slim. Co-working spaces accounted for about 15% of new lettings on Hong Kong Island through the first half of 2017. While this may not appear significant, it is impressive when you take into account that the Grade A office market posted a net withdrawal of about 56,000 sq ft over the same period.
So where did I go wrong in my initial assessment of co-working in Hong Kong?
Well, a lot of it has to do with the business models that are being rolled out here in Hong Kong. Instead of relying solely on start-ups, operators are focusing on corporate occupiers. We saw this early on when HSBC took out a 300 seat membership at WeWork's Tower 535 location in September 2016, providing a glimpse of how traditional office occupiers can utilise co-working space to their advantage.
With more and more occupiers looking at different ways to manage their real estate costs, a combination of 'hot-desking' and co-working memberships could potentially provide the savings required without the need to relocate. Moreover, occupiers could benefit from the increased flexibility afforded by co-working memberships.
The development of this part of the market is now moving very fast. At least one corporate occupier has reportedly approached a co-working operator to discuss the possibility of taking on extensive memberships if the operator is able to secure an appropriate location; akin to an anchor tenant in the traditional leasing model. In Central, where tight vacancy rates and sustained demand from PRC corporates has resulted in rents climbing by up to 15% in the top-end of the market over the past 18 months, co-working space is becoming an increasingly attractive option.
Market growth, however, is not without constraints. Co-working locations are typically going to be restricted to buildings where rents are at a level whereby operators can still turn a profit. Back-of-envelope calculations we've done previously—which take into account membership costs, opex and margins—suggest that most operators can only afford to be located in office buildings where the rent is HKD 50 per sq ft per month or less. What this means is that those taking memberships with an eye to staying in Central will likely have to accept working in non-Grade A office buildings. Those that consider being in a Grade A office building a must will likely have to consider locations outside of Central, where rents are lower and more feasible for operators. This trend is already emerging, with several operators negotiating on spaces in decentralised locations such as Hong Kong East and Kowloon East.
The growth of co-working in Hong Kong is not only beneficial for occupiers. It opens the door for investors too. Early on, there were questions about whether operators would consider smaller floor plate buildings (less than 5,000 sq ft). While the investment market for these smaller 'pencil' buildings—found in and around Central—is quite liquid, surging prices have seen yields tighten considerably. Given that these buildings have historically traded in the range of HKD 20-40 per sq ft per month, this is a challenge for investors seeking to improve rental yields. The relatively higher rental affordability of co-working space operators provides an opportunity to lift rents and the appeal of such investments. Indeed, we've already seen operators targeting these buildings, and in some instances leasing them in their entirety.
With at least 500,000 sq ft of active requirements currently in the market, it will be interesting to see whether the growth of co-working can be sustained and become more than just a fad. My view is that the market is growing a little too quickly and will need to consolidate somewhere down the line. But in the interim, I expect co-working to continue to thrive as corporate occupiers continue to explore new ways to manage real estate costs.
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For more information, contact Denis Ma.
Head of Research, Hong Kong
+852 2846 5135
Senior Manager, Marketing & Communications
+852 2846 5008