Will WeWork's woes affect Hong Kong's overbuilt co-working sector?

By Pearl Liu pearl.liu@scmp.com / https://www.scmp.com/business/companies/article/3034608/will-weworks-woes-prick-bubble-among-hong-kongs-overbuilt-co?utm_medium=partner&utm_campaign=contentexchange&utm_source=EdgeProp | November 26, 2019 4:59 PM SGT
A quick glance at WeWork's Hong Kong website gives a glimpse into the co-working company's operations in the city. The start-up operates eight hubs in key business districts, plans to open four more by the year-end and has recently signed leases for another three.
WeWork's runaway expansion in Hong Kong seems a world apart from the troubles that have gripped its US parent. Until Wednesday there was every chance that one of the world's most valuable unicorns would have spectacularly unravelled had Japanese conglomerate and major investor SoftBank not stepped in with a US$9.5 billion rescue package. The deal also sees co-founder Adam Neumann leave the company, although he walks away with stock valued at US$1.2 billion.
WeWork's rapid expansion in Hong Kong has seen it acquire about 1 million square feet. Although it is nearly a third less than the 3.7 million sq ft it operates in London, it still translates into about 1 per cent of Hong Kong's leasing market, while the industry as a whole in the city accounts for 3 per cent.
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WeWork's rapid expansion masks the harsh realities about the sector. Most of the players in the co-working space are not profitable.
WeWork's shared office space, in Causeway Bay. Photo: Jonathan Wong alt=WeWork's shared office space, in Causeway Bay. Photo: Jonathan Wong
Now valued at less than US$8 billion after the bailout, WeWork has seen losses pile up over the past three years " rising from US$429 million in 2016 to US$890 million in 2017 and nearly doubling again to US$1.6 billion last year. As of June this year, the start-up's minimum lease obligations stood at US$47.2 billion while it sold leases only worth US$3.4 billion globally, according to media reports.
"Expansion in the flex space sector has slowed, vacancy is increasing, rents are falling and businesses are going to be more cost sensitive during this time of uncertainty," said Michael Glancy, senior director of Hong Kong markets at JLL.
Hong Kong's economy has taken a beating since anti-government protests started in June against the extradition bill that was formally withdrawn on Wednesday, affecting sectors such as hotels, retail and airlines. And the trade war between the US and China " two of the world's largest economies " is not helping matters either. Financial Secretary Paul Chan Mo-po said on Tuesday that Hong Kong had already entered into a technical recession because of negative growth in the last two quarters.
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As Hong Kong remains in the grip of its biggest ever social unrest since the UK handed over the territory to China in 1997, enthusiasm towards start-ups, the major users of shared offices, has been hit as even deep-pocketed investors are tightening their purse strings.
"We do expect some locations to either close, re-gear or be taken over in the next 12 to 24 months," said Jonathan Wright, head of flexible workspace services at Colliers International Asia.
Another industry consultant who requested anonymity, said that too were many players trying to grab as much market share as possible by paying insanely high rent " usually two to three times the market rate.
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"Such practice is particularly not workable in Hong Kong, where rents are already insanely high. As a result, they are loaded with very heavy burden of leases. Now, if landlords have a choice, they will not choose any co-working operators. It's just like burning money," he said.
Some landlords that had latched on to the bandwagon have already got their fingers burnt.
In March, Kr Space, one of the biggest co-working space operators in China, walked away from its lease of seven floors in Chinachem Group's One Hennessy in Wan Chai, and said it would stop expanding in Hong Kong.
View of One Hennessy in Wan Chai. Co-working space operator Kr Space reneged on a deal with Chinachem to lease seven floors in the building. Photo: Edmond So alt=View of One Hennessy in Wan Chai. Co-working space operator Kr Space reneged on a deal with Chinachem to lease seven floors in the building. Photo: Edmond So
Chinachem filed a lawsuit against Kr Space in Hong Kong High Court for failing to execute the lease and was seeking over HK$500 million in damages.
But co-working operators have been coming up with innovative ideas to avoid being sued for reneging on contracts, forming new companies with low registered capital solely for the purpose of signing an individual tenancy lease.
For example, in October 2018, WeWork signed a 10-year lease for four floors in Hysan Development's flagship building Lee Garden One, in Causeway Bay, through a company that was formed that very month. 33 Hysan Avenue Tenant has a registered capital of only HK$10,000, according to the Companies Registry.
"Hi-tech or new-economy firms sometimes adopt such structure during their fast expansion to separate the main entity's cash lifeline and assets from other units," said said Kenneth Yeo, director, head of specialist advisory with accountancy firm BDO.
Yeo said that if these specially formed units cease operations when things turn bad, creditors have no means of chasing the main entity. "As long as the main entities or directors do not play a role of guarantor, they are also off the hook."
What this means is that if co-working operators breach long-term tenancy contracts, Hong Kong landlords can only hope whatever is in the tenant's accounts or assets, like desks and chairs, can be seized to cover their dues.
Market observers said that landlords should brace themselves for uncertainty as they see the expansion frenzy coming to an end.
"The acme of the party has passed," said Vincent Cheung, managing director of Vincorn Consulting and Appraisal. "Co-working space operators will [soon] be seen as high-risk tenants and will be asked for larger deposits that will further squeeze their ability to profit."
The Post asked many developers if they had made contingency plans in the event co-working space operators withdraw and whether they would implement stricter clauses in the lease agreements going forward to protect their interests. Most of them did not reply and some were vague.
Swire Properties said "we are very selective in our choice of co-working operators within our portfolio".
WeWork was rescued by Japan's SoftBank in a US$9.5 billion deal. Photo: AFP alt=WeWork was rescued by Japan's SoftBank in a US$9.5 billion deal. Photo: AFP
The city's biggest developers are known for being cautious in their approach towards tenants. Although they have embraced co-working operators with enthusiasm, they are cautious about new-economy companies.
Cheung said that it would be rather difficult to convince some of the big landlords to sign long-term leases with a new-economy company that has a small registered capital.
"They are usually quite cautious and usually ask for much higher rent and deposit from new-concept companies," said Cheung.
A good example of a landlord playing it safe is CK Asset Holdings. The flagship firm of Hong Kong's richest man, Li Ka-shing, signed a record-breaking leasing deal with BitMEX last year. The cryptocurrency trading platform not only paid an eye-watering HK$225 per sq ft per month but also one year's rent upfront as deposit just to secure office space in the grade A Cheung Kong Center.
"Co-working operators are not making money," said Neil Anderson, director and head of office space at Hongkong Land, which owns 4.84 million sq ft of office space, most of it in the main business district of Central.
He said that the company has turned down some major co-working operators who wanted to lease space as "I don't want the 'co-working' name in our portfolio."
Meanwhile, the pressure that WeWork finds itself in to generate revenue to cover costs is being felt across the industry. Many small co-working firms, having signed up to expensive leases, are under huge pressure to attract users, with many spaces lying half vacant.
Adam Neumann, co-founder of WeWork, will leave the company as part of the rescue deal with SoftBank. Photo: Reuters alt=Adam Neumann, co-founder of WeWork, will leave the company as part of the rescue deal with SoftBank. Photo: Reuters
"Some players now are willing to cut prices and are being more flexible just to get people in. Low income is better than no income at all," said Wu Fangyu, founder and CEO of MilkGarage, a Hong Kong portal whose members can get access to co-working spaces of its partner firms.
Currently it has 10 stations across the city, including the main business districts of Central, Sheung Wan and Causeway Bay. It aims to have more operators on board by the end of the year.
Market observers believe the flexible office market is here to stay, but it is due for a shake-up. They see new business models emerging.
"An industry consolidation is coming. Stressed players will shut down and new operators will enter the market. A number of operators that have yet to establish a presence in the city are still actively looking for opportunities to enter the market," said JLL's Glancy.
Colliers' Wright believes that a management deal " which allows a landlord to outsource the operation of the flexible workspace while retaining control of the space " will be increasingly preferred by landlords and cash-strapped co-working operators.
"This enables landlords to capture upside while allowing the operator some downside protection. The landlord retains control of the space and, critically, the revenue, while the operator takes a fee for service and shares in some upside."
This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2019 South China Morning Post Publishers Ltd. All rights reserved.
Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.