On today’s show we’re talking about the office real estate market. And no, we’re not talking about WeWork.
I had the opportunity to take over a co-working space that had been operated by an accountant. they had the master lease for about a 7,000 square foot office space that had been divided up into small offices ranging in size from 100 square feet up to about 800 square feet. There were a total of 25 separate spaces, of which all but three were leased. The accountant who owned the accounting firm died, and the wife of the accountant didn’t want to manage the real estate. In fact she was also in the process of trying to sell the accounting firm.
The owner of the building was a major national landlord with billions in assets. The offices were renting for $500 to $800 per month for the smaller ones capable of housing one to two professionals. The accounting firm had fallen behind on its rent payments to the building owner was in default under the terms of the lease. The owner had since engaged with another company in the co-working space who ran the floor for a year and they too had fallen behind on their lease payments. The building owner had finally taken over operation of the floor, but in reality didn’t want to be dealing with 25 individual tenants. I already was running another small shared office rental business and the building approached me to take over the running of this 7,000 SF space. I reviewed the financials and the master lease agreement. The tenants were paying below market rents. The expenses were pretty simple to analyze. There was the rent for the entire floor, a few miscellaneous expenses for the photocopier and printer, insurance, and the salary for the receptionist for the floor. The two major expenses were rent at $14 per SF NNN, about $28/SF gross, and the receptionist. The rent wasn’t a bargain, but it was certainly quite fair for a modern B-Class office building. As the business was currently operating, it would break even at 95% occupancy and would generate about $40,000 a year at 100% occupancy. I might be able to raise the rents over time, but it wasn’t clear how many tenants would seek alternatives if I increased the rent. The business would generate a profit if I eliminated the receptionist, but then there would be nobody apart from myself actually working inside the business. That was not something I was prepared to do. It was an inexpensive way to expand in the co-working business. I would inherit all the furniture, all the equipment. It was an instant revenue stream. As is, the business represented too much risk. There was no way I would sign a 5 year lease complete with personal guarantees when I had no guarantee that the tenants would stay with me at a higher monthly rate. So I decided to decline the opportunity.
In the latest co-working news, WeWork competitor RocketSpace is pulling the plug on its operations. RocketSpace is a San Francisco-based coworking startup founded in 2011.
If RocketSpace files for bankruptcy, it will join another San Francisco coworking company called Sandbox Suites, which filed for Chapter 11 bankruptcy reorganization in April.
The prices at Sandbox are pretty attractive if you’re a tenant. An office with two desks costs $1,000 per month. That includes 10 hours of free use of a meeting room each month. I’m talking about an office in San Francisco or in Silicon Valley. That’s incredibly cheap.
The problem with these co-working businesses is that the labor costs are high for the number of tenants. A co-working space doesn’t really function properly with zero staff, and the front office staff doesn’t offer enough perceived value for the tenants that the customers would be willing to pay a premium for it.
None of these companies have a profitable business model. I couldn’t even make the numbers work with zero capital investment, taking over an existing business.