Distressed deals loom at flex sector’s inflection point

The flexible and co-working office sectors are set to see a rise in forced consolidation as the coronavirus pandemic poses the industry its greatest challenge yet and widens a gap between leaders and laggards. Flex operator Knotel announced this week that it will sell its business to Newmark Group and put its US operations into Chapter 11 bankruptcy as it attempts to restructure into “a more capital efficient business”. Amol Sarva, Knotel’s co-founder and chief executive, said: “The pandemic created a uniquely challenging operating environment, with significant impacts on leasing velocity and the rate of renewals in key markets, particularly New York and San Francisco. We must address this now to position our business for sustainable growth and a successful future.” Knotel’s bankruptcy does not include its international operations – the company has a sizeable footprint in London – but analysts see M&A as likely in the broader European market as well. At Colliers International, head of flexible workspace consulting Tom Sleigh said M&A will be struck as the industry matures. With a “highly fragmented” market in Europe, Sleigh added, the most likely transactions are distressed purchases. Consolidation on the cards Cal Lee, global head of Workthere, Savills’ workspace brokerage, said M&A in the market has been “far more muted” than might have been expected and occupancy in the UK “more robust than people might give it credit”. “However, the next six months will remain challenging and we do not expect the market to bounce back until Q3 or Q4,” Lee added. “As such, I would expect to see some further consolidation, at both a building and operator level in the coming months.” James Rankin, head of research at workspace adviser the Instant Group, expects the market to continue growing in terms of supply, but with fewer operators. “For some the impacts of Covid-19 could not have come at a worse time, with large expansion plans already in play and over-exposed portfolios in the short term creating a market ripe for M&A activity,” Rankin said. “Nearly every industry goes through a period of M&A activity at some point as consolidation is used to drive new opportunities, leverage new technologies, introduce economies of scale and, importantly, capture new markets. 2021 is shaping up to be that year for the agile workspace industry.” Many industry professionals have predicted that providers of flexible workspace will benefit in the wake of the pandemic, arguing that less rigid lease agreements and the use of different locations will prove more attractive to occupiers than insisting all workers are based in a traditional headquarters. Delayed recovery But ongoing lockdowns and other Covid-19 restrictions have pushed back the timeframe for an upturn in demand. Serviced office group IWG – itself keen to acquire smaller rivals – recently said that any recovery in its business this year would now be delayed. “Most flexible workspace operators have had a challenging time since the first lockdown was introduced,” said Emma Swinnerton, head of flexible workspace at Cushman & Wakefield, noting that usage of flexible workspaces has dropped to 10-15% of pre-lockdown levels. Swinnerton added: “The level of impact does, however, vary by operator and even by individual building depending on client mix and average agreement duration.” At Spacemade, a company advising landlords on developing their own flexible workspace, co-founder Dan Silverman said the industry faces “massive disruption”. Like Colliers’ Sleigh, he said a rise in takeovers of distressed operators is coming. “The mismatch between long-term lease liabilities and shorter-term revenue has rendered the old business model all but over,” Silverman said. “As we emerge from the pandemic, the provision of flexible space is likely to increase substantially as businesses demand increased flexibility; however, it will be increasingly landlords providing it directly, enabling a much closer relationship with their tenants.” Some providers are pushing ahead with ambitious expansion plans even in the face of the ongoing pandemic. Blackstone-backed The Office Group this week opened Regent Street’s first flex office in what was once part of the Liberty department store. TOG co-founder Charlie Green said: “The pandemic has pushed all of us to rethink the way in which we live and work, but the office will still have a central role to play.” To send feedback, e-mail tim.burke@egi.co.uk or tweet @_tim_burke or @estatesgazette