The Business Case for Bringing People Together
As my previous post outlines, the modern housing, sense of community, and flexible rental contracts make co-living an easy sell for a specific type of global worker.
However, for the investor, the return on their investment also needs to be attractive.
The risk of flexible rental contracts results in decreased cash flow certainty for investors. During the Covid-19 pandemic, many co-housing developers and operators struggled. as renters gave up leases to move out of expensive cities. Many of the largest co-living players don’t own their underlying assets, primarily the apartment buildings. Instead, they sign master lease agreements which allows them to sublease the building to renters. This allows for rapid scaling of the company, but when occupancy drops, it is easy to face cash flow problems.
Cushman and Wakefield, one of the world’s largest commercial real estate service providers, released a fascinating report in July of last year on the future of co-living in the US, post-pandemic.
An extract of the report immediately caught my attention :
As of Q3 2020, co-living assets increased their effective rent per square foot premium over studio rents to 22.2%. Even so, co-living rents continue to offer an average 20%+ discount in housing costs per lease to competing studio products.
In essence, co-living offers lower rent to renters, while also promising higher rent per square foot/meter for developers and landlords. This seems counterintuitive, but since communal areas are shared, a higher density of renters can be achieved for a given building. This increases the total rent that landlords can collect, but renters also share in the financial benefit of the shared amenities.
It is important to understand how this data was compiled. Cushman and Wakefield compared co-living properties in New York City, Los Angeles, San Francisco, Miami, Washington DC, Chicago, Seattle, Boston and Philadelphia against Class A studios built after 2014 in the same cities. As per Investopedia’s definition, Class A real estate “represents the best buildings in terms of aesthetics, age, quality of infrastructure, and location”.
It is also important to understand the concept of total housing cost. Total housing costs refers to the total cost a tenant incurs while staying in a unit. In traditional units, furnishing, utilities, WiFi, are often not included in the rental cost. In contrast, co-living properties tend to offer an all-inclusive price. In order to make a fair comparison, Cushman and Wakefield compared the total housing cost of both options.
Again, this is a limited subsection of co-living – modern buildings in some of the US’s most expensive cities. It is hardly a fair view of worldwide co-living, but it certainly warrants further investigation into the potential return for investors.
The report also had some other interesting findings. Despite the philosophy of short term, flexible contracts, Cushman and Wakefields’ report seems to indicate that co-living leases are set to increase to 9 – 12 month leases on average. Short-term leases, for periods in the 3–6 month range, are being reduced or removed. For landlords, this promises a more stable cash flow while also reducing the operational costs of constant renter turnover. From a renter perspective, this also creates some degree of semi-continuous community, as opposed to occupants constantly fluctuating.
It also appears that the demand for economies of scale has started to change the co-living space. Previously, it was mostly existing real estate being converted into co-living properties. However, since the entrance of significant investor interest, developers are constructing fit-for-purpose buildings. According to the Cushman and Wakefield report, the average size of planned co-living developments at the time of publishing was 180 beds. This enables economy of scale, and justifies more desirable amenities such as a gym, workspaces, etc. A consolidation has also started to happen within the space. Ollie was acquired by Starcity last December. Starcity, in turn, was then partly acquired by Common (the acquisition was of its management agreements, i.e. the agreements to manage and sublease buildings). Quarters was acquired by Habyt in March of this year.
However, some other players had less successful outcomes.
WeLive, WeWork’s co-living arm, fell short of its grandiose plans. Housing is a much more complicated field than working spaces, subject to larger space requirements and regulations. Considering WeWorks internal struggles with its core product, it was unlikely to be in the best position to scale a related, but more tricky business model.
In the same New York Times article that outlines WeLive’s short lifespan, it also includes a quote by Brad Hargreaves, the founder and CEO of Common (which is now considered the biggest co-living player in the US). At the time, he said:
“There is huge demand. The challenge has always been supply.”
This seems to be echoed by Roam’s seizing of their operations. In a remarkably candid analysis of their trajectory, the company published the following on their website:
Unfortunately, as it turned out long before COVID, leasing buildings in exceedingly expensive cities at what is most likely already the tail end of an economic and weird cultural boom, and running them at a loss backed by speculative capital is, well, not a good long-term business to be in. That’s why we’re taking the year off and converting the idea of Roam into a broadly owned real-estate company.
Real estate, no matter how it is rebranded, is still a rigid, asset-heavy industry. It does not scale in the same way as tech startups. Optimistic P/E investments, flashy marketing and designer rooms can hardly fix it. Master leases put co-living companies in a tough situation when occupancy rates drop. Roam’s demise seems to point to this in their post.
However, as the Cushman and Wakefield report concludes, co-living developers and operators have “continued to evaluate and source new sites since the COVID-19 pandemic began. This activity is predicated on the common view that respective markets will be in recovery by the time new projects deliver in 2022 and beyond.”
For the players that can scale sustainably, the investment case for co-living appears strong. In my next post, I will discuss the success factors from a consumer point of view such as. the location, amenities, other occupants, etc. I also delve deeper into some of the most interesting co-living players and their designs and concepts.
