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As office vacancies rise, landlords are more willing to rent to flexible-workspace providers. Will the trend last?

A Breather co-working space in downtown Manhattan. Breather | Instagram
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As the COVID-19 pandemic drives up vacancy rates in office buildings across Canada, some flexible-workspace providers see an opportunity: negotiate better deals on their existing leases, and sublet prime real estate from big businesses that suddenly have more square footage than they need. However, while commercial real estate lawyers and landlords say there’s been an increase in willingness to work with workshare providers, they also warn the trend may be short lived.

“Anytime there is an immediate month-over-month increase in the number of subleases available in a city, you’re going to see landlords allowing their space to be used on a more temporary basis,” said Simon Crawford, partner at Bay Street law firm Bennett Jones. “But whatever temporary benefit flex-office-space companies might be seeing, I don’t read it as being the beginning of a new trend.… Landlords still prefer major institutional tenants.”

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Talking Point

An increase in office vacancy rates and subleasing availability in major Canadian cities could be advantageous to co-working space companies like Montreal-based Breather, whose CEO told The Logic recently that his company had benefited from that uptick in supply, because it provided greater flexibility in negotiating leases. But Breather is now reportedly considering fundraising or even a sale, as the pandemic takes a toll on flexwork companies.

The pandemic-induced work-from-home phenomenon has taken a huge toll on the co-working industry, which lets clients rent temporary workspaces for as brief a tenure as a couple of hours. The small- and medium-sized white-collar businesses that tend to use flexible workspaces are also cutting costs and asking their employees to work from home to limit the spread of COVID-19. In early September, IWG, the parent company of co-working space giants Regus and Spaces, filed for creditor protection in Canada, saying that without it, it could face a “lockout” by landlords, which could affect 3,000 of its 15,000 occupants. WeWork saw its membership numbers shrink by 11 per cent, and its revenue decline by eight per cent in the third quarter of 2020, compared to the quarter before. New York-based flex-office company Knotel is facing lawsuits from four landlords alleging it has not paid over US$1.6 million in rent. Real estate firm CBRE Group, too, has recently decided to scale back expansion plans for its co-working brand Hana. 

Many of these co-working spaces have struggled to lease prime office real estate, which landlords usually reserve for large institutions like banks, tech firms and professional services companies that are able to enter securely into long-term leases. Flex-office providers tend to be forced into older buildings and less desirable spaces.  

In an interview late last month, Bryan Murphy, CEO of Montreal-based flexible-workspace provider Breather told The Logic his company had benefited from the increase in supply of office space available for subleasing or direct leasing; with more options, he said, the company was able to get creative with the kinds of deals it makes. 

“Traditionally we would sign a long-term lease with landlords,” he said. “But in 2020, we switched to a landlord-partnership model, which is more flexible. We enter into a rent-share arrangement with the landlord where we manage the space: 70 per cent of our tenant’s revenue goes to the landlord, we keep 30 per cent.”

Murphy said that the pandemic had been “good” for Breather’s business, adding that he was “100 per cent confident” the traditional way of working would not resume when the pandemic was over. “Every company that we talk to, they are all saying, ‘When we go back, we are going back with 20 per cent less office space,’” he said. “That means they are all going to shift out of their old leases, so while we’re at it, let’s look at all these flexible offerings.” Murphy also said Breather clients would start to see “many more” new spaces available to lease in the coming months, suggesting that the company had new deals on the table. 

However, after that interview with Murphy, Business Insider reported that Breather had met with investment bankers to explore its options, including raising another round of funding or even a sale. Murphy did not respond to The Logic’s request for comment on the report, and a Breather spokesperson declined to confirm it, telling The Logic the company “does not comment on this type of business matter.” Cyril Ebersweiler, general partner at VC firm SOSV and an early investor in Breather who continues to be a minority shareholder in the company, said it would not be unusual for a company like Breather to work with banks “at [its] level of funding and revenue.” The company has raised US$127.1 million since it was founded in 2012—its most recent raise of US$3 million in combined debt and equity, from investment firm TriplePoint Venture Credit, was in May 2020, but it had previously raised US$46.4 million in mid-2018 in a deal led by the Caisse de dépôt et placement du Québec, Menlo Ventures and Singapore’s Temasek Holdings, according to data from PitchBook, and an undisclosed amount in December 2019. 

Gordon Wadley, COO of Dream Office REIT, which leases office space to Breather, would not say whether the company was in discussions over revenue-sharing partnerships of the kind Murphy described, but said the idea was “interesting.” 

“Especially when times are uncertain, having a tenant like Breather, that offers a tremendous amount of flexibility, is complementary to any real estate strategy,” he said, adding that Dream had never any problems collecting rent from Breather. 

There has certainly been an increase in office-space availability in major cities like Toronto, Montreal and Vancouver, as many companies extend their pandemic work-from-home policies. Data from CBRE shows that in the third quarter of 2020, vacancy rates in most of Canada’s downtown office markets climbed by a full percentage point, to 2.4 million square feet of space available nationally for direct lease. The amount of office sublet space in downtown Toronto, for instance, increased by 200 basis points to 1.5 million square feet. But office rent rates in Toronto and Vancouver continued to hold steady, the CBRE report said. 

“Without question, Canada’s largest office markets are experiencing a shift in demand and businesses continue to weigh the long-term impact of COVID-19 and the ability to work from home on their operations,” said CBRE vice-chairman Paul Morassutti. “That said, the third-quarter numbers are similar to what was seen during previous recessionary events and do not yet reflect anything more significant than that at this juncture.”

However, even if companies like Breather are able to secure these leases, they still face the challenge of recouping their money.

One real estate lawyer, whom The Logic has agreed not to identify because he has some co-working companies as clients, said that in the summer months especially, when many COVID restrictions had been lifted, there was an increase in the pace of sublease deals between co-working companies and tenants in large office buildings in downtown Toronto. But one of those deals fell apart after a co-working company he chose not to name could not find clients to use the space it had subleased. 

“This was an older building, so it was already hard for that existing tenant to find a subleaser. The co-working company came in quickly, but exited quickly,” he said. “It just didn’t work—and both sides lost money.”

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Crawford, the Bennett Jones lawyer, called the deal-making flexibility on leases that companies like Breather are claiming they have right now “a bit like selling popsicles on a hot day.” 

“Sure, buildings that are more vulnerable to short-term vacancies may be more likely to entertain short-term solutions. This may be a short-term boom, but it is likely not sustainable as soon as things return to normal.”