Boutique Office Tower Developer Doesn't Want This Type of High-Profile Tenant
The developer of a swanky boutique office building going up in Houston isn't a fan of a type of tenant that's been a hot topic of debate in the past year.
Stonelake Capital Partners doesn't want coworking tenants at its 15-story office tower rising in Houston's affluent River Oaks area, an oak tree-lined neighborhood known for multimillion-dollar homes and high-end retail. Coworking companies, which lease a portion of a building, renovate it and sublease it often on flexible terms to businesses small and large alike, aren't always a good fit for smaller boutique buildings because they tend to need more parking spaces than a typical tenant, according to Stonelake.
The 210,000-square-foot building, called 200 Park Place, at 4200 Westheimer is scheduled to cost $42 million to build, according to a filing with the Texas Department of Licensing and Regulation. Stonelake broke ground on 200 Park Place at the beginning of 2019 without any tenants and has since leased about 30% of the building. It's in discussions with prospective tenants for a total of 65% of the tower.
"We're really not considering coworking at 200 Park Place. Before WeWork became ‘NoWork’ they wanted two full floors at 200 Park Place and we wouldn’t engage with that," William Peeples, a principal with Stonelake, said during a panel discussion hosted by the Urban Land Institute in Houston. WeWork canceled its initial public offering in September and its valuation fell from an estimated $47 billion to as low as $8 billion. A source familiar with WeWork's business said the company had no formal record of an inquiry at the 200 Park Place building.
The sentiment reflects how office developers and investors across the country are grappling with how to tackle flexible office space leases. Some landlords say coworking in a building can boost the desirability of a space, and help fill the leasable area, while others argue it is best to keep coworking tenancy below a certain threshold to manage risk of the tenants exercising their short-term leases and leaving in an economic downturn. And others simply avoid coworking tenants all together in favor of tenants with longer-term leases.
Research from National Valuation Consultants Inc. suggests buildings with 30% of space tied to coworking can ding a property’s capitalization rate, lowering the expected rate of return enough to cut the value by hundreds of thousands to millions of dollars, depending on the building's size and other factors. In a 2018 survey of investors by the real estate services provider CBRE, about 57% of investors thought coworking could reduce the value of buildings if about 40% to 60% of the space was leased to shared office space providers.
Stonelake's Peeples said coworking leases clash with the "different environment for a boutique-type size building" and said shared office space tenants, who typically use short-term leases to rent anywhere from a few desks to a whole section of a building, tend to be "a big parking hog." So it is not "something we’re considering currently" at 200 Park Place, which should be completed around April, he said.
For Stonelake's 200 Park Place, two floors would equate to about 26.3% of the building, according to CoStar data. The building includes eight levels of podium parking and a ninth floor terrace and amenity lounge. A fancy restaurant space is planned for the first floor. The building is next door to the River Oaks District, a 650,000-square-foot open-air retail center with high-end tenants such as Cartier, Harry Winston, Baccarat and Dior.
For New York real estate investment firm Clarion Partners, some amount of coworking in a building can help, not hinder, its performance, as long as it stays under 20% of a building’s occupancy.
"The challenge about coworking is it still has to be financeable. I think most lenders are still saying that coworking can be complementary, it can provide energy into your building, your space, but above 20% of your tenancy, that’s a little bit more of a challenge," said Onay Payne, managing director of Clarion Partners, speaking at the same ULI event with Peeples of Stonelake.
"We do have leases out to WeWork and other coworking providers, but we’re really careful about the amount of security we get, so either cash security or line of credit. We need a substantial line of credit to cover a year, or year and a half of rent if they blow out," Payne added. The blow out concern stems from lenders who are concerned the short-term leases common with coworking mean a lack of security for a building.
Clarion Partners has a building in its portfolio that is fully leased to WeWork in the South Lake Union neighborhood of Seattle, not far from Amazon’s headquarters. Payne argues that building is an exception because it’s a small, niche, boutique building that could quickly be leased back out. The demand to be near Amazon has led to record office building prices recently.
CBRE analyzed 31 sales over the past five years of office buildings with at least 10% of flexible space tenants compared to 104 buildings with no flexible space tenants.
Many buildings with flexible office space performed well when compared to overall national and market-specific averages for cap rates, CBRE found. This probably reflects the quality of the building and where coworking firms chose to locate, CBRE’s study said. About 45% of buildings with coworking space performed on-par with their peers, while 10% had a more favorable performance, or lower cap rates. The remaining 45% of buildings with flex space had higher cap rates, or less favorable performance.
Those metrics improved when considering only buildings with lower coworking concentrations of under 40% of total tenancy. Among those buildings, about 67% traded on par with peers, about 7% were more favorable and 27% were less favorable, CBRE found. Buildings with coworking levels higher than 40% mostly performed worse, with cap rates at an average of 46 basis points higher than their peers.
CBRE also found Class A office buildings tended to have less than 30% of their space dedicated to coworking while Class B buildings tended to have higher concentrations of shared office space.
Earlier this year, HR&A Advisors, a real estate and economic development consulting firm for WeWork, found there is a rent premium with "above the average rent growth" and a sales premium showcasing triple-digit growth above the original purchase price for WeWork’s portfolio in Boston, Los Angeles, San Francisco, Chicago, Washington, D.C., and Toronto.
As WeWork recovers from its devaluation and layoffs, its competitors are on the defensive, arguing that they offer different models that avoid "growth for growth's sake." Some coworking executives are pursuing partnerships with landlords. However most landlords treat coworking as a traditional tenant-landlord relationship, CBRE research has found. That means there is no profit-sharing potential for landlords, who have to balance potential problems with creditworthiness, longevity of leases and variable business models across flexible space operators.
Even with potential risks of coworking though, some landlords think it’s better to take advantage of having their buildings filled by those tenants rather than sit on the sidelines. Coworking proponents say flexible space can a diversify a building's revenue stream while providing a high-end space that can be re-tooled should any coworking company go bust.
"When WeWork started to show signs of distress, everyone was running to their new technology so we could figure out how much WeWork exposure" investors and landlords had and in what cities, said Jane Page, CEO of Lionstone Investments, a real estate investor, at the ULI panel. Then, companies realized "that space is totally reusable. It’s not so much about the operator as it is about the space that is now built out well," she said, adding, "I think coworking is here to stay."
In Houston, WeWork has expanded its leased space not far from the 200 Park Place tower. The New York-based company recently announced it’s nearly doubling its footprint in the Galleria area on the heels of opening in a new downtown tower, 609 Main, developed by global real estate firm Hines. WeWork is one of a dozen or so private startup real estate, construction and property technology firms to reach the$1 billion in speculative valuation, the mark at which venture capitalists begin describing a privately held startup company as a "unicorn."
For the Record
Mark O’Donnell, Josh Meltzer, David Gordon and Jennifer Jordan with Savills represented Compass in its lease at 200 Park Place, which was designed by Dallas-based Beck Group and is being built by Harvey Builders. Other tenants at 200 Park Place include Charles Schwab, which leased about 10,000 square feet on the first floor for an office that will operate like a retail banking location. Peloton Commercial Real Estate’s Trevor Franke and Streetwise Retail Advisors’ Scott Gardner represented Charles Schwab in its lease. Cincinnati-based Nelco Architecture Inc. designed Charles Schwab's space, which should be complete in May, according to filings.
Stonelake plans to relocate its Houston office from 5847 San Felipe St. to 200 Park Place in a 4,782-square-foot space on the ninth floor.
Connor Saxe and Brad Beasley with Colvill Office Properties are responsible for 200 Park Place’s office leasing. CBRE’s Bruce Wallace and Radkey Jolink are responsible for the project's retail leasing. Texas Capital Bank is the project's lender.
