By Andrew McIntyre

Law360 (July 31, 2020, 11:03 AM EDT) -- The coworking sector has been hit especially hard by the COVID-19 pandemic amid health and safety concerns associated with office layouts, and experts say more trouble is likely in store for coworking operators as well as owners of those properties.

With occupancy levels plunging as the pandemic continues, operators like WeWork will on the one hand likely shed large amounts of space given the uncertainty of the model going forward.

But owners will also likely face challenges, both in terms of collecting future rent and also getting future financing from banks, according to experts.

Here, Law360 looks at three ways the COVID-19 pandemic is fundamentally upending the coworking model.

Operators Will Likely Shed Space

WeWork and other operators of coworking space are likely to downsize their footprints amid falling demand, and that means companies will have to evaluate each property and figure out ways to shed space.

WeWork and competitors such as Industrious and Regus typically have either management agreements or leases with building owners, and then offer the space to third parties through the coworking model. In the case of management agreements, landlords sometimes are also involved in the operation of the space.

"We're hearing rumors that [WeWork is] trying to shed space and terminate deals that they've done," said Keith Edelman, executive managing director at real estate organization Colliers International. "We've heard they're trying to terminate a deal for 150,000 square feet at 830 Brickell [Plaza in Miami]. ... Overall, I think you'll see all of [the coworking companies] try to downsize."

Law360 couldn't immediately confirm that rumor, and a WeWork spokeswoman declined to comment on that Miami matter.

One issue for WeWork is that it has taken on so much space so quickly. Edelman said typical lease deals in South Florida are for 5,000 square feet of space, and WeWork, by contrast, has done deals for between 80,000 and 150,000 square feet of space.

"WeWork is scrambling. Its competitors are scrambling," said Scott Goldstein, who also an executive managing director at Colliers International.

Of course, WeWork and its competitors are trying to walk a fine line that's predicated in large part on when a COVID-19 vaccine is developed. While the sector may be able to withstand a short period of time without a vaccine, an extended period of time without a vaccine could fundamentally reshape it.

And experts expect demand for coworking and other office space to remain low, at least in the near future.

"The ultimate effect the pandemic will have is companies will realize people don't need to be in an office eight hours a day to do their work, and people can work remotely and be effective," said Robert Reichman, a partner at Greenspoon Marder LLP. "That will have an impact on the entire real estate industry, and on office building and office leasing."

"There will be a negative impact. People will realize they don't need as much space," Reichman added.

Banks May be Reluctant to Provide Financing

While operators like WeWork have one set of concerns, the parties that own coworking buildings have their owns concerns, one of which is access to future financing.

For lenders, top of mind is the tenant mix on a property, and experts say banks are now in a holding pattern when it comes to decisions to lend on buildings that have coworking tenants.

Lenders "have to be very concerned, is our opinion, if the majority of their building is rented by one of these coworking groups," Edelman said. "They are potentially in jeopardy of collecting rent down the road."

Indeed, coworking is complex from a lender's point of view because of the two levels of income. The coworking company has a management agreement or lease with the landlord, and the operator in turn, as a quasi sublease, offers space to a third party. There are thus two potential bottlenecks in the money flowing to the owner, which has lenders on edge.

And most arrangements for companies to use coworking space are short-term, often month-to-month, which doesn't help instill confidence in the lenders.

"I think ... there's a wait-and-see there," Reichman said, regarding lenders. "It ultimately comes down to cash flow. The owner, landlord, they need to maintain a certain cash flow to meet their mortgage and taxes."

"To the extent that cash flow is based upon projections, that's the problem. Ultimately, the long-term effect will likely be the cash flow is not going to be there," Reichman added.

Models Will Change

While coworking operators will likely give back some of their space to their landlords, companies will also have to re-imagine what the space they retain should look like amid the pandemic.

While years ago, the capacious executive private office suite was en vogue, the model in recent years has shifted to more flexible, open floor plans. But now COVID-19 has, in a sense, flipped that new model upside down.

"It's been a complete reverse," Edelman said. "People are afraid to spread germs."

One major hurdle for the sector, Goldstein said, is putting the necessary safety protocols in place. That could include upgrading the HVAC system to circulate air more frequently. And it could also involve a redesign to create more closed off spaces, indeed a reversal of the open floor plan model that defines so many of these spaces.

The coworking model also comes with additional questions, since parties generally have an obligation to offer certain shared amenities to users. Just how those coffee shops, bars, lounges and even kitchens can now be set up is a major question.

"With the new normal, people are looking at their spaces and trying to decide how they're going to retrofit or change the layouts of their office," Louis Archambault, a partner at Saul Ewing Arnstein & Lehr. "With social distancing and new guidelines, it's a more permanent question of how much space do we need. People are more willing to do more remote access."

For the moment, it's largely a wait-and-see approach for operators.

"Most companies we're seeing are in a holding pattern. People are still working from home, or virtually," Edelman said. "The coworking sector is going to get dead hit harder than most, based on their layout. ... Companies now need their own spaces and private offices."

Indeed, the very essence of coworking means that that subsector of the office market may need the biggest changes in configuration, given the pandemic.

"It's certainly a challenge," Archambault said. "Every office tenant is going to have to face adjusting their floor plans to make sure they are in compliance with the new normal."

--Editing by Emily Kokoll and Sarah Golin.

Update: This story was updated to clarify the different approaches coworking companies use to operate spaces.

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