By Clare Jim and Brenda Goh
HONG KONG/SHANGHAI (Reuters) - Co-working space operators in China are shifting their focus from ambitious expansion plans to services such as customizing offices for clients, as rising vacancy rates and tighter financing slow their exponential growth of the past two years.
The strategy shift marks a turn of fortunes for the Chinese co-working industry, whose rapid expansion has helped operators such as Ucommune, MyDreamPlus and Kr Space raise hundreds of millions of dollars.
The combined area of co-working space in four first-tier cities in China surged by almost 60 percent between the end of 2017 and October last year, according to industry association China Real Estate Chamber of Commerce.
However, 40 percent of the co-working centers were more than half empty as of October and 40 co-working brands had shut in the first 10 months of 2018, it added.
"There's a shake-out in the flexible office space," said Paul Salnikow, global CEO of The Executive Center, which entered China in 2001 and currently operates 45 premium flexible working centers in nine Chinese cities.
"Since November, we've seen operators in China walking away from centers, trying to give it back to the landlord. We've been offered furniture from some of these people, saying they're trying to raise money."
A common solution for firms appears to be diversification into services that require less capital investment, such as office design and management.
"Our focus this year is 'management output'," Mao Daqing, founder of Ucommune, one of the largest co-working space operators in China, told Reuters.
The company expected to partner with enterprise clients and open another 30 flexible working centers for them this year, providing design and management services, from 15 currently, he said. Ucommune's own branded centers would add five to 10 more to the over 200 already in place.
U.S.-based WeWork started providing such services in China last year and also plans to grow the business.
One industry executive who declined to be identified told Reuters the asset-light model helped to shift rental costs to clients, boosting income.
LANDLORDS AT RISK
A survey of Chinese flexible working space operators by real estate consultancy CBRE in January found that around 68 percent planned to slow or halt expansion this year.
But the rise in vacancy rates and operators dropping out of the business could also spell trouble for Chinese office landlords, especially in major cities like Shanghai where co-working is more common than the rest of Asia-Pacific.
"Co-working operators need to go further asset-light and slow one-off CAPEX investment to stay in operation," said Virginia Huang, CBRE Greater China managing director of advisory and transaction services.
"What this means is landlords also share some risks of this industry, not only the operators."
Terms of underwriting co-operating operators are also changing, with landlords bearing more costs and risks.
Stanley Ching, Citic Capital's head of property, said operators were increasingly seeking fit-out subsidies and leasing on profit-sharing models with landlords, as they become more reluctant to pay high rents to secure space.
LaSalle Investment Management, which rents space to co-working operators in China, said picking the right operators and limiting exposure was crucial.
"They're not recession-proof yet; they haven't gone through a recession, we don't know who's going to survive or who's not," said Elysia Tse, LaSalle IM Asia Pacific head of research and strategy.
"So we'll make sure our portfolio of co-working tenants is a small minority portion."
One positive trend for co-working operators is the growth in demand from larger corporates amid China's broader economic slowdown.
"As companies' outlook on the economy turns conservative and they want to save office costs, they turn to co-working space which provides flexibility," said Ucommune's Mao.
"Our clients for office design service also increased for this reason."