• Fabio De Gaspari

Coliving victims

Updated: Feb 23

During this epidemic times, many coliving brands shouted out their claimed "immunity" to the pressures caused by lack of tenants and distress resonating in the real estate markets, attributing a more residential base than hospitality one, trying to differentiate from the ill-fated cousins (hotel/hostels/short-term rents..).

And honestly, someone is emerging stronger, more diversified and able to recover the level of occupancy way better than other real estate segments.

But coliving has always been immune to failures? No at all, also in "normal" times some operators have gone bust.

Just look at Bedly in 2019: https://therealdeal.com/2019/08/07/after-bedly-what-the-demise-of-a-startup-says-about-the-health-of-co-living-in-nyc/

Growth hacking done from inexpert guys, VC pressures, mismanagement, etc.

You could explore this interview to know better the case https://www.youtube.com/watch?v=K2MQNZnfvOA&t=2957s

Other M&A operations in 2020 covered some distressed situations.

And then this living segment has begun 2021 with a big, sad, announcement: Quarters US operations went under. https://therealdeal.com/2021/01/18/quarters-the-wework-of-co-living-files-for-bankruptcy

The title resonates across the industry also because they claimed to be the WeWork of the coliving. Can't agree more on that, they only waited for the same end.

But i want to digress on the debate that surged after, related to the main cause that collapsed Quarter operations: many industry experts pointed to the master lease business model as the principal reason for the bankruptcy and to an excessive growth strategy unable to cover also a minimum downside. And it's totally true: how is it possible to survive low occupancy for longer when you need to assume long term liabilties, also VC money will finish at one point.

Definitely can we tell that management agreement model is the only one able to survive (sharing the risk between landlords and operators) or that only operating owned assets is the recipe to success? Probably yes.

Is the master lease dead or wrong? Obviously any landlord will now double check the financial position of any operator and they will be pretty skeptic but at the same time also to obtain partnership agreement will be very difficult, particularly because the operator will need scale to be profitable (so large infrastructure, personnel, funds, etc).

My view is that master lease is not wrong, it's only way more risky but also potentially much more profitable. There's a inherent directional bet on the rent market in terms of pricing.

Honestly Quarter has done right to default on their LLC, not because they didn't think that occupancy will recover in the future but because they totally missed the entry locking price.

They signed fixed rents at prices totally different from now:

So here above the price dynamics of a studio in NY: 25% cheaper in a year. It means that your selling price for rooms need to adapt to a drastically changed reality.

And here a 4bdr units in NY: imagine that this is the type of units rented long term by Quarters to be then subleased. Also assuming that they signed a discount for being in size in 2018 (imagine 4750), now it could be rented at 1000$ less!!!! Capitalize this for a long term span and it's easy to understand why it's better to default as soon as possible.

The same in other cities in US, look below Washington:

I imagine that Quarters tried to renegotiate their leases but NY landlords are often unwilling/unable to lower the prices for reasons as taxes, mortgage, CMBS etc.

More insights emerge from this article published on Bisnow: https://www.bisnow.com/national/news/hotel/short-term-rentals-not-all-recovery-107308 where also the lenders are driving market trends, pushing landlords to adopt partnership agreement after suffering arrears with some operators.

BUT: assume that you are a newly launched operator and you need to choose a model, landlords are under pressure, open to negotiate and prices have drastically changed, now you can rent the same size apartments 25% cheaper than a year ago, in NY, at the lowest price since 2015, what would you do it? Is it trying to catch a falling knife? Maybe.

It's like a swap: you pay fix and receive variables. If the variables recover in the years you do large gains. And due to medium short leases of tenants, you can increase quickly your listing prices in case of recovery.

I would say that also master leases at the right prices have a lot of sense, surely more risky for both parts but also way more potentially profitable for the operator. If you sense that the timing is right and the price paid can provide you a good risk/reward, go long and do it!

Obviously i'm conscious that in this model there's a misalignment in terms of incentives: if an operator can exit the contract with this tactic, investors will remain with empty spaces and no income. It's also pretty obvious that an operator acting in this way will have his reputation burned.

This type of decisions are installed in the DNA and business plan of the coliving brand, being a platform or small scale living operator with niche coverage or whatsover will influence the model chosen.

I would not call master lease wrong per se, it could be necessary some times to start and to be part of the growth plans, with the right percentage and taken at the right times/ways.

As in the retail space, where landlords agree to receive a lowered fixed rents plus a turnover based fee o revenue splits, new model of contracts will have to emerge in the coliving industry to better align the two parts. I speculate about pre-agreed minimum guaranteed plus a percentage fee, with some bonus levels and moving bands to renegotiate linked to the rent price dynamics of the markets. Or pure management agreement with some call option on the value of the assets in case of refinancing/reversion.

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