Over the past 12-months, co-working operators have leased more than 700,000 square feet of floor space—and currently negotiating on a further 900,000 square feet—in Hong Kong as they seek to grow their service offering and gain a dominant market share. While the sector’s growth has been a boon for landlords filling vacancies, its rapid expansion comes at a time when the rental market appears to be entering the later stages of a 10-year growth cycle and is further fuelling the debate over the long-term sustainability of co-working in the city.

One of the big question marks on co-working has been the argument that it is essentially a business model built around subletting; where operator margins depend on the revenue being generated from subscribers exceeding rent paid. This model inherently works well when rents are on the rise but there are concerns that it may not be as viable in a market downturn when landlords lower rents below what the operators are paying. Whilst some operators have been able to secure more flexible leasing terms with landlords, in some cases committing to a profit share fee structure rather than rent, such arrangements are the exception rather than the norm.

While this argument seems to make sense at a higher level, it does not take into account the counter-cyclical features that co-working offers.

Firstly, co-working provides flexibility. Historically, when rental markets in Hong Kong turn south, they are usually accompanied by a big drop in demand. All major corrections over the past 30 years have arisen from a major global economic event. Yet it is also during these periods of uncertainty that office occupiers typically prioritise flexibility above all else. In this regard, the demand for flexible real estate may actually benefit the co-working sector.

Secondly, occupiers can still benefit from lower rents if they are willing to move to more decentralised locations or non-Grade A office buildings; not dissimilar to what we’ve seen in the past when occupiers were forced to relocate as part of a broader effort to control costs. With the rental gap between Central and other major office submarkets in Hong Kong currently averaging from a range from HKD 70-110 per sq ft per month, co-working operators in decentralised locations will have plenty of scope to attract occupiers looking for both real estate flexibility as well as cost control.

Thirdly, downturns can sometimes lead to an increase in demand for smaller offices as laid off senior executives seek to establish their own enterprises. In a 2013 news article, The Executive Centre noted that its banking-related client base in Hong Kong increased from 29.5% to 51% between January 2010 and 2013 with 102 individuals from the banking sector setting up shop in their offices in 2012 alone. Given the similarities between serviced offices and co-working, it is easy to see how operators could potentially experience an uptick in demand in a market downturn.

Lastly, co-working can help lower upfront costs associated with relocation by amortising the capital expenditure involved in moving into and fitting out a new office. In a market downturn, access to funding is always a lot more restrictive. The impact of capital expenditure on cash flows cannot be overstated. In the past, we have seen occupiers being forced to renew at higher rental levels rather than taking the lower rental option because of difficulties in securing upfront capex. Opting for a co-working solution would help mitigate this issue.

Based on the above assumptions, it would appear that operators in decentralised locations where rental gaps against Central are already quite significant may perform better. But this doesn’t necessarily mean that operators paying higher rents will simply capitulate. Those with larger portfolios, especially with a strong presence in decentralised locations, will be in a better position to weather a downturn.

Moreover, if we look at co-working beyond the optics of subletting and view it as a service then the viability of the business model extends beyond a simple discussion around subscription rates and office rents. Operators are increasingly using technology to capture user data and exploring how this data can be monetised to serve as an additional income stream. While the full value of this data and other services remains unclear at this stage it could potentially allow for operators to absorb lower margins—or even losses—for some locations whilst staying profitable, overall.

It will be interesting to see how co-working shakes out when the rental market eventually turns, which is an inevitability. Just don’t be surprised if the sector holds up better than expected.

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