01 March 2018

Business model of Co-using spaces and risks

Polly Chu
Partner | Hong Kong

Recently, the concept of co-sharing economy has become increasingly prevalent. The concept of co-sharing is not only limited to physical objects but also include spaces, for example, co-working spaces and co-living spaces and these two have been seen to merge into co-sharing space.

Co-working spaces have become increasingly prevalent. They are very popular in cities with a strong entrepreneurial culture and prohibitive rent – such as New York City and Hong Kong.

The market has developed the concept of co-living from the concept of co-sharing space. In mid-2017, for instance, a property developer struck a deal in purchasing an ultra-luxury complex in Shouson Hill Road and converted it into 270 co-living space as small as 80 sq.ft. for leasing to young graduates, jobseekers, professionals. In fact, many other real estate investors and even small hotel operators are looking to enter this market as there is a strong demand for smaller units amidst of sky-rocketed home prices and rents. By subdividing into more units, the total yield can be substantially increased. Hotels and serviced apartments are particularly well-poised, not least because they require relatively minimal alteration in becoming a co-living space and re-branding it with a new lifestyle and co-sharing concepts, experiences and benefits.

These two trends are increasingly converging. Led by multinational brands in North America, China, and Hong Kong, operators are blending the concept of co-working space and co-living space together. This sharing culture is sprinkled with a heavy emphasis on the spectacular interior designs and lifestyle amenities of the properties such as gyms, shops, cafe and restaurants within the building to enable high quality co-working and co-living spaces.

Although this represents a burgeoning business opportunity, it also raises certain business risks.

Some operators do not hold or own properties in Hong Kong and operate their business by renting premises. They would have to pay high amounts of decoration fees and initial deposits, coupled with insurance expenses and marketing expenses in order to attract customers, members, sub-tenants and investors. At the same time, they may also have to organize social events (e.g. yoga classes, seminars etc.) and uphold and maintain the quality of public facilities and common areas (some premises have a common area which amounts up to 40% of the total gross floor area). These operators would have to face an immense financial pressure upon their commencement of business and they have to generate revenue by collecting membership fees, sub-tenancy rents or help organizing seminars. If these operators cannot meet their financial obligations, they may not be able to continue to run their business and accordingly, may be subject to re-entry by the landlord. This is a risk that operators, landlords, investors, relevant members, sub-tenants may have to face.

Landlords and operators may continue to invest and develop the concept of co-using and co-sharing properties / premises in the future in order to avoid directly competing with developed and matured hotel groups or companies which provide serviced apartments services. However, there are quite a number of legal and business risks involved.

Before the fit out process commences, operators and landlords have to reach a consensus on the rent-free period, the responsibilities and liabilities of the operators and the commencement date of the business operation. Landlords and operators will have to ensure that fitting out works shall not violate any Buildings or Fire Ordinance or any other Ordinance or regulations nor the Government Lease and Deed of Mutual Covenant or Management agreement of the building (if any). If the works to be carried out are those defined under the Buildings Ordinance, then approval has to be additionally obtained from the Buildings Authority and other relevant government departments. The fit out process if not well managed may in essence prolong the rate of recovery of costs and the date of commencement of business operation.

Another tricky problem arises when a number of sub-tenants collectively rent a co-sharing space. Since the co-sharing spaces is being occupied by multiple sub-tenants, there is no clear delineation between them and when one particular facility is worn or torn, the landlord or operator may face difficulty in ascertaining who shall bear the responsibility. As such, the sub-tenancy agreements will have to clearly set out the responsibility for maintaining and up keeping the conditions of the premises and the facilities therein and reflect the potential risk onto the rent amount payable.

Land use will also be an important consideration to any owner or operator, especially given the current trend of co-living and co-working spaces merging under one roof. This will entail a mixed use of the building. Whether or not this will be allowed will have to be determined by reference to the relevant Outline Zoning Plans, DMC and government lease etc.

Furthermore, the types of activities that the members or subtenants or licensees can engage in the building, the loading capacities of electricity, water or air-conditioning or persons per floor, and the occupants' ability to obtain the relevant trade licence for their intended business activities etc. have to be carefully managed. For instance, the landlord may lease a building to an operator, subject to the condition that none of the occupants will engage in food and beverage or money-lending activities. In turn, the operator will need to include such restriction in their arrangement with their members or sub-tenants or licensees.

Another key item to bear in mind is the right of re-entry granted to landlords under most leases. The right of re-entry is the right granted to a landlord to repossess its property if specified breaches of the lease, such as the non-payment of rent, occur. If due to the default of the operator the landlord exercises the right of re-entry, the master lease/tenancy will be forfeited rendering all sub-tenancy agreements to be terminated and forfeited. In other words, the actual occupants of the property will lose their occupation due to the breach of the operator. The operator may then have to bear the loss suffered or incurred by its members, sub-tenants or licensees.

As the entrepreneurial and freelance economy continues to grow, so will the co-working and co-living industries. Despite all the optimism surrounding the business, it is important to be conscious of both the business and legal risks of this market. Those who would like to develop or sign any agreements relating to co-working space or co-living space should consult legal advice before doing so in order to protect their rights.

Polly Chu Partner | Hong Kong

Category: Article