Co-Living

Group 14 – Alexa Vittoria, Niranjan Gadkari, Max Rodman & Bruce Phelp

Co-living is a new approach to an old model. It is the concept of developing properties – or entire communities – that combine living spaces with functional amenities and services. These properties are actively managed by a brand that produces events and curates a community feel for residents.

Co-living has existed over the ages in many forms – Danish housing associations, the Israeli Kibbutz, and more. In its modern form, co-living is beginning to take the shape of large-scale, institutional residential developments in central, urban locations.

The problem: we need more housing in cities. Major global metropolises are already over-crowded. The global population will grow from 7 to 11 billion people in the next 20 or 30 years. The urban population will increase from 55% to 75% in the same time period. People cannot afford to buy homes anymore and many are finding it increasingly hard to afford rent.

A solution: co-living, at scale. Co-living developments typically shrink the size of the apartments to ~25 sqm, fitting c. 2x as many people in a given building. They also provide workspace for residents, removing the need for a separate office space, which eventually will free up more space in cities for accommodation. In return for a small apartment (relative to what people are used to), co-living delivers tenants an affordable apartment in a central location, flush with services and amenities and community management that middle-income tenants would only have dreamed of previously. Co-living makes life convenient and flexible for young professionals, expats, or anyone else looking to infuse more community feel into their lives.

 

 

While the concept is great conceptually, how does it tie-in with the United Nation’s Sustainable Development Goals (UN SDG’s)? In fact, several UN SDG’s are relevant to the real estate and housing sectors:

3. Good health and well-being
4. Industry, innovation and infrastructure
5. Sustainable cities and communities

As a whole, the real estate industry is moving towards a focus on sustainability, and specifically the goals (3, 9, 11) above. Investment firms, developers and municipalities all have these concepts in mind as they develop properties and communities. That said, real estate is so often still a number and IRR driven industry, and developers comply with these goals as long as they are consistent with achieving return targets.

Co-living is, in some ways, a breakthrough business model in real estate. It is what we will call a ‘win-win-win’ amongst landlords, tenants, and societies:

–        Landlords benefit from achieving higher tenant density in their properties, ultimately translating to higher rental yield on investments

–        Tenants benefit from gaining access to quality, affordable apartments in central locations that fit their preferences, lifestyle, and social needs. All they had to give up was a bit of extra space that they weren’t using anyway.

–        Society benefits from:

o   Potential for huge amounts of additional housing in urban locations given the possible boom in the co-living sector

o   Co-living developments tend to be developed and inhabited by forward and global-thinking people, who pay close attention to energy efficiency, sustainable material use, and other key ESG topics.

o   Co-living properties also tend to focus on health and wellness, encouraging healthy lifestyles and behaviors in the properties as much as in and around the local communities.

 

 

How do these goals compare to the industry’s current sustainability goals?

The real estate industry has a relative degree of sustainability orientation. Most modern developments, whenever possible, strive to achieve BREEAM or LEED Certifications. These certifications are ‘stamps of approval’ to validate that a given building complies with a variety of standards regarding heat, energy, water, and other efficiencies. They have been successful to date, having validated over 1 million buildings, and with a growing pipeline.

In addition to BREAM and LEED, other certifications push real estate developers to think about human wellness as well as environmental factors. The WELL Certification, launched only in the last few years, seeks to evaluate properties both on sustainability measures as well as on measures relating to human wellness. Examples include:

• Sufficient light
• Plants and greenery
• Open spaces for socializing
• Appropriate operational plans and working hours, etc.

Between BREAM, LEED, WELL, and other certifications, the real estate industry is taking tangible steps to encourage all actors to build more sustainable properties. These certifications align with all three SDG’s listed above, but the industry still has a ways to go. The certifications are expensive ($100k+ all in cost), so are less feasible for smaller developments with tight margins. Further, they are well known in larger, western cities, but do not yet have widespread adoption in emerging markets. The real estate industry should seek to publish an easy to follow set of guidelines and specifications that will help developers around the world to build more sustainable properties without imposing the cost burden of one of these certifications.

 

 

Are the current initiatives in this industry contributing to achieving your sustainability goals? Where do these initiatives fall short?

The current approach of the building and property development industry is to focus on using greener materials and more sustainable designs. The overall goal is to reduce daily energy requirements as well as reducing the environmental impact of the initial construction.

Institutions such as the Green Building Council provide accreditation for buildings that meet a level of sustainability, and this has incentivized a shift in the industry. However, these initiatives only focus on a single aspect of a greater problem. Developers are still incentivized under the traditional approach, to pursue maximum returns by creating high-end housing or offices in areas where land is in high demand. The net result is that lower population densities are achieved in high demand areas, which means more people are forced to commute greater distances to work, and only the wealthy can afford to live in the city centers. Thus, while the buildings themselves may be more sustainable, they are not contributing to a more sustainable city and way of life.

 

 

How does this business model outperform existing business models both financially and environmentally/socially? Do financial growth and social/environmental impact form a feedback loop (i.e. the faster the growth, the larger the impact and vice-versa)?

 

Co-living: financial outperformance

Co-living is poised to create a major shift in urban housing because it delivers clear benefits to tenants, landlords, and society.

Tenants:

The average tenant swaps the old model (a c. 500 sqft studio or 1 bedroom apartment) for the co-living apartment. S/he trades largely unused personal space for i) rental savings and unique experiences + hotel-style services. Given the needs of today’s urban dwellers, this is a trade many are happy to make on a sustainable basis.

 

Landlords:

The above graphic illustrates the additional rent/sqft that a landlord earns through a co-living model. In this example, standard residential rental models deliver $60 / sqft p.a., while co-living delivers $90 – $98 / sqft. It is important to note that a co-living operation requires additional operating expenses given the staff and operational load.

As a result, while rental income increases by c. 50% on a per sqft basis, co-living NOI (net operating income) typically increases by 15% to 25% vs. traditional residential models. This increase often translates to an additional 150 – 250 bps of rental yield on a development, and often delivers outsized returns to co-living developers. Seen through an alternate lens, a co-living developer targeting the same returns as with standard residential products can bid more for development sites. If this holds true over the next 5 – 10 years, co-living should gain significant traction as real estate investors realize its potential to help them acquire properties and increase assets under management.

Co-living as a model, therefore, is sustainable. It outperforms existing residential models from both tenants’ and landlords’ perspectives.

As far as sustainability is concerned, co-living should perform on par with – or better than – existing models. Co-living developers are especially aware of environmental trends (given their positioning with young professionals), and focus on achieving LEEDS, BREEAM, or WELL Certifications. Additionally, co-living creates community for its tenants. Given the growing loneliness and isolation epidemic that plagues modern, technologically-enabled society, co-living goes a step further in its benefits for society and alignment with the SDG’s.

Happily, co-living presents a positive flywheel effect of growth and impact. As the co-living sector grows and more developers realize the financial gains of the business model, more properties will be built. Thus, more tenants will learn about the model and will seek a co-living lifestyle for themselves. The net effect is an uptick in the number of people co-living and thus greater sustainability in large cities.

 

 

Why could this innovation be game-changing (demand and/or supply point of view)?

The co-living movement could be game-changing on two fronts; it could not only solve some serious gaps being experienced in the demand for housing, but it also has a chance of alleviating gaps on the supply side.

The demand for housing has changed over the years. As new generations come and go, we transitioned from a society that lives communally, to one that believes in the dream of owning a home. As supply constraints have emerged, demand has had to react and behaviors have changed. There are also intergenerational changes in demand which the market is not adequately addressing. This is where co-living could make a difference.

The first way co-living meets demand is by providing inhabitants of the housing an experience. Millennials have shown that they prefer to discover and experience things rather than acquire them, and home ownership is a goal fewer and fewer millennials are aspiring to, either because they can’t afford to or because they would rather spend their money today. Co-living meets this need because it offers its inhabitants the prospect of living in a high quality, stylish and modern residence with good amenities without owning the property. The free capital can then be used elsewhere.

The second demand gap that co-living aims to address is that of social interaction. Due to the degradation of the nuclear family and globalization, there have been significant increases in the rate of loneliness amongst adults. As such, residents seek social interaction and community. Through communal spaces and community managers, co-living is creating an entirely new avenue for social interaction.

The final demand gap that co-living solves for is the demand for time. As working hours get longer and the pace of life quickens, people now seek ways to save time. Co-living companies assist in this manner by including cleaning services, basic supplies (soap, toilet paper) and close-by amenities in the cost of the accommodation.

Additional to the demand gaps, there are some significant supply-side issues that co-living aims to solve as well. These relate to the affordability and quality of housing.

Co-living spaces aim to be cheaper than buying or renting alternative accommodation. This is particularly important in a world where home prices in major cities are often many multiples of income, and especially younger people are susceptible to being crowded out of the housing market.

How does co-living achieve this affordability? Much of it is to do with the efficiency with which the accommodation is built. Not only are the residences much smaller than usual apartments (often under 25 meters square), but they also do not have private living areas. Through this, and by managing the co-living commune, management can achieve economies of scale.

Affordability is not the only benefit of scale. Co-living spaces are often advertised as being energy efficient (due to their modernity) and sustainable (due to the sharing of resources). Furthermore, they are furnished with high quality and attractive furniture, something that most landlords are unwilling to provide.

Co-living has the potential to be game changing on both the demand and supply side. Its ability to provide an experience, promote social interaction at a price easy on the financial and moral purse, could see it being adopted rapidly by not only millennials but more mature consumers as well.

 

 

What are the potential costs and risks of this innovation? What are the barriers to scaling this business model?

Currently, co-living is perceived as somewhat of a millennial fad. The two most significant risks and barriers to widespread adoption are uncertain demand and long-term industry commitment.

Co-living requires individuals to sacrifice personal space and autonomy in their residential lives. While early adopters in the US, urban millennials, perceive the benefits of co-living to outweigh these negatives, it will be more challenging for the industry to convert gen x and baby boomers. These generations tend to equate residential space with success and achievement, even if it requires a sacrifice in location. They grew up with the concept of the American Dream, suburban house with white picket fence included. They value ownership, status and permanence much more than millennials and will be less inclined towards co-living unless it becomes a necessity.

Additionally, the current economic climate, with increasing jobs, especially in urban areas of the United States, does not create an urgency for co-living. People are making more money and can afford their own spaces. Residential booms in large cities are creating more and more housing for these professionals who feel no pressure to make any of the sacrifices required for co-living. Many of these developments also offer amenities similar to co-living spaces, without the social pressure.

Co-living businesses will also need to commit to these business models in order to create a sustainable future for the industry. Maintaining high quality, technologically and environmentally innovative spaces can be resource-draining. As late adopters join residences out of economic necessity, rather than shared values and mission, they will require less from the experience and companies risk shifting back to low-income housing business models. On the other end of the spectrum, as more luxury co-living spaces are built, they risk pricing out lower-income residents and contribute to the cycle of inequality. Savvy developers could work to capture this corner of the market by creating a lower-priced, lean version of the model.

 

 

What are possible next steps to mitigate the risks associated with this business model and to allow it to scale?

In order to mitigate the risks associated with the business model and allow for wide-scale adoption, the co-living industry will need to create a clear value proposition that resonates with a larger portion of the population and provide consistent services that outperform traditional residential models.

Residences will need to be purposefully built to suit the needs of older inhabitants, families, etc. Using a modular approach design with opportunities for customization would be a way to mitigate this risk. Additionally, the industry should adopt a two-pronged strategy to attract the low end and high-end markets with consistent values but amenities to suit their target markets and outperform competitors in the traditional real estate industry.

To generate widespread awareness and interest in co-living, the industry should look to re-brand to appeal to more segments of the population. Additionally, businesses can partner with environmental groups and local governments to educate the population on the benefits of co-living and remove any perceived stigmas.

 

 

What are the potentially negative social/environmental impacts of this business model?

While the arguments for co-living as a contributor to sustainability are strong, there are some potential negative impacts of the business model from an environmental and social perspective.

On balance, co-living is likely to be more environmentally sustainable than purchasing a much larger apartment or house. However, the business model encourages scale, and only with scale does it become viable due to the high fixed cost of property development. The building of very large scale properties will result in extremely high-density population and there is a risk that the infrastructure currently in place at that location (unless it is in an already high-density location) will not be able to cope. This will mean that there may be more congestion and pollution in areas where co-living is prevalent.

The second environmental issue is that at present, co-living has worked far better with a greenfield rather than brownfield development model. This is because the building layout and amenities need to be supportive of the business model. The construction of large buildings is carbon intensive at least initially.

There are a number of social impacts that need to be considered as well. Co-living attempts to solve the loneliness that many people feel in our connected world, but there is also a view that it perpetuates the idea that social interaction is a problem to be solved through innovation. Where living spaces are traditionally somewhere to unwind and disconnect, there is a potential for them to become places where sub-par interactions are forced, and where residents rely on these interactions for their social needs entirely.

Finally, much of the negative press around co-living has been around the way companies make the business model more viable by hiring underpaid staff, often from developing countries. While this isn’t a problem confined to this business model in particular, it remains to be seen whether companies in this space are able to provide the high level of service they want to in a way that is right by their workers.

As is the case with any of the SDG’s, there is no silver bullet, and co-living is not going to solve sustainable city living on its own. The problem is multifaceted and requires a holistic solution that sees a shift in the way we live. With the clock is running on our planet, inertia is not an option. We each need to take responsibility for our part in the problem and make the shift toward sustainability.