Leasing activity by coworking and flexible workspace operators, which has been growing at a frenetic pace, is accelerating at an even faster clip. In our January 2019 U.S. Flexible Workspace & Coworking report, we noted that coworking inventory across the 19 markets we surveyed increased by almost 50% in the 18-month period ending in Q2 2018 to a total of 27.2 million square feet.

Coworking inventory growth in the second half of 2018 (H2 2018) has been even more dramatic, with operators leasing 5.8 million square feet of space, in 92 transactions of 25,000 square feet or more, increasing flexible workspace inventory by a further 21%. All of this is occurring at a time when the real estate industry is starting to question the sustainability of the coworking model in a cooling economy.

Where is this growth taking place? Manhattan remains by far the dominant market with a further 2.7 million square feet leased by coworking firms in H2 2018, equivalent to 47% of the total. Manhattan saw more coworking space added during this period than the remaining top 10 markets combined, where a further 2.4 million square foot was leased, led by 585,500 square feet taken in Washington, D.C. San Francisco and Dallas follow next at 482,250 square feet and 331,800 square feet, respectively.

Outside of Manhattan, coworking inventory growth to date has been strongest in markets with a significant tech presence such as Boston, San Francisco and Seattle. As such, Dallas and Washington, D.C. are playing catch-up. Among the nine secondary markets we surveyed, coworking leasing volume in Denver, bears out the continued attraction of tech-centric cities, with 226,600 square feet of flexible workspace added in H2 2018.

Who’s taking the space? WeWork’s dominance in terms of sheer size is undeniable, with 3.6 million square feet of leases signed in the second half of 2018, representing 62% of the overall total. Half of the space leased by WeWork during this period (1.8 million square feet) was in Manhattan across 21 properties. The company signed a further 25 leases across 11 cities in the same time period led by four leases apiece in Denver, San Francisco and Washington, D.C.

Regus’ creative working concept, Spaces, follows next with almost 840,000 square feet leased in 14 transactions across nine cities, including two leases of more than 100,000 square feet in Manhattan. In third place, flexible workspace provider Knotel signed nine leases totaling 375,000 square feet. While Knotel’s footprint is primarily focused on Manhattan, two leases totaling 86,000 square feet were signed in downtown San Francisco.

How sustainable is this pace and the coworking model in general? While flexible workspace still accounts for less than 2% of office inventory across our survey base, the success of the concept has broken the mold in terms of lease structures and raised the bar for tenants’ workspace expectations.

Evidence from the first quarter of 2019 shows that there is no sign of a slowdown, particularly by WeWork, which signed a further six leases of 100,000 square feet or more during the first three months of the year, and 11 of the 15 largest leases signed by coworking operators across the 10 leasing U.S. office markets during the same time period.

WeWork’s activity in Q1 2019 was led by a 250,000 square foot lease at 1 Lincoln Street in Boston’s Financial District and 201,230 square feet taken at 199 Water Street in Downtown Manhattan. The growing share of enterprise clients, who now account for 32% of WeWork’s customers, is a factor in the company’s confidence, as well as a reported $2.2 billion in pending new membership contracts.

As the coworking sector matures and the U.S. economy–and thus, office market–cools, we expect that mergers and consolidations will rise. Acquiring a locally-based niche player is a quick way of establishing a presence in a new market. At the same time, look for operators to continue to diversify their offerings—both to differentiate themselves from their competition and attract a broader client base. In one recent example, Convene announced a partnership with healthcare startup Eden to place clinics in some of its properties.

One question sits front and center. How will coworking fare in a cooling economy and slowing office market? Three central issues present themselves: the extent of any downturn, tenant preference and the operating model.

A significant market correction would present the greatest challenge to the sector—especially if office rents start to fall. WeWork announced that its occupancy rate fell from 84% to 80% in 2018. Although this is partly a function of its rapid expansion—adding more space to its portfolio which then takes time to lease up—will such operators see occupancy fall further in a declining market? A balance will need to be struck between remaining competitive on pricing while satisfying investor expectations.

Occupier response is crucial. If profits fall and budgets tighten, will firms still embrace the flexible workspace concept or retreat in to under-utilized space leased directly elsewhere in their portfolio? Mid-size companies and enterprise clients are now firmly established users of flexible workspace. While the startup community will likely shrink if venture capital funding declines, the choices made by these larger tenants will be the key determinant of how coworking would fare in a recession.

Some tenants may choose to decamp into secondhand and sublease space due to the lower rents and short lease terms on offer. However, while being cognizant of costs, enterprise clients may still demand the combination of a quality collaborative and creative environment with occupancy flexibility that high-end coworking space provides.

As landlords and operators seek to hedge risk, we expect that partnership and revenue share agreements will continue to rise. Under this model, providers are freed up from signing a long-term lease while owners have a partner in place responsible for, and committed to, taking care of managing, maintaining and marketing their space, even in a downturn.

Stephen is the National Director of Office Research for Colliers International, where he focuses on analyzing office property trends, compiling Colliers’ thought leadership and delivering timely market projections to provide clients with a leading edge in our industry.