If you expect N ones at the output, how can this machine be simulated in the space smaller than N?
This machine must decrement the digit N at the beginning of the tape, and move to the end of the tape to write "1", so it runs in time O(N^2), not O(N)? (as it takes N "trips" to the end of the tape, and each "trip" takes 1, 2, 3 .. N steps)
Since turing machines can not jump to any place on a tape in constant time (like computers can), does it have any impact on real computers?
But to answer your question: "space" here refers to working space, excluding the input and output.
EDIT: This makes sense because if you look at all problems with N outputs then that is just the same as "gluing together" N different decision problems (+ some epsilon of overhead)