Real Estate

WeWork On The Rocks Again – What Comes Next

Well-informed readers are surely aware that co-working giant WeWork stated last week in a 10-Q filing that “substantial doubt exists about the company’s ability to continue as a going concern”. Given that WeWork lost about $600 million in the last six months and only has approximately $680 million in liquidity currently available, I can see why that warning was necessary. Looking ahead, if WeWork does actually close the adverse impact on landlords could be significant if its leases are not picked up by another co-working operator or several operators.

Accordingly, any future lenders or investors will have to think very carefully before committing additional funds to what has been a money-losing business from day one. Indeed, it is a distinct possibility that other coworking operators will look to scoop up the profitable locations in a bankruptcy sale.

Further, I don’t think this development tells us much about the future of the office market because WeWork has been a money-losing business from inception in 2010, even though it was once valued at $47 billion. While WeWork had a brilliant idea that revolutionized life in the office and how we work, it was never a profitable business. That said, this news was certainly an unwelcome development for landlords in major markets like New York City, where WeWork has a major presence estimated at 6.8 million square feet.

WeWork said in a statement that it will focus over the next 12 months on reducing rental costs, negotiating more favorable leases, increasing revenue, and raising capital. But how many bites at the cherry is WeWork going to get? The company has already been through more out of court restructurings and reorganizations than you can shake a stick at. According to Barclays Bank, since 2019 WeWork has already amended over 590 leases in a combination of partial terminations to reduce its lease space, rent reductions and rent deferrals, offsets for tenant improvement allowances and other strategic changes. Guess what – that is the work normally done in a bankruptcy proceeding, as in a bankruptcy unprofitable leases can be rejected by the debtor, while profitable leases can either be assumed or sold at auction.

WeWork has done everything possible in the business cycle that can happen to a company – except make money. They have been scammed by their founder, tapped the international private investment community and credit markets, borrowed billions from Softbank and obtained equity funding via public offering through a special purpose acquisition company. One would have to have a very strong stomach to invest in this company with fresh money going forward. WeWork was a great concept, but its business model was flawed from the start by overpaying for leases. But when the case study of WeWork is finally written at business schools, it is more likely to be seen as fitting the old paradigm of a company founded by a charismatic individual with an innovative idea who expanded too quickly and engaged in self-dealing to boot. There’s nothing original or new about that.

If WeWork goes under, it could have a particularly damaging impact in my neck of the woods – New York City – where I am the president of a company that helps tenants lease office space. WeWork is one of the largest tenants in New York City with over 70 leases spread over many landlords, both well-known and otherwise. Indeed, at one point WeWork was the largest tenant in NYC. Fortunately, New York is an approximately 540 million square foot office market (the largest in the world), so while the impact of a possible WeWork closing would be significant, it would not be fatal.

Nevertheless, the potential fall of WeWork will have consequences, most notably for its landlords in the event of a WeWork default. Many own properties that are already under stress, particularly if their loans are expiring and the landlords are facing higher interest costs without a replacement tenant for WeWork. Of course, under the WeWork model, WeWork effectively sublets to thousands of member tenants that could remain in its spaces even if a WeWork overlease is rejected in bankruptcy. It will be a substantial administrative burden for the landlords to take over management of the co-working spaces, but they may have little choice absent other co-working buyers stepping in to take WeWork’s place by purchasing their leases at auction.

Of course, Softbank has billions of dollars of sunk costs in WeWork. Will they come to the rescue again? Or will there be a bankruptcy auction of the leases? Other co-working operators may believe that they can run the place better and may relish the opportunity to buy up the leases for profitable locations. But one thing that WeWork’s struggles do not mean is co-working is dead. The idea still has vitality and there is considerable demand because of the flexibility of short-term leases and the camaraderie that co-working centers offer to their tenants regardless of which company is operating them.

Another major challenge WeWork now faces is the classic problem of a self-fulfilling prophecy, which we regularly see when a company is known to be considering a bankruptcy filing. The troubled company’s customers – in this case WeWork’s members – are understandably reluctant to do business with it going forward until its status is clarified. Given the widely publicized news about WeWork’s situation, what new tenants are going to sign up for new leases, or as they are called, membership agreements? Further exacerbating the situation, most of the WeWork leases are either month-to-month or for short terms, which were widely embraced by tenants. So what will tenants do at the end of their leases? Many WeWork members will likely look for alternative office arrangements until WeWork’s future is resolved, making the situation worse.

In the short run, WeWork’s troubles mean more dislocation to an already battered office leasing market and pain for landlords currently facing high vacancy rates due to remote work and a 525-basis point increase in interest rates. No wonder Starwood CEO Barry Sternlicht recently said in a Bloomberg television interview with David Rubenstein that the real estate industry is “in a category 5 hurricane.” Nevertheless, even with that dire prediction and all due deference to John Maynard Keynes regarding the long run, I am an optimist on the long-term future of the office and cities in general. More on these issues to come in future columns.

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