The Real Deal New York

Investors discount office buildings with high WeWork occupancies: Cushman

New study shows cap rates expand when co-working tenant has a large footprint
By Rich Bockmann | August 29, 2018 08:00AM

WeWork’s Adam Neumann (Credit: Pixabay and Freepik via Flaticon)

WeWork has spread like wildfire in just a few short years and now occupies more than 5.1 million square feet in Manhattan – enough to fill almost two Empire State Buildings.

But would an investor want to own a property entirely occupied by – or even one with a relatively large exposure to – the co-working phenom?

A new study by Cushman & Wakefield shows that investors apply a discount when pricing office properties with large WeWork occupancies.

“With this new co-working environment, we haven’t yet been through a full office cycle,” said David Bitner, Cushman’s head of capital research for the Americas and co-author of the report. “Particularly on the bank side – which are providing the debt capital – there’s some conservatism on their confidence and underwriting.”

Cushman looked at 17 office buildings across the country that traded between the beginning of 2016 and the start of this year. The study found that properties with high WeWork occupancies traded at capitalization rates that were higher compared to the overall market rate for similar buildings – indicating that investors viewed these properties as risker bets.

“The cap rate actually ended up being higher once you got above 40, 45 [or] 50 percent of the building, in most cases,” said David Smith, Cushman’s head of occupier research.

The report’s results were pretty clear-cut: Of the 17 buildings studied, all eight where WeWork occupied 40 percent or more of the space traded at cap rates higher than the average.

Of those eight properties, six traded at a rate that was roughly 50 to more than 100 basis points higher than the average. The other two were within the normal cap rate range.

When WeWork occupancy dropped below 40 percent, properties generally showed a compressed cap rate, meaning buyers saw them as safer investments. Five out of the nine properties with low WeWork occupancies sold at cap rates that ranged from about 30 to more than 75 basis points below the average. The other four were within the normal range.

There was one building from New York in Cushman’s study: 85 Broad Street in Lower Manhattan, which Ivanhoe Cambridge bought last year for $652 million.

WeWork occupies 25 percent of the 1.1 million-square-foot tower, which traded at a cap rate of 3.9 percent. That was 85 basis points below the average for Downtown Manhattan, showing the highest premium for a WeWork-occupied building in the study.

There are examples in Manhattan where WeWork occupies all or most of a building’s office portion. The company in June signed a 60,000-square-foot lease for the entire office portion of United American Land’s 408 Broadway in Tribeca. And it occupies about 70,000 square feet at the roughly 87,000-square-foot 88 University Place, where WeWork’s sole member is IBM (it’s worth noting that WeWork CEO Adam Neumann also owns an undisclosed stake in 88 University Place).

Bitner said that the market may still have anxiety stemming from flexible-space provider Regus’ bankruptcy following the 2001 recession. But he said he expects WeWork to fare better through the next inevitable economic downturn, and that investors on the other side will feel more comfortable underwriting buildings occupied by the company.

“If that’s based basically on an anxiety about a scenario that won’t actually come to pass, then you could see those assets reprice as we go into the next office expansionary cycle,” he said. “So for a longer-term investor that might be a really attractive play.”