WeWork’s landlords buckle up

With the company in chaos, property owners brace for the worst

Oct.October 01, 2019 11:00 AM

Bill Rudin and Dock 72

For New York City landlords needing a quick fix to fill empty office space, WeWork has been a go-to tenant for years.

Now, with the office-space company in turmoil, those property owners suddenly feel a lot less secure. Some are turning to WeWork competitors to line up options in the event they need to suddenly fill space.

“Many conversations are high-level,” said Katharine Lau, senior director of real estate at Industrious, an office-space company that enters partnership agreements with landlords. “We are seeing an increase across the board.”

Frayed nerves were a common theme in interviews with half a dozen property owners who lease to WeWork, which last month suspended plans for an IPO, pushed out its charismatic CEO and made other changes in an effort to salvage its future.

WeWork has an eye-popping $47 billion in lease commitments to landlords. The company has acknowledged that it sees no clear path to profitability in the near future, and multiple estimates say its cash reserves will only cover rent obligations until the spring. What happens then is anyone’s guess.

Its immediate future is just as cloudy. With its IPO indefinitely shelved, the company is reportedly in talks for a $3 billion debt package from Goldman Sachs and JPMorgan, contingent on more equity being raised, most likely from its largest investor, SoftBank. Another, far-flung option could involve the company being acquired by a larger firm, perhaps with vast real estate assets.

For landlords, neither scenario is reassuring.

“We’re nervous,” said one Manhattan landlord who owns a building entirely occupied by WeWork.

“The challenge of any landlord that has a significant tenant facing financial problems is one of credit,” said Jay Neveloff, the head real estate attorney at Kramer Levin Naftalis & Frankel. “Any potential uncertainty that the rent will be paid will have a ripple effect.”

Some would be able to find replacement tenants more readily than others, and one said WeWork pullouts would present an opportunity to acquire distressed assets.

“I would like to buy more buildings that WeWork is going to go out of,” said the owner of the building wholly occupied by WeWork, “because there is going to be a lot of pain out there.”

WeWork’s troubles began in August, when its IPO prospectus was met with fierce criticism from investors and observers. Landlords held their own muted concerns; some cringed at disclosures in the document, notably egregious self-dealing and conflicts of interest. One landlord even sued WeWork to terminate its lease in a Manhattan building.

In an analysis of two dozen CMBS ratings reports for properties across the country — representing about 10 percent of all active or announced U.S. WeWork locations — The Real Deal found that credit rating agencies have increasingly viewed WeWork, and co-working tenants in general, as a negative in their risk assessments.

Although the risk is minimal for institutional landlords, some have made big bets on the company. Rudin Management and Boston Properties, for example, have anchored their Brooklyn project Dock 72 with WeWork. Rudin also filled 110 Wall Street with WeWork and its co-living offering, WeLive.

Others are still contemplating WeWork tenancy. At 120 Broadway, landlord Silverstein Properties has been negotiating for WeWork to take a full floor. But WeWork has provided no guidance on its intentions with the space going forward.

Rudin, for its part, expressed confidence in its project with WeWork at the Brooklyn Navy Yard. “The Boston Properties and Rudin Development team is excited to open Dock 72 this week, as hundreds of WeWork members are now moving into the building,” said Nick Martin, a Rudin spokesperson, on Sept. 27.

Market impact

The impact of a We collapse would be on individual landlords more than on entire markets. Still, WeWork occupies tens of millions of square feet globally and is the largest tenant by square footage in New York, central London, Washington, D.C., and elsewhere. And New York is its largest market.

From the third quarter of 2017 through the second quarter of 2019, WeWork accounted for almost 3 million square feet signed in Manhattan, or 5.5 percent of the borough’s gross leasing volume, according to Dan Alpert, an investment banker with Westwood Capital, who wrote a column in Business Insider on the topic.

During that period, Manhattan absorbed 2.3 million square feet of commercial space, he said, and without WeWork, gross leasing volume would have declined over the same period by 700,000 square feet.

“When you look at it in terms of absorption, it’s hard to ignore,” Alpert said in an interview.

But a WeWork implosion would not crash the city’s commercial leasing industry.

“While WeWork has a large footprint in New York City, it still represents a tiny fraction of the market,” said Jordan Barowitz, a spokesperson for the Durst Organization. “And there are few landlords who are exposed to a great extent.”

Red flags about the viability of WeWork as a tenant have been raised in investor circles for years. Since 2017, Kroll Bond Rating Agency has seen WeWork’s presence in buildings backed by commercial mortgage-backed securities loans as a negative risk. Aside from concerns about conflicts of interest, the ratings agencies say, the company’s core business model is yet to be tested by a bad economy.

“Our primary concern with WeWork is that while it has been successful pioneering the shared-office concept, the company has yet to post a profit or experience a downturn,” Morningstar noted in a mid-August ratings report on a loan backing 600 California Street in San Francisco. For the same loan, S&P added that “tenants may rapidly cancel their memberships as employment dynamics shift.”

Even so, landlords have increasingly filled their buildings with the office-space company. In New York at least five buildings are occupied entirely by WeWork, and 18 others have greater than 50 percent occupancy.

Some landlords say they took measures to offset the risk of renting to the startup. For example, Rory Greenberg, a part-owner of the Security Building in Miami, where WeWork is the sole tenant, previously told The Real Deal that he was comfortable signing the lease because WeWork said it would do its own tenant improvements and space buildouts rather than bake those costs into the rent.

But as a safeguard against WeWork defaulting on its lease payments, many lenders have forced landlords to maintain reserves for a “cash flow sweep,” a clause that makes it mandatory to use excess cash flow to pay outstanding debt.

Getting debt in the first place has proved a hurdle for some landlords. One New York landlord, who is negotiating an acquisition of a Manhattan building, was approached by WeWork repeatedly about leasing the entire property. But banks considering providing financing for the purchase told the owner that if WeWork was the sole occupant, any debt would be as low as 50 percent of loan-to-value, according to a person familiar with the matter. In recent weeks, the landlord walked away from WeWork’s offer.

Wells Fargo, which has financed 12 buildings with WeWork leases, said that as a general rule, it will not lend to a building that is more than 20 percent occupied by co-working companies.

“We have tried to limit our exposure to co-working and noncredit tenants,” said Mark Myers, Wells Fargo’s head of commercial real estate.

The issue presents a quandary to landlords already providing space to WeWork. While they are restricted by lenders, who are hedging their own bets, WeWork has been offering to take vast floor plates and build out the space — an enticing proposition.

Landlord unease is already emerging in overseas markets. In London, discussions have stalled on two majority WeWork-occupied buildings, including the world’s largest co-working building, WeWork Waterloo, which Singapore-based Bright Ruby Resources had previously agreed to acquire, according to Bloomberg.

It may well be a moot point, anyway: WeWork was reported to have frozen all new lease negotiations in the days following Adam Neumann’s departure as CEO. The company has denied that characterization, and landlord Sage Realty later announced that WeWork had signed a 363,000-square-foot lease at 437 Madison Avenue, a 40-story office tower.

Meanwhile, landlords already leasing to WeWork will keep watching its cash reserves dwindle. One observer spotlighted the corner that landlords are in.

Dror Poleg, a co-chair of the Urban Land Institute’s Technology and Innovation Council and an adviser to Breather, a WeWork rival, said WeWork should hold off on renegotiating leases until the final hour.

“If there’s a crisis,” Poleg said, “landlords won’t have an option.”