When a loan to the We Company’s newly-formed $2.9 billion property investment fund, ARK, was taken to the commercial mortgage-backed securities market in August, analysts had some concerns.
Beyond conflict-of-interest issues stemming from the fact that ARK was using the loan to finance its purchase of 600 California Street, where WeWork would be the largest tenant, credit analysts from Morningstar and S&P Global also questioned the very viability of the company and its business model.
“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’s report noted in mid-August, soon after the co-working firm released its IPO prospectus, which has polarized investors.
S&P echoed the sentiment, pointing out that, “There is inherent risk to the sustainability of the co-working business model in an economic downturn, during which tenants may rapidly cancel their memberships as employment dynamics shift.”
This was far from the first time that credit analysts have shown skepticism in WeWork. 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.
Map by Yoryi De La Rosa
These concerns have become more pointed in recent years, as the prospect of a recession and the firm’s planned public offering later this month have resulted in greater scrutiny of its business model. This week, the company announced sweeping changes to its corporate governance. (Fitch Ratings on Friday said this amounted to a “credit positive” after its downgrade of the company last month.)
“WeWork has yet to prove itself in an economic downturn,” said Michael Brown, the managing director of CMBS ratings at Kroll Bond Rating Agency. “That’s the risk that we see and frankly is very difficult to quantify at this point.”
WeWork declined to comment, citing its pre-IPO quiet period.
In mid 2017 — well before concerns about WeWork’s viability in a recession became widespread — Kroll began including a warning about WeWork and co-working in pre-sale reports for CMBS loans on properties where the company is a major tenant, TRD’s analysis found.
“Although the company has grown each year since it was established in 2010, short term space users may be more vulnerable in an economic downturn compared to traditional long term office leases, which has the potential to impact WeWork’s operating profitability and, in turn, its ability to maintain its lease payments,” a Kroll report noted in August 2017, in reference to the six-story mixed-use property at 8 West 126th Street in Manhattan, where WeWork is the sole office tenant.
Six more Kroll reports published since then have contained similar wording, with WeWork’s presence at a property always listed as a negative among “Key Credit Considerations.”
Kroll’s view of WeWork appears to have been less negative before 2017. Though some of the agency’s ratings reports from 2014 to 2016 mention “tenant concentration” as a negative for properties where WeWork was a large tenant, no concerns were raised in regard to WeWork or its business model in particular.
WeWork competitor Knotel received similar treatment from Kroll in a March 2018 report for 22 West 38th Street, where Knotel is the largest tenant with more than half of the 12-story building’s total space. Kroll’s report made the same observation, noting its potential vulnerability during a downturn, which could “impact Knotel’s operating profitability and, in turn, its ability to maintain its lease payments.”
Meanwhile, fellow flexible workspace provider Regus has not drawn much attention from credit analysts. At most Regus properties examined by TRD, the firm was not a large enough tenant to pose significant risks for the building’s overall financing.
But as rating agencies have highlighted the downsides of WeWork as a tenant, landlords continue to focus on the positives in their public statements.
“WeWork is well prepared for the future,” Marc Horowitz, the head of leasing at Cohen Brothers Realty Corp., said after WeWork expanded its lease in October 2018 at the Red Building in Los Angeles. Months earlier, a Kroll report had highlighted WeWork’s presence at the property as a negative credit consideration.
At the same time, details included in ratings reports show that landlords have been attuned to risks associated with WeWork. At Ivanhoe Cambridge’s 85 Broad Street, up to $10.8 million of the lease’s value is guaranteed by the We Company. And at Winter Properties’ 57 East 11th Street, WeWork is providing a $7 million security deposit on top of a $8.2 million parent company guarantee.
Ivanhoe Cambridge has gone on to be a major partner of WeWork’s, contributing $1 billion in equity to the ARK investment fund. A spokesperson for Ivanhoe Cambridge declined to comment, while other landlords identified in ratings reports, including Cohen Brothers Realty, Winter Properties and A&H Acquisitions, did not respond to requests for comment.
To further mitigate risk, lenders have required landlords to maintain reserves for a “cash flow sweep,” clause, which makes it mandatory to use excess free cash flows to pay outstanding debt in the event WeWork defaulted on its lease payments. Brown, the Kroll analyst, said this is not unique to WeWork but to tenants that hold a majority of space in buildings.
As the Wall Street Journal reported in July, major landlords like Columbia Property Trust and SL Green have also been demanding bigger guarantees from the company for its leases recently.
“We’ve gotten what we feel is very fulsome coverages between letters of credits and parent guarantees,” SL Green director of leasing Steven Durels said in an earnings call in January. Although he declined to discuss specifics, “I can tell you that from a credit perspective, we think we are well protected.”