The Co-Working Giant Spirals Amidst Liquidity Crunch Sparking Landlord and CMBS Worries

Alison Griswold’s Oversharing newsletter has been all over the WeWork mess and this recent missive includes a solid and stunning collection of links-all-things-WeWork. Things could get even worse if a financing doesn’t get done. Like, soon. Per The Financial Times:

WeWork’s bankers are scrambling to complete a new debt financing package as soon as next week to buy time to restructure after the company’s failed initial public offering left it running short of cash at a faster rate than expected.

Two people briefed on the fundraising efforts said the office company’s cash crunch was so acute that it had to raise new financing no later than the end of November. Fitch Ratings downgraded WeWork’s credit rating last week to CCC+, warning that the lossmaking company’s liquidity position was “precarious”.

Fitch estimates WeWork’s current funding arrangements might only carry it through another four to eight quarters unless it rapidly reduced the rate at which it has been burning cash.

Interest payments are, of course, small potatoes relative to massive lease obligations but WeWork has $702mm of 7.875% unsecured notes with biannual interest payments. Its next payment is due 11/1/19. That would be a $27.9m nut. The timing couldn’t possibly be worse.

This barrage of bad news has the haters drooling:

In other words, nearly 10% of the outstanding unsecured bonds are short. Man, the vibe around this thing isn’t exactly Kibbutz-like.

Some other bits here: (i) JPMorgan Chase & Co. ($JPM) is trying to get other banks to participate in the “emergency financing package” but the-always-winning-to-the-point-of-the-game-seeming-rigged Goldman Sachs Group Inc. ($GS) is currently not in talks to participate, effectively walking away from an earlier IPO-based commitment to the company; and (ii) Softbank may sink more money into this pit but is renegotiating the price of its earlier issued shares in the process (read: this is leverage baby).

If you’re wondering why a senior lender might be hesitating to join JPM in a syndicated senior secured loan, the issue may very well be this: secured by what, exactly? In terms of assets, the company has roughly $15b in leases (which, obviously, have an offsetting liability, and the quality of which will be variable and in need of examination) and $7b of property and equipment, i.e., desks, chairs, barista equipment, yogababble, etc. Given all of the beer swilling and hooking up that occurs at these places, equipment has a questionable lifespan and, by extension, value.

Compounding matters is the fact that enterprise tenants — a key component to WeWork’s go-forward viability — appear to be balking. Per The Information:

“We were looking at doing a couple deals [with WeWork], and thinking about it quite differently now. Are they going to invest in the market?” said Robert Teed, vice president of real estate and workplace for ServiceNow, a publicly traded cloud computing company that puts some of its employees in WeWork spaces. “It’s making us stop and think. It’s awfully noisy. Will they do what they say they’re gonna do?”

And, so, people are beginning to fear what happens if…uh…as?…WeWork falls. Here is a Wall Street Journal article about the President of the Federal Reserve Bank of Boston’s concerns about WeWork, co-working and CRE. It seems his concerns may not be misplaced: cracks are beginning to form in Boston’s commercial real estate market, generally. Here is a Financial Times piece about WeWork halting new lease agreements, a move that “will rattle commercial property owners across the globe who rented to WeWork, which often upgraded the spaces so the group could re-let the buildings to its own customers.” This change in pace will “cut[] out a significant source of demand in large urban property markets where it operates.” Landlords are battening down the hatches. Per Financial Times:

Two landlords of large WeWork sites in London, who asked not to be named, said they would not sign new leases for the foreseeable future and were making contingency plans for their existing WeWork offices in the event of a restructuring.

“It would not be prudent for us to do anything [new] with them until we see how the new management will operate,” one landlord said.

The magnitude of this cannot be overstated. WeWork accounts for over 7mm square feet of office space in New York City alone — making it the largest tenant in the Big Apple. Its $47b in lease obligations is well-documented — including $2.3b in obligations due in 2020 — but to put that in perspective, that figure puts WeWork in third in terms of lease commitments IN THE WORLD.

So, the first question is, “what happens to the existing money-losing properties if WeWork cannot sure up liquidity?”

Back to the FT:

Alex Snyder, assistant portfolio manager at CenterSquare Investment Management in Philadelphia, said: “WeWork has structured many of its leases so that they can simply collapse the special purpose entity it’s trapped in and walk away. This vacancy pressure on the market [would] be painful.”

This ⬆️ is a nuance that a lot of the media — quick to push a sensationalist bankruptcy narrative — seems to miss. The company is set up like a REIT with each individual property non-recourse to the parent. If properties fail, WeWork will just “mic drop” the keys and walk away, leaving landlords with large spaces to fill. What happens then is anyone’s guess. Another co-working space takes over? 🤔

Which gets us to the second question, “if WeWork is no longer expanding, who will fill CRE supply?” These charts ought to give you a sense of the magnitude of WeWork’s reach ⬇️. With this halting, landlords will need to start looking elsewhere.

To add an another layer to this, all of this has people concerned about CMBS exposure. Trepp recently issued a report on this issue. They conclude:

WeWork is certainly a growing exposure for the CMBS market; one that concerns people. The volume of WeWork loans in CMBS, post 2010, is approaching 1% of the entire CMBS market and about 4% of loans backed by offices, so that exposure is meaningful.

The biggest issue is not the pulling of the IPO per se, but the broader concerns about the firm’s viability. The worst-case scenario would be that the firm continues to burn through cash and can no longer support all of its lease obligations. If that were followed by a period of non-payment of rent by WeWork, but physical occupancy and current payments by the firm’s sub-lessees, that would make for some interesting work for landlords and special servicers. Stay tuned.

Wolf Richter — someone who has a reputation for alarmist takes — adds:

These “special servicers” may already be licking their chops. When a CMBS loan defaults, or sometimes even when the building loses a critical tenant but the loan hasn’t defaulted yet, servicing gets switched from the master servicer to a special servicer, as laid out in the pooling and servicing agreement (PSA). The special servicer’s role is to figure out if the borrower can become current via a loan modification or a debt workout. Under many PSAs, special servicers have the right to purchase the building at a discount if the very same special servicer decides the loan cannot be brought current. So, yeah — this might get interesting.

And there are additional complications. WeWork is so large in some markets that a reduction in leasing demand from WeWork, or an outright unwinding of its leases, would put downward pressure on rents and prices in those markets, making it that much more difficult to sort through the fallout in the market from problems at WeWork.

Stay tuned indeed.

*****

More on WeWork: here is a provocative thread about WeWork’s effect on the venture system and what its failure presages for other unicorns in growth-at-alls-costs-even-if-the-business-model-is-faulty mode; here is the WSJ and here is Bloomberg’s Matt Levine, respectively, discussing the personal loans to Adam Neumann; and here is a pointed must-read Harvard Business School study discussing the company’s business model. We particularly enjoyed this bit:

Fundamentally, WeWork engages in “rent arbitrage” by signing long term leases, generally 15 years, at one rate and subleasing the space to SMEs and Enterprise members at with shorter durations. While the cost per desk is lower for the member, the aggregate rent WeWork receives is higher for the space due to the density.

The practice obviously creates a duration mismatch which leaves WeWork, or the special purpose vehicle that entered into the lease, exposed to market fluctuations in the event of a downturn. The short duration of the subleases leaves WeWork exposed to the risk that tenants might abandon the space on short notice leaving WeWork liable for the master lease obligation. They are also exposed to the credit risk of the SME subleasees.

WeWork does not believe a market downturn will impair their business. To the contrary, WeWork maintains that as businesses contract, they will be attracted to WeWork’s business model as it will offer SMEs and larger Enterprises the needed flexibility and lower cost structure per employee during a recession. Indeed, Neumann highlights that the Company was founded during the Great Recession and attracted tenants. Time will only tell if this will be accurate, but it is worth noting that their main competitor, Regus, now IWG, went bankrupt during the Great Recession. (emphasis added)

BURN.