Coworking Industry Set to Grow, Challenges CMBS Underwriting: Morningstar


Coworking is poised to play an increasingly significant role in the commercial real estate industry and will pose challenges to underwriting and valuation standards in the commercial mortgage-backed securities market, analysts at Morningstar Credit Ratings wrote yesterday.

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As of November 2016, coworking companies leased approximately 1 million square feet backing 1.1 percent of the $139.32 billion in outstanding CMBS.  

While few CMBS loans have coworking exposure at the moment, economic uncertainty could mean that corporate tenants will switch to coworking space to manage expenses and space. Morningstar analysts are particularly focused on office tenants that signed inxpensive, 10-year leases after the financial crisis and could face hefty price increases at the time of lease renewal. Analysts found that leases on 182.2 million square feet of office space, backing $75 billion in CMBS, expire through 2018. If only 1 percent of those tenants switched to coworking, the amount of coworking space in CMBS would double.

“In today’s fast-changing and uncertain business environment, flexibility and agility are priceless,” analysts wrote. “As companies of all sizes are tightening expenses and space, we expect coworking to expand because of enduring trends that are shaping workplaces.”

The growth of coworking space will likely be uneven, adding an extra layer of risk.

“We believe growth will come in fits and starts, as factors such as unpredictable revenue streams, lack of long-term commitments and economic uncertainty will play a role,” analysts wrote. “Additionally, fixed costs can be high because coworking providers usually rent their space upfront and must build out the space and amenities before they can lease space to tenants.”

As the coworking space evolves, underwriting and valuation standards must also evolve in order to protect investors from cash flow volatility. While larger and better-capitalized companies will account for a larger part of the sector, investors may experience some bumps as smaller players come and go. To counteract this volatility, lenders may seek additional security in coworking space-backed CMBS loans as a protection mechanism.

Morningstar identified six coworking companies that are among the top five tenants for CMBS collateral. WeWork, perhaps the best-known company, currently operates 128 coworking locations in 39 cities. WeWork has become one of New York City’s largest occupiers of commercial real estate, leasing 2.8 million square feet as of January 2016 according to Newmark Grubb Knight Frank—a massive increase from the 42,000 square feet it leased in 2010.

As previously reported by Commercial Observer, WeWork’s growth has had its share of industry speculation, but CMBS exposure to the company is small. It leases roughly 500,000 square feet in eight properties that back $514.1 million in loans. But, as the company leases more than 40 percent of the space at six properties backing CMBS loans any future problems could be magnified due to concentration risk.—C.C.