Is Coronavirus the Knockout Punch for WeWork?
By Nicholas Rizzi April 10, 2020 7:00 amreprints
WeWork (WE) ended 2019 with a failed initial public offering, the loss of its bombastic and proselytizing co-founder and CEO Adam Neumann, a huge cut to its eye-popping $47 billion valuation, laying off thousands of workers and needing a bailout from investor SoftBank (SFTBY) Group before it ran out of cash.
The last thing the coworking giant needed was a worldwide pandemic that emptied the majority of its locations, especially for a company where a shared work environment is its raison d’etre. Amid talk of companies wanting to take over entire buildings for their exclusive use, the thought of workers desiring shared, communal space has dropped precipitously out of favor.
WeWork was already facing questions over its survival — as IPO filings showed it burned through billions each year — before the spread of the novel coronavirus wreaked havoc on the global economy. Now there’s increasing fear among some that WeWork could go dark, leaving scores of empty office space in its wake.
“In this pandemic, a business model like WeWork is in deep shit already,” said Alexander Snyder, an analyst at CenterSquare Investment Management who’s been following WeWork closely. “They’re standing on a precipice and looking into a very deep abyss.”
“The longer this goes on, the more and more I worry about them going bankrupt,” he added. “They have a shorter fuse before most things detonate.”
WeWork staked its place in the real estate industry by acting as a sort of middleman between office landlords and smaller companies who would not or could not commit to a standard 10-year lease. Instead, WeWork would sign the long-term lease with building owners, then offer the space to single workers or organizations with more flexible options. That model leaves it on the hook for at least $47 billion in lease liabilities worldwide.
“It’s a risky business model and very exposed to macro-cycles,” said Brad Tisdahl, the CEO of Tenant Risk Assessment which evaluates tenants’ creditworthiness for landlords around the country. “I think people are right to ask the question, ‘What if WeWork and other coworking companies go down because of the economic impact of COVID-19?’”
And the company is already showing some signs of strain. WeWork stopped paying rent in April on some of its United States locations to try to cut costs and hired JLL and Newmark Knight Frank to renegotiate its leases, the Wall Street Journal reported on Wednesday.
“WeWork didn’t pay on any of our locations, we didn’t receive a notice,” Jared Epstein, the principal of Aurora Capital Associates, said during a recent Commercial Observer webinar. “That’s a scary situation.”
A spokesman for WeWork said in a statement that it “believes in the long-term prospects of our locations and our relationships with landlords” and has tried to work with owners on rent.
“Rather than implementing a company-wide policy on rent payments, we are individually reaching out to our more than 600 global landlord partners to work in good faith towards finding asset-specific solutions that benefit all parties involved,” the spokesman said.
WeWork’s occupancy rate fell to roughly 64 percent at the start of April as thousands of its members refused to pay rent or tried to terminate their leases, even after it demanded the fees, the Financial Times reported. WeWork members have already complained about WeWork’s decision to keep much of its locations open and still charging fees despite many of them not using the space.
“It is appalling because they are making members pay membership dues in full yet we can’t use the space, they are not providing any services at all while their employees work from home,” a WeWork member for two years — whose location had a confirmed coronavirus case — told CO in an email. “We have been trying to come to an agreement about April dues but they go radio silent in between communications leaving no just resolution.”
The WeWork spokesman could not provide specific numbers of how many tenants did not pay, but said the company chose to keep its locations open because many members fall under the essential business category.
“WeWork is home to many members whose companies are critical businesses to our society — whether they be in healthcare, insurance, cleaning product supplies or others — that are relying on us in order to continue operating,” the spokesman said. “For that reason, WeWork locations remain open and accessible to members. As we navigate the COVID-19 pandemic, we are committed to supporting our members and will continuously evolve our plans.”
Earlier this month, majority backer SoftBank pulled out of its deal to buy $3 billion worth of shares in WeWork from stockholders, a huge chunk of its multibillion-dollar bailout that took away Neumann’s nearly $1 billion golden parachute. (A special committee of WeWork’s board of directors later sued SoftBank for the move, arguing a breach of contract.)
Even though the news looks bad on the outset for WeWork, some argued it was the right move for SoftBank since it was only slated to mostly help Neumann and certain institutional investors and will free up some money for SoftBank to pump into WeWork.
“That money was just going to benefit existing shareholders, it wasn’t going into the business itself,” said Dror Poleg, a former advisor to WeWork competition Breather and the co-chair of the Urban Land Institute’s Technology and Innovation Council. “I think that’s much better news for WeWork as a business.”
Still, canceling the deal allows SoftBank — which has been trying to sell off $41 billion worth of assets to survive the coronavirus pandemic — to hold back an additional $1.1 billion in financing to WeWork.
“That’s the part that will sting,” Snyder said.
In a letter obtained by CO that was sent to investors on March 26, WeWork CEO Sandeep Mathrani and chairman Marcelo Claure wrote that the company has $4.4 billion in “pro forma cash and cash commitments” as of December 2019 which gives them enough headway to withstand the coronavirus epidemic.
“We believe this provides us the financial resources and liquidity to execute our plan through 2024, including managing the near-term challenges and volatility presented by COVID-19,” Mathrani and Claure wrote, adding that WeWork’s revenue increased 90 percent year over year in 2019 to $3.5 billion. “We didn’t take on this opportunity because it was going to be easy. We took this job because we believe in the power of WeWork as a platform.”
WeWork has $1.3 billion in net debt, which includes $669 million principal amount for its senior notes due in 2025, Reuters reported in October 2019. In its IPO filings from last summer, WeWork said it has a future lease obligations of $47.2 billion
Some think SoftBank’s deep pockets can help WeWork weather this latest storm, but many are worried about the possibility of failure given the sheer amount of space it leases, especially in Manhattan where it’s the largest office tenant.
“I’m scared about that,” Epstein said. “A lot of us saw this playing out years ago, that they were becoming too big to fail in terms of real estate.”
In Manhattan, coworking companies lease a total of 14.7 million square feet and take 3.1 percent of its office inventory, according to a report by Savills. The top five coworking providers — WeWork, Knotel, Regus, Convene and Spaces — are committed to paying more than $755 million in annual rental income to landlords until 2030. If all the coworking space went back on the market, it would increase Class-A availability rates by 48 percent from its current 11.6 percent to 17.2 percent.
Knotel has already announced plans to give back 1-million-square-feet across its worldwide portfolio — with a good chunk in Manhattan — and Convene has temporarily shuttered its locations.
WeWork is at the top of the list and represents 58 percent of all coworking in Manhattan with 8.5 million square feet and about $486.3 million in annual rent committed to landlords, Savills found. It’s also the single largest office tenant in the borough across any industry.
“Especially on the smaller side, a lot of these coworking providers tend to occupy sometimes upward of 50 percent of that building,” Danny Mangru, the research director for Savills’ New York and Tri-State region, said. “That rental income could be wiped out. It could wipe out the entire rent roll if WeWork goes bankrupt.”
As of August 2019, WeWork completely rents at least five buildings across New York City and occupies more than 50 percent of the space in at least a dozen others, The Real Deal reported.
Savills’ report tracked five landlords that had the most coworking space in their New York City portfolio and found each had the potential to lose between $28 to $38 million in base rent through 2029 if coworking companies fail.
“It’s a significant amount of rental income that should [coworking companies] just shut the doors they would lose out,” Sarah Dreyer, the head of Americas Research for Savills said. “We should see some trying to work with these providers to mitigate that.”
The landlords include CIM Group which has 33.3 percent (400,000 square feet) of its 1.2-million-square-foot portfolio leased to coworking, the Moinian Group which has 12.2 percent (600,000 square feet) of its 4.9-million-square-feet given to coworking and SL Green Realty Corp. which has 2.1 percent (500,000 square feet) of its 23.6 million square feet leased to coworking.
“It will be a disaster for New York landlords,” Poleg said. “Some of them will tell you that it’s fine. I hope for them that they don’t believe that, because it means they’re not prepared.”
Tisdahl agreed it would be painful for the Manhattan office market if WeWork dissolved, but it would be spread out to enough landlords and buildings to not be totally catastrophic.
“They have diversification in A and B buildings all throughout Manhattan, a lot of landlords and a lot of ownership groups,” Tisdahl said. “The diversification is fairly good so that the pain can be spread out among a lot of different landlords.”
Savills’ report broke down WeWork’s Manhattan space into three categories: densely packed ones mostly dedicated to coworking where workers mostly cram into hot-desks, ones a bit larger dedicated to more mid-level companies and ones focused on enterprise clients. It found that the first category represents about 1 million square feet in Manhattan and poses the biggest danger for WeWork regardless of its survival.
“Those are really the very, very dense spaces,” Dreyer said. “That might be one side of their portfolio that’s the most obsolete if it came back on the market right now.”
Because the coronavirus spreads in such close quarters, many expect people will be hesitant to pack into such dense spaces in the future.
“Putting a lot of people together in the same space and sharing all the amenities probably is not something people are going to be interested in for the foreseeable future due to this virus,” Epstein said.
But as long as SoftBank can survive this and the pandemic doesn’t keep offices empty longer than three months, Poleg and others expect WeWork’s chances for survival to be as good as it was a few weeks ago, when it was already bracing for a rocky 2020.
“They were planning to take a lot of pain this year,” Poleg said. “They were planning on renegotiating a lot of leases.”
CEO Mathrani has been reaching out to landlords in New York to see if it could turn leases into profit-sharing agreements to cut its rent bill by as much as 30 percent, Bloomberg reported.
Bloomberg reported that early talks haven’t been good, but some expect as the pandemic wanes on and more companies shutter and vacate spaces, WeWork will have a better chance.
“This has created an opportunity,” said Dan Teran, co-founder of Managed by Q which was bought by WeWork last year then sold at a loss to rival Eden in March. (Teran was WeWork’s head of corporate development and ventures until he left in October 2019.) “Landlords are open to conversations today that they would not have been a few months ago.”
Nobody seems better suited for that task than Mathrani. The newly minted WeWork CEO helped steer mall owner GGP out of one of the largest bankruptcies in real estate history and is known for his ability to renegotiate leases, Poleg added.
And whenever companies can return to the office, flexibility is going to be their minds more than ever before with many wary of signing a long-term lease during a recession.
“If demand for flexible offices was growing very fast a year ago, I don’t see that companies will be more willing to sign long-term leases,” Poleg said. “[WeWork’s] view of the world has just been expedited by a few years. The future that they have been planning for is arriving.”
But it’s not just WeWork that has been struggling during this time. Other competitors in the flexible office market have felt the crunch during the coronavirus pandemic. Convene laid off nearly 150 employees, Industrious laid off 90 employees and The Wing cut half of its corporate workforce.
Knotel — which was crowned a unicorn last year and cheered WeWork’s struggles — cut half of its 400 employee workforce and told landlords it would give back 20 percent of its 5-million-square-foot portfolio, as CO previously reported. It also reached out to some New York City landlords saying it won’t pay April rent.
The company’s troubles precede the coronavirus epidemic, as Business Insider reported Knotel stopped paying vendors for months and substantially missed sales targets before.
(Disclosure: Observer Capital, led by Observer Media Chairman and Publisher Joseph Meyer, is a Knotel investor.)
The whole flex-office industry is in danger of consolidation and losing operators because of the coronavirus pandemic, but WeWork stands a significantly better chance as it has the luxury of the deep-pocketed SoftBank which will likely be unwilling to take a loss on one of its biggest investments during this time, Poleg said.
SoftBank head Masayoshi Son admitted in a recent Forbes interview that he paid too much for WeWork — SoftBank pumped a total of $14.25 billion into the company — but stressed his commitment to turning it around.
“We paid too much valuation for WeWork, and we did too much believe in the entrepreneur,” Son told Forbes. “But I think even with WeWork, we’re now confident that we put in new management, a new plan and we’re going to turn it around and make a decent return.”
Even without the backing of SoftBank, Teran said WeWork stands above the rest simply because it offers something better to tenants.
“I think they have the best product, maybe I’m slightly biased but they really do,” Teran said. “The problem’s never been with the product.”
Yet it still remains a pivotal time in WeWork’s 10-year history and its fate is heavily tied to SoftBank’s survival.
“If they can’t survive this, they probably wouldn’t survive anyway,” Poleg said. “They’re dependent on SoftBank. It would be hard to find anyone that would be willing to help them.”