A WeWork location in New York's SoHo neighborhood. The office-sharing giant said this week it will slash 30% of its workforce.
Source: AP Photo
The turmoil surrounding The We Co. and its ill-fated initial public offering this fall will dampen the broader coworking craze, with unknown consequences for office markets and landlords, industry players said.
This week, WeWork Cos. Inc. backer SoftBank Group Corp. moved to take over the office-sharing giant, which in turn said it would slash up to 4,000 jobs, or about 30% of its workforce, and narrow its focus to the U.S., Europe and Japan to preserve its dwindling cash reserves. This is a sharp turn for a company that had defined itself by its global reach and an imperative to "elevate the world's consciousness."
"I do think landlords are going to be more cautious, probably, in the near term," Ted Klinck, president and CEO of Highwoods Properties Inc., which does not have exposure to WeWork, said on an earnings call this week.
Michael Lewis, REIT analyst at SunTrust Robinson Humphrey, said WeWork's troubles have exacerbated real estate investors' concerns about coworking. He deemed REITs' overall exposure to WeWork, and to the coworking segment generally, to be low, but said the impact on major office markets could be significant. WeWork was signing 500,000 to 1 million square feet a month at the apex of its growth trajectory, and it was the largest office lessee in New York and London by the time it unveiled its IPO plans.
"There is a view that they have been supporting rents just through their sheer leasing velocity," Lewis said. "You look at the net absorption that you've seen in Manhattan over the last couple of years and you compare that with the amount of space that WeWork has taken down, and it appears pretty serious on the surface."
REIT opinions on a potential softening in New York office market fundamentals have been mixed so far this earnings season. SL Green Realty Corp.'s head of leasing said to expect a "little bit of pullback" in coworking leasing, while Empire State Realty Trust Inc., which has no exposure to WeWork, reported no slowdown in the market overall in recent weeks.
"We're seeing employment growth from a broad base of different tenants," Tom Durels, Empire State Realty's executive vice president of real estate, said. "The answer, simply, is 'no' — no change in activity, no change in momentum related to WeWork."
Manus Clancy, a senior managing director at data and analytics firm Trepp, said WeWork grew too much, too fast, and at the wrong part of the cycle. By the time the company's expansion really picked up, the market was in the eighth inning of the financial recovery, so its cost basis was higher than it needed to be, he said.
"They're not the first guys to try this [shared office space]," he said of WeWork. "But everybody else who has tried this has done it over the course of much longer periods of time and grown incrementally."
Clancy said the unusual complexity of WeWork's corporate structure and lease agreements is a concern that, in a worst-case scenario, could spiral out of control. Rent payments flow up to WeWork through a tangled web of entities, and in some buildings WeWork is both the tenant and the landlord. Looking at that web alongside WeWork's debt obligations, it is not always clear who owns the cash flow, he said.
Owners of all but the highest-quality space likely will feel an impact from WeWork's pullback, Clancy added. The company has not been leasing AAA-grade space by 2019 standards, but the class A product of yesterday.
Others were more optimistic about the near term insofar as the real estate model that WeWork helped popularize — shorter leases for open and shared, amenity-rich office space — has been embraced by traditional landlords. SunTrust's Lewis said REITs have been building out the historically smaller "flex" side of their businesses, and some are starting their own coworking units. Should WeWork's business shrink further, many enterprise leases on its tenant roster could be converted into shorter-term leases with REITs.
Raleigh, N.C.-headquartered Highwoods, for its part, is looking into developing its own "coworking-lite" model, with fewer amenities than the WeWork model, and without its own onsite personnel, Klinck said on the company's earnings call.
"I just think it's here to stay," the executive said of the business model. "And I think over time, the flexible space market is going to continue to grow. I think companies want space quicker, and they want more flexible terms."
Daniel Lisser, senior director at real estate brokerage firm Marcus & Millichap, said average lease terms are likely to moderate as various industries continue to rethink their space needs. "A lot of smaller companies really don't want to get into the ins and outs of how much per square foot, and have to have an architect and a contractor," he said. "They want to move in next week."
Even larger corporate tenants now seem to appreciate lease flexibility and are willing to pay marginally higher rents for a shorter or more flexible lease duration, Lisser said. He expects more landlords will look to develop WeWork-like business units in a bid to meet individual demand themselves.
"What landlords are saying is, if WeWork can do it, so can we, to some extent," he said.