The Potential Harsh Impact of WeWork's Bankruptcy on Urban Areas
WeWork's bankruptcy may inflict a painful impact on cities, as America's office market struggles with an excess of vacant spaces
America has a glut of empty offices.
Now, some offices face losing WeWork, which has more than 600 locations in major cities.
WeWork's filing for Chapter 11 bankruptcy on Monday has created uncertainty regarding the future of the real estate company. As part of their restructuring, WeWork has announced the termination of several leases in the United States. This bankruptcy declaration will exacerbate the financial pressure faced by commercial landlords, who have leased significant portions of their office buildings to the co-working company.
Office landlords have long been in a rush to lease out space to WeWork, as they saw flexible office spaces as the future of office life. Unfortunately, these optimistic bets have turned sour, leaving some property owners with significant debt in order to stay afloat. According to Trepp, a commercial real estate data provider, approximately $270 billion in commercial real estate loans held by banks will reach their maturity in 2023.
A yurt listed by Radious in Portland showing a desk and a meeting space.
Courtesy Radious
Co-working spaces are becoming increasingly unconventional. The collapse of WeWork will result in a rise in unoccupied spaces and potentially lower rental costs for tenants. This, in turn, will bring about financial hardships for landlords who are already struggling to meet their debt obligations in a market with high interest rates. Experts in commercial real estate warn that in the worst-case scenario, this situation could lead to landlords defaulting on their loans or mortgages, thereby having a larger impact on the banking system and causing further declines in city tax revenues.
"According to a report by Moodys economist Ermengarde Jabir, office properties, already struggling with financing difficulties and declining values, now face the potential of unexpected vacancies. This could have a domino effect on smaller and mid-sized banks that hold landlords' debt, leading to stricter loan regulations for homeowners and business owners. Additionally, investor concern about the state of the financial system may increase due to the bankruptcy. The recent collapses of Silicon Valley Bank and Signature Bank have already raised fears about the vulnerability of banks to the troubled commercial real estate market. Goldman Sachs estimates that 55% of office loans in the US are currently held by banks."
The impact of WeWork's bankruptcy is not only concerning for the office market, but it could also have negative consequences for municipal governments that heavily rely on commercial property taxes to fund essential services. This could ultimately result in budget reductions. To put things into perspective, office properties in New York City contribute to approximately 21% of the total tax revenue. Stijn Van Nieuwerburgh, a real estate professor at Columbia Business School, expressed his views on the matter, stating that WeWork's bankruptcy is a significant blow to an already troubled office market. This only adds to the plethora of challenges that the office market is currently grappling with.
No single tenant can make or break the office market, he said. But "as much as any one tenant can matter, WeWork would be it."
Cities hit hardest
WeWork's bankruptcy is expected to have the greatest impact on its offices in New York City, San Francisco, and Boston, according to experts.
CoStar, a commercial real estate data firm, reports that approximately 42% of WeWork's occupancies are located in these three cities. As part of its restructuring plans, WeWork intends to shut down 1.9 million square feet, which accounts for about 35% of its overall presence in these markets.
In New York City, WeWork, formerly the largest corporate office tenant, primarily leases older "Class B" buildings. These buildings have been considered less attractive to potential tenants compared to newer "Class A" properties. On average, WeWork's Class B buildings are 96 years old, whereas Class A buildings are 48 years old. CompStak, a real estate firm, reports that approximately 65% of WeWork's leases are in Class B properties, with Class A properties accounting for 30% of their leases.
A WeWork in New York City. New York, San Francisco and Boston could be hurt most by WeWork's bankruptcy.
According to Alie Baumann, CompStak's director of real estate intelligence, WeWork's significant presence in Class B buildings is not ideal for New York City's office market. Concerns about office obsolescence and declining demand in this category of buildings have led to a decrease in the average purchase size for new deals in Class B buildings of 36% since 2019.
WeWorks rents in those buildings also were higher than the rest of leases, so landlords cant easily recoup lost rent from other tenants.
Office market woes
More than one-fifth of offices across the United States are currently vacant, as per JLL, a leading commercial real estate firm. The bankruptcy of WeWork has further added to the challenges faced by the commercial real estate industry, which has been severely impacted by the pandemic. With fewer people returning to offices and decreased spending in downtown areas, companies have been downsizing their office spaces and renegotiating rental agreements.
The sector has been greatly affected by the sharp rise in interest rates in the past year as commercial building purchases are usually funded through substantial loans. Baumann stated that this setback is the most recent in a series of challenges faced in the past year, with both interest rates and maturing debt levels on the rise.
Landlords may face challenges filling the vacant space in Class B buildings, as demand is generally weaker in those locations. Consequently, they may seek new tenants as replacements for WeWork, potentially at lower rental rates.
Other owners will attempt to repurpose their buildings for different purposes, such as healthcare, higher education, or residential use. However, these conversions can be challenging as some buildings are not well-suited for, for example, new residential units or fail to meet regulatory standards.
"Finding suitable alternatives is not an easy task," stated Van Nieuwerburgh from Columbia University. "I anticipate that Class B and C buildings will likely remain as unproductive assets until they undergo bankruptcy and are acquired at significantly reduced prices."
