WeWork’s November bankruptcy filing is expected to have a significant impact on commercial mortgage-backed securities deals with loans exposed to the flexible office space provider in New York, according to a report released late November by KBRA Credit Profile.
While there are other major metropolitan areas with exposure to WeWork, New York’s office market will be hit hardest given the concentration of the rejected leases on the city’s properties. Still, the bankruptcy filing and lease rejections do not add imminent maturity default concerns, though falling office valuations and elevated interest rates will impose challenges on borrowers with rejected leases.
The report noted that the withdrawal of WeWork as a main tenant will make it harder for the landlords to lease the space in the near term and maintain cashflows.
New York-based WeWork is seeking to reject 69 North American leases, which are linked to loans in 12 CMBS loans totaling $1.85 billion. Two loans – financings on 183 Madison Avenue in Manhattan and Lake Shore Towers in Irvine, California – are part of five commercial real estate collateralized loan obligations, according to KCP.
Unlike Chapter 7, where the filing companies are required to liquidate their assets to pay off the debt, Chapter 11 bankruptcy allows the entities to maintain the operation of their business while raising a restructuring plan amid the bankruptcy process.
Candice Kline, a Chicago-based bankruptcy attorney at Saul Ewing, says being able to reject leases is at the core of WeWork’s strategy to reorganize through a Chapter 11 bankruptcy.
“There is a special power for debtors that only exists in bankruptcy, which is the power to reject unexpired leases,” says Kline. “That means they are able to use the rejection power and bankruptcy to get rid of bad lease agreements and use bankruptcy to deal with any damages arising from the rejection breach.”
In addition, Kline says debtors could leverage motions to the bankruptcy court to negotiate with landlords, which also makes an efficient route to dispose of unfit leases.
“Debtors seek to leverage a tight notice procedure where landlords will have 10 days to respond, and use the bankruptcy court to enforce procedures around a security deposit and escrow,” she adds. “It gives the debtors additional leverage and control over how they’re interacting with the landlords. It really shifts the balance of power in favor of the debtor’s reorganization.”
Tony Natsis, partner and chair of the real estate group at California-based law firm Allen Matkins, says bankruptcy can improve the health of a balance sheet for a company in distress. “If [WeWork] has good space in a good building, they’re going to keep it. So the landlords that are already doing well with their buildings are going to be the beneficiaries of WeWork.”
Over the long term, WeWork is expected to see an improved outlook if the firm manages to maintain a streamlined balance sheet with fewer expenses and less overhang of unfit leases through bankruptcy, Kline says.
Nevertheless, bankruptcy does cause pain for certain investors as the “bankruptcy waterfall” flows through the capital stack. Debt and equity investors will be paid, from the highest to the lowest priorities across the capital structure, with risks of being reimbursed partially or fully wiped out, Kline adds.
New York-based data provider Trepp tracked $182 million of CMBS loans in which WeWork occupies more than 90 percent of the space, and most of the underlying assets are in New York. Properties with a high WeWork exposure are more closely watched by analysts.
“WeWork [bankruptcy] was less impactful than perhaps the media would suggest,” says Kline. “It may have a more serious impact for certain buildings that may have relied on WeWork to fill some gaps.”
Similarly, Scott Sherman, founder of Miami-based manager Torose Equities, says it is still early to see how that impact plays out. “It’s going to be case by case, market by market, and building by building.”
Sherman adds that, though the New York market may be affected most with major exposure to WeWork’s bankruptcy filing, Torose Equities is seeing some buying opportunities driven by discounted pricing, migration trends and rent growth in the office sector.
“Here in South Florida, there’s been a lot less distress on the office front, just because fundamentals have remained strong,” Sherman says, adding that his company has completed several value-add office acquisitions this year, benefiting from the rising rents and occupancies of certain properties.
“We’re buying [offices] for 20 to 30 percent [of the price], less than what they would be a year and a half ago, [but] fundamentals are better. It feels like a great opportunity, but it’s not the typical distress situation.”
Additionally, despite some market participants concerns that co-working companies’ business models are being challenged in the current economy, Sherman says WeWork’s situation alone may not reflect how other co-working space markets are faring.
“We’re seeing a lot of demand for co-working [space in Florida]. It’s been healthy this year,” Sherman says. He adds that shared workplace providers like Regus and Venture X are actively expanding in Miami’s trendy neighborhoods.
Still, he notes it is probably too soon for investors to feel ready to take distressed properties because the market is still digesting and figuring out what lenders could do in the current environment. But for investors who are contrarian and want to buy value, the office sector has some unique buying opportunities.
“Now that rates have plateaued, you’ll start to see more capital sources start to come back into the office sector,” says Sherman, “but for the most part, they’ve been on the sidelines for the past year.”