Are Co-Working Companies Too Big To Fail?
Co-working companies are a growing risk to the strength and integrity of gateway markets and could soon become too big to fail. In addition, ongoing co-working expansion risks commoditization of class A and B plus office properties. These are bold statements that require some rationalization, so let us explore why landlords should cast a wary eye toward the next co-working tenant seeking a large lease.
Most of us are familiar with the concept of “too big to fail” from the 2008 financial crisis and subsequent eponymous book and movie. The notion is perhaps best expressed by J. Paul Getty’s famous quote, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” If co-working companies cross a critical occupancy threshold in any significant market, they could effectively become too big to fail in the eyes of local landlords. That threshold is currently unknown, but co-working is likely approaching it as major operators like WeWork and IWG (Regus) become more ubiquitous.
A report by Cushman & Wakefield notes that the top two co-working providers, Regus (IWG) and WeWork, manage roughly two-thirds of all co-working space and estimates that co-working companies represent about 30 million square feet of space in the top 87 U.S. office markets. Markets like New York City are particularly saturated with co-working tenants which occupy north of 10 million square feet, or roughly 2.7% of total office inventory. While that is no small figure, it is somewhat diluted in that leading co-working companies WeWork and IWG occupy more costly Class A and B plus buildings, thus amplifying the potential problems should any one of these companies become distressed.
Consider Regus, which in January of 2003 went through a major restructuring after its U.S. operations filed for bankruptcy protection. The company noted that its U.S. business suffered from an adverse business climate and could no longer command the rental rates following the run up to the first dotcom bubble. Prior to filing Chapter 11, Regus sought first to restructure lease terms with major landlords. At the time Regus managed somewhere between five million square feet and 14 million square feet globally, according to company filings and an article in Fast Company in March of 2000. Compare that to the 30 million square feet that Cushman & Wakefield measured in the U.S. alone and the scale of the issue becomes more apparent. In 2003, many landlords saw Regus spaces go dark. The fast-paced growth of WeWork and IWG’s renewed momentum suggest the problem could repeat itself, just on a grander and more expensive scale.
Landlords with WeWork as a tenant today have long remaining terms on their leases coupled with expensive tenant improvement packages. If WeWork becomes distressed at the parent level, it may in fact be too big to fail, and ownership would be forced into restructuring leases.
Co-working companies like WeWork and IWG have the potential to devalue and commoditize class A and B plus office buildings in gateway markets. They effectively bring in class B and C tenants, potentially upsetting existing tenants while simultaneously devaluing the property in the eyes of other investors. According to a “Wall Street Journal” article from September of 2018, WeWork failed to execute a lease at One World Trade Center in part due to security concerns and issues from an existing co-working tenant. Another article from “The Real Deal” a month earlier noted that investors eyed WeWork buildings skeptically and saw reduced asset valuations.
Hedging your Risk
TRA noted in an earlier post that lease structure with co-working tenants can have a material impact on ownership’s risk. The best protection is having fully leased space with significant enterprise occupancy. Holding a substantial security deposit or letter of credit is important, and the corporate guarantee offers a modicum of additional protection. Landlords may want to consider new ways to structure leases with these tenants going forward in order to better protect against an unfavorable business climate. Look at ways to enforce early termination of a lease, and be creative in structuring rent around the company’s key operating metrics of occupancy and profitability. We have reviewed dozens of co-working leases in recent years across major U.S. markets, and TRA can help.