Amid increasingly acute financial troubles, flexible office provider WeWork is shedding space to stay afloat. But even in cases where rent is still being paid, the risk of early lease terminations, space reductions or rent negotiations has grown significantly since the company admitted last month its future was in “substantial doubt.”

With its significant footprint in key office markets around the world – estimated at around 44 million square feet in 2022 by Statista – WeWork’s actions will bring further pain to a sector already grappling with uncertainty over its future relevance. The acuteness of this agony will vary from market to market, and from building to building.

In the US, where broker CBRE found WeWork has 18.8 million square feet of inventory as of Q2 2023, the company had been downsizing for some time, even before the impact of the pandemic on the office market. Occupancy by square footage peaked in H2 2019, and has declined by 33 percent since then.

But while the continuation of this trend is not surprising, given the increasing likelihood of WeWork filing for Chapter 11, the manner in which the company restructures will leave some landlords out in the cold – as it already has.

“Landlords are always concerned a tenant will leave, but it all depends on how you securitize their lease. It also depends on how much downtime you need to re-lease and what you can re-lease the space for,” says Greg Kraut, co-founder and chief executive of New York City office manager KPG Funds.

“They can’t do anything as long as the tenant keeps on paying the rent. But if they have to refinance their building, or they need to sell, no lender or potential buyer is giving any credit for WeWork, which poses a major issue for commercial landlords that have them.”

In a research note, Barclays finds there is $7.5 billion in CMBS loans with exposure to WeWork as a tenant in the US, of which 38 percent is concentrated in New York City. WeWork has more than 6.4 million square feet of inventory in Manhattan, per CBRE. There, private equity-backed owners of buildings with WeWork as a tenant include Northwood Investors, Beacon Capital Partners and Ivanhoé Cambridge – representatives from all three firms did not respond to PERE‘s request for comment on their exposure.

Kraut says KPG Funds, which owns and operates medium-sized office buildings in the city, has not yet needed to lease to a flexible space provider, but would not rule it out “if they leased it out at the same price I was renting the space for and I got enough of a security deposit from them.”

He tells PERE that he thinks WeWork grew quickly in New York by taking “all the bad spaces that were out there – 90 percent of them were spaces that were unleasable for landlords.” In those Class C spaces, he says, WeWork has probably already given up a lot of its leases, “but I think some still exist.”

Even in high-quality offices, however, landlords have been burned by WeWork handing back the keys.

One example is Hong Kong-based Phoenix Property Investors. The manager, which owns the Grade A Tower 535 in the Causeway Bay area of the city, signed WeWork on a nine-year lease across eight floors of the 26-story office tower back in 2016, adding another floor in 2018. In early 2021, however, the flex provider handed the keys back to Phoenix and vacated all nine floors prematurely.

“Any landlord who has a 26-story building and nine of those stories disappear in terms of tenancies would worry,” says Benjamin Lee, the firm’s co-founder and managing partner. “We owe fiduciary duty to our investors to do whatever we can to find a solution as swiftly as possible. Our priority was to protect our investors’ interests and to strategize to rent the space back up quickly.”

He tells PERE that Phoenix was fortunate to be able to re-lease the 100,000 square feet that WeWork left behind within 12 months. Certain existing tenants such as global retail giant Amazon also increased their presence in the building. “We did not have to spend a lot of capex to return the floors to space we could use again.”

Lee explains that after WeWork left, Phoenix sued the company for damages incurred by the early lease termination. “We stood firm because we had to – we had our LPs to protect. We were able to recoup beyond the capped amount on the guarantee,” says Lee, who confirmed the legal proceedings have since concluded.

“I’d rather this situation had not happened. But it happened, and I don’t think we had the worst experience with it.”

Playing the ‘game’

Not all managers in this position were able to move on with the asset in question, however. Indeed, Lee credits the strength of the Hong Kong office market – where work from home is considerably less common than in Europe or North America – as a key factor here. “The market has to be there, otherwise no matter how hard you work, it will be very difficult for you to re-rent the whole building back up in less than 12 months.”

Over in central London, where the vacancy rate is 9.4 percent as of Q2 2023, as per broker JLL – above the long-term average of 5.5 percent – another case of premature lease termination by WeWork had a notably different outcome.

At 125 Shaftesbury Avenue, WeWork handed back the keys to owners Vestas Investment Management and Savills Investment Management shortly after sole tenant Meta’s lease expired in 2021. WeWork had signed a 20-year lease shortly before the property was sold to the partnership for £267 million ($337 million; €312 million) in 2018. Instead of re-leasing the building, which was built in 1982 and refurbished in 2018, the owners appointed CBRE in June to sell it with vacant possession. The asking price has been reported in the region of £175 million.

Kiran Patel, deputy CEO and global CIO of London-based Savills IM, which also owns the Charlemont Exchange in Dublin, which is fully let to WeWork, admits the firm was initially “sceptical” of WeWork owing to its limited profitability, but believes there remains a place in the market for providers of flexible space with built-in ancillary services.

“From a real estate investment perspective, taking any occupier has a financial risk. It doesn’t always pay off, but that’s the game of investment management – it’s risk and reward,” he says.

As to whether or not Patel is concerned about the Charlemont Exchange asset, he notes that “at the moment, the rent is still being paid. We can see WeWork has full occupancy in the building, so the investment is doing what it’s meant to be doing.”

However, he adds that “in hindsight, if we had a similar occupier with the same credentials, paying the same rent, taking the same lease length, but with stronger financials, and that was available to us at the time of leasing, we would have chosen the latter.”

What’s next?

Even landlords with “bulletproof” leases with WeWork should be worried, says Michael Kovacs, founding partner of Castleforge. The London-based manager has long been critical of WeWork’s business model, including calling out the 125 Shaftesbury Avenue investment on a number of occasions as an example of what can go wrong, especially in the context of a single tenancy.

“WeWork may have to give up moderately profitable centers, or centers that could become profitable once they get leased up again, in order to limit all their operating costs,” he explains. Even if WeWork stays in the building, it will likely need to reduce the agreed rent, so landlords have the dilemma of taking less rent or having a bankrupt company. “This might force landlords to take a hit as the owner of a property, even if the asset is performing well.”

Indeed, Kraut points out the company is still 100 percent occupied in many facilities in New York. “The only way WeWork will get off the hook on some of these leases that they still want to get rid of is if they go bankrupt. I think they’ve probably tried every other way to do it,” he says.

Despite having already taken steps to reduce its footprint, WeWork’s ongoing financial woes will spell trouble for a number of landlords, particularly in cases where a building’s loan is approaching maturity.

“That lease is a sword of Damocles,” muses Kovacs. “You’re just waiting to find out when you stop getting paid money and have to try to do it all by yourself.”