There has been a lot of discussion about the recent collapse of WeWork, the co-working space operator. WeWork marketed itself as a collaborative environment, subleasing its areas to small businesses. It quickly became the largest private office tenant in Denver with 700,000 square feet of office under lease in 5 locations and 4 on the way.

Unfortunately, the bloom on the once-prized flower is now fading. The end of last year, WeWork disclosed that the company was forced to restructure in order to survive and started to vacate many of its locations. As a result of this corporate uncertainty, last December one local landlord withdrew from negotiations for 67,000 square feet of office space in Denver’s Golden Triangle.

As a commercial real estate attorney, I can see a few lessons to be learned for both internal parties and outside observers as a result of this event.

Lease Guarantees Affix to Entities Able to Fulfill the Secured Obligations

Apparently, many of the WeWork leases were entered into by a WeWork subsidiary without a guaranty from the corporate parent, The WeWork Company. A corporate guaranty allows a landlord to seek recovery awards from the guarantor in the event of a tenant’s default. As a result of WeWork’s corporate struggles many of the WeWork sub-entities that were structured were abandoned which left many landlords holding the bag.

What this means is that huge expenditures that went into finishing space for WeWork’s occupancy will go unrecovered. In addition, some landlords are will be forced to duplicated expenses to attract replacement tenants in order to mitigate the loss of WeWork.  

Chasing Leasing Trends Can be a Volatile Business Strategy

The hottest trend is not always the safest commercial real estate investment.

Despite marketing to the contrary, WeWork is a not a technology company.  The truth is that WeWork is just the latest version of an idea that has had mixed success in the past.   It enters into long-term leases with landlords and short-term leases with subtenants.  In fact, there are others smaller companies that operate in a similar fashion to WeWork.  All of these companies are susceptible to marked fluctuations   Owners may be tempted to deviate from market rates and security requirements in order to attract a particular tenant, but there are limits. This is a tough long-term strategy.  WeWork’s business model has a fundamental problem that is less obvious when the office market is strong.  According to George Schultze in the October 19, 2019 issue of Forbes:

“The real problem with WeWork is that its whole business model is flawed with excessive leverage. There’s really nothing special about what they do—providing shared office space to short term tenants. But when the economy starts to turn and new business startups decrease or fail more because of the risk of recession, that’s when a company like WeWork could really be exposed and have tremendous downside risk. That’s because it has long-term fixed expenses that aren’t matched with its short-term clients who can come and go as they choose. Like an insolvent bank with long term assets but short-term funding, WeWork is subject to the proverbial “run-on-the-bank” risk because of its massive long-term lease liabilities.”

Lack of Leasing Agreement Can Lead to Subtenant Losses

Customers are attracted to companies like WeWork because they allow for simple access to office space in prime locations.  These occupants take advantage of smaller spaces and shorter lease terms than are typically offered by landlords.  However, most of these occupants are subtenants with no contractual relationship with the landlord.   A landlord has no obligation to honor the subleases when a sublandlord, such as WeWork defaults.  When WeWork terminated or abandoned an office location, it effectively terminated the rights of its customers to occupy such space.    

Except for those subtenants that successfully executed new agreements directly with the master landlord, the former WeWork subtenant needed relocate.

Market Corrections Allow Stakeholders to Correct Past Mistakes

The collapse of WeWork may not bad for all stakeholders. The sudden availability of space may result in opportunities for occupants and landlords. Office landlords obviously prefer to fill vacant space as soon as possible. Given the sudden surge of newly available space, some landlords might be willing to accept more aggressive lease terms in order to find new occupants.  Those businesses in need of space with good credentials might be able to take advantage the increased available vacant square footage.     

The Takeaway

WeWork highlights some dangers of investing in fad real estate arrangements. Fads are short term and most leases are long-term. Real estate owners should be aware of the risks of leasing to occupants engaged in this type of business model to incorporate the additional risk posed by market fluctuations.  

The final takeaway is this: Sometimes it is worthwhile to pursue a high-risk tenant if the benefits outweigh the potential costs.  Just be aware of the circumstances that may arise from this type of arrangement and mitigate your risks as much as possible.