Our well-informed clients and friends likely saw the recent news that Knotel, a flexible leasing operator which had over 4 million square feet under management, filed for Chapter 11 bankruptcy on Monday. Knotel’s U.S. operations are focused on private workspaces for mid-size and enterprise companies in New York and San Francisco.
In most instances, bankruptcy would be indicative of further bad times ahead.
But to the contrary, it is in fact the opposite in this case. That is because the funder and potential buyer of the company is an affiliate of real estate industry giant Newmark Group Inc.
Some of the coverage in the financial press has focused on the fact that Newmark is providing Knotel with approximately $20 million in new debtor-in-possession financing to allow Knotel to continue operations during the bankruptcy proceeding. However, that buries the lead which is that Newmark affiliate Digiatech LLC has made a $70 million stalking horse bid for Knotel at an auction of Knotel’s assets. It will be very interesting to see if other major real estate players join the bidding at the auction.
Newmark is not a bank. While it is happy to receive double-digit interest on its loan along with a senior superpriority lien on the Knotel assets which props up its minority equity interest in Knotel, that is not what this deal is about. Most importantly, this is a strategic play by Newmark to buy the company at or near a market bottom.
Why would Newmark do this now? First, bankruptcy gives the debtor (Knotel) a great advantage in dealing with its real estate leases. The debtor can reject all of its unprofitable leases as both tenant and sublandlord, and assume those leases which have value. As a result, Knotel has already filed a motion to reject numerous leases including the sublease for a space under construction in San Francisco which is being built for Amazon.
Further, the debtor has great leverage in this market to renegotiate burdensome leases it may want to keep. In addition, Knotel may even look for new large city office spaces at today’s reduced rents to relet if the market improves. Landlords will likely welcome the opportunity to partner with the deep-pocketed Newmark to help reduce record-high vacancy rates.
It is particularly noteworthy that Knotel’s leases are primarily in New York and San Francisco. According to the widely followed back-to-work barometer survey by Kastle Systems of its buildings in major metropolitan areas, these two cities had building occupancy rates of just 14.4% in New York and 11.7% in San Francisco during the past week. So there is nowhere to go but up.
Nevertheless, the new Knotel appears undaunted by the challenge. In an affidavit filed with the bankruptcy court, Knotel’s chief financial officer stated his belief that the short-term flexible leases will be very competitive in the current business environment. I agree, as the feedback we have gotten from many of our clients is that they do not want to make long-term commitments at this time with so much uncertainty in terms of both health and the economic climate. With this business model, Knotel and other flexspace operators are poised to pick up new tenants who have far more options now due to the relative success of remote working when the pandemic finally ends.
In contrast, many of the more traditional landlords are still being required by their lenders to enter into long-term leases under the terms of their mortgages. Those landlords are significantly hamstrung because leases of five years or more are not attractive to many tenants whose long-term business and return to office plans are uncertain.
As further evidence of an upward trend in the flexible space industry, the Wall Street Journal reported on Friday that there are two potential special purpose acquisition vehicles being formed with the goal of taking WeWork public at a valuation of over $10 billion. Given that WeWork was on the verge of bankruptcy due to its own scandal a few months prior to the pandemic, this was a somewhat astonishing and very positive development.
Putting the Knotel and WeWork news together, I think a trend may be developing. We may be coming close to a market bottom, at least as it relates to flexible office leasing space with short-term leases on offer. Some very sophisticated and deep-pocketed operators are clearly starting to see a light at the end of the tunnel, even if most tenants are not back in the office yet. With more vaccinations coming on line and daily cases starting to fall perhaps we are finally heading in a positive direction.
So that’s the way I see it. We will of course be keeping a sharp eye on market developments and will keep you informed. As always, please let us know what you think. And of course, if you would like to discuss your office leasing needs, please feel free to contact us.
Be safe and well.