Below is an updated version of my latest Forbes.com column.
Our well-informed readers are likely aware that a couple of weeks ago, WeWork withheld interest payments due on five senior secured notes totaling approximately $95 million. In an 8-K report, WeWork stated that it has a 30-day grace period to make the payments before an event of default, that it has the liquidity to make the interest payments, and that it may decide to do so in the future. However, as an on-the-ground office leasing agent, I believe that an important factor has been overlooked in the commentary on the payments that WeWork elected to withhold. That is the negative impact on tenant demand that will likely result from protracted negotiations with WeWork’s creditor constituencies.
WeWork also claims in the 8-K that “entering the grace period is intended to allow discussions with certain stakeholders in its capital structure to begin while also enhancing liquidity as the Company continues to take action to implement its strategic plan.” As a corollary, in an interview with the New York Times WeWork’s chief executive David Tolley (just promoted from interim CEO) described the move as “typical” as a “precursor to a conversation.”
Notwithstanding the benign characterization of the missed payments by management, there is now another major hurdle for WeWork to overcome. With the failure to make interest payments, it clearly appears that WeWork’s problems are expanding. WeWork already was in an extended negotiation with its landlords to attempt to renegotiate leases and exit unprofitable locations, and now it has thrown down the gauntlet to noteholders.
WeWork is trying to exercise its leverage on its major creditor constituencies by conveying the message that the failure to make concessions will result in a bankruptcy filing. That puts landlords in a very difficult predicament because bankruptcy law caps the claims they could make against WeWork at the greater of (a) 15% of the remaining rent, not to exceed three years or (b) one year’s rent. Adding insult to potential injury, in a bankruptcy landlords would likely receive pennies on the dollar on their reduced claims. Indeed, making a deal with WeWork now might not even help the landlords’ situation if WeWork files bankruptcy anyway. The grave situation facing landlords (and lenders as well) was summarized yesterday by Daryl Bible, the CFO of M&T Bank, who was quoted in Crain’s New York Business as saying that “if something [office space] is not leased today, we assume it’s not leased for three years”.
Compounding the problem for landlords, some with significant exposure to WeWork are already feeling the pain. For example, it was just reported that 1440 Broadway, a building with approximately 40% of its rentable area leased to WeWork will hand back the keys to its lender.
There is also substantial systemic risk as well to individual landlords which is growing. According to the Real Deal, data analyzed by Trepp shows that landlords which have WeWork as a top five tenant owe about $2.6 billion in collateral mortgage backed security debt. About half of those loans come due within 12 months and nearly 80 percent are either watchlisted, delinquent or in default. As a result, the consequences of wide-ranging WeWork lease terminations could have a cascading impact on the broader CMBS market.
However, there is only so much that a company that is running out of cash can do to renegotiate its major debt obligations outside of court. At some point, bankruptcy becomes a self-fulfilling prophecy, and it may be better for WeWork to start lining up the necessary senior superpriority financing to fund a sale or reorganization in Chapter 11. This is the dilemma that WeWork’s board, including the newly retained directors with experience in reorganization proceedings, must address.
Further exacerbating the problem, WeWork has undertaken multiple sets of negotiations with its landlords outside of bankruptcy over several years. But without meaningful progress, the exercise becomes futile absent new investment or an improvement in the underlying business.
This leads to a very important piece of the WeWork puzzle that has been overlooked by commentators. I am hard-pressed to see how WeWork can possibly attract future tenants, known as members, to its spaces in its present condition. That is because many members are month-to-month tenants. Other members have leases for relatively short periods such as six months or a year. Until the present situation is sorted out, there is little incentive for members to sign new leases when they have no idea who their landlord will be, what the rent will be, whether their center will stay open and what will happen to their security deposit.
As a result, new tenants or tenants whose leases are expiring may have doubts about entering into new leases until they have a better idea of what is going on at the company. In August, WeWork previously warned they could run out of cash in the next 12 months. Any drop in leasing activity will only make things worse.
Perhaps WeWork will successfully demonstrate sufficient progress in its negotiations with its landlords and noteholders that will impress prospective investors to provide additional funding. At present, that appears to be a tall order.