Recent disclosures regarding WeWork’s cash flow problems include the news that it has hired the law firm Weil Gotshal & Manges as restructuring counsel. This inevitably leads to speculation about the shape of a potential bankruptcy filing if the present negotiations with Softbank regarding a recapitalization or JP Morgan Chase regarding new financing are unsuccessful. Moreover, the recent news that formaldehyde was found in 1000 WeWork phone booths could literally prove toxic for the company.
We at Wharton Property Advisors are in close contact with bankruptcy experts and tracking developments with an eye on what may happen to WeWork’s subtenants in a possible WeWork bankruptcy. A few key points:
1) Most of WeWork’s recent leases are for “Enterprise Spaces”. These are stand-alone spaces of approximately 5,000 to 20,000 rsf, very different from the original co-working model.
2) It is important to emphasize that bankruptcy does not necessarily mean closure. Rather, bankruptcy represents an opportunity for the debtor to reject unprofitable leases and focus its business on those leases that are moneymakers. A bankruptcy would, therefore, allow WeWork to reject leases with unfinished costly buildouts while retaining leases for completed spaces which are already cash-flow positive or could become profitable.
3) WeWork’s master leases with its landlords likely contain non-disturbance agreements protecting it in the event of foreclosure on the building or landlord ownership change and allowing WeWork to attorn by paying rent to the new owner. In addition, savvy landlords will have inserted clauses in those master leases requiring WeWork’s subtenants to attorn to the over landlord in the event that the master lease is terminated, or the landlord otherwise succeeds to WeWork’s position vis-à-vis the subtenants.
4) An attornment clause would mean that the landlords could effectively take over rent collection for many of the leases that WeWork rejects in bankruptcy. Those spaces could actually be profitable for landlords as the cost of operating space for individual tenants is not much more than it is already. For example, if WeWork is paying $50 per square foot to the landlord on an enterprise space, and the subtenant is paying $80 psf to WeWork, the subtenant would then remit $80 directly to the landlord. In that scenario, the landlord would pocket the $30 psf mark-up without providing much more in the way of additional services than is required already.
5) As for the co-working spaces, the situation more complicated. The administration of small tenants and the services required as well as the ongoing need for marketing to the public would be more burdensome to landlords used to dealing with larger corporate tenants. Those landlords might need to retain outside operators to deal with the fallout of rejected leases.
Much of the bankruptcy discussion is likely to focus on what happens to the WeWork shareholders. Under the Bankruptcy Code, senior classes of secured and unsecured creditors must be paid in full ore receive property equal to the amount of their claims before shareholders may retain their equity interests unless the creditors agree otherwise.
Accordingly, we expect a lively valuation battle. But we will leave that to the investment bankers. The enterprise tenants should not be greatly affected by a WeWork bankruptcy. However, that remains to be seen for the co-working tenants. Stay tuned.
What is your opinion on this fascinating saga? Please let us know what you think.
