As our well-informed readers know, the Wall Street Journal has reported that WeWork expects to file for bankruptcy next week. For now, the WeWork bondholders have entered into a seven-day forbearance of the grace period to declare a default in order to provide additional time for negotiations.
It has been evident for many years that WeWork’s business plan was not working, and the only thing that stopped a bankruptcy from being filed earlier was the willingness of both private and public investors to keep the company afloat despite billions of dollars in losses. Indeed, after WeWork filed its warning in early August with the SEC stating that it might run out of cash in the next six months and simultaneously retained directors with expertise in bankruptcy and reorganization, the die was cast.
Our general counsel Eric Haber points out that fortunately for WeWork, the Bankruptcy Code is tailor-made for its situation. In American bankruptcies, the debtor has the opportunity to reject burdensome leases in an effort to right size its business as WeWork CEO David Tolley has stated. After a lease is rejected by the debtor (WeWork), the landlord will be left with an unsecured claim that is likely to pay pennies on the dollar. Further, adding insult to injury, the landlord’s claim will be capped at the greater of (A) one year’s rent or (B) 15% of the remaining rent due on the lease, not to exceed three years.
This provision will relieve WeWork of burdensome obligations like its vacated California Street lease in San Francisco, whose owner has sued to recover approximately $250 million that would otherwise be owed for the remaining term of the lease. It also provides powerful leverage for WeWork to renegotiate marginal leases, when landlords consider the alternative of a large empty space, which will in many cases be very difficult to lease in class B and C buildings which represent more than half of WeWork’s portfolio. In an excellent article in Crain’s New York business that dove into the bankruptcy process in detail (see the link below), Eric pointed out that a bankruptcy “will be very painful for the New York office market, whose condition I would characterize already as somewhat dire,” However, because WeWork has already downsized somewhat it only represents slightly more than one percent of New York City’s office space so the impact will be limited except for those landlords that have a high concentration of WeWork space in their buildings. In addition, the trophy buildings will not be affected at all.
A frequent correspondent asked yesterday if there is a wider lesson from WeWork, which got me thinking about the question. The rise and fall of WeWork is similar to many other business failures, but with a unique twist. Let me explain.
On one hand, this is a cautionary tale that is as old as the hills. To some extent, this is a classic story of the hubris of entrepreneurs with a great idea who expanded too fast and overpaid for their product (office space), with some self-dealing apparently thrown into the mix.
The major difference between WeWork and other failed startups is that their idea was truly revolutionary. It is important not to lose sight of the fact that the company had a brilliant idea to humanize the workplace which drew in billions of dollars from sophisticated investors. In a sense, the company succeeded in its noble attempt to transform offices around the world – just not financially. It is ironic that WeWork fulfilled its mission in a sense but lost a fortune in the process. Unfortunately, the business model was flawed. I am reminded of a very wise friend (Peter Roth) who had the foresight to ask me around five years ago if I could explain why WeWork had such a high valuation, and whether the business was sustainable in the long term. I was stumped as to how to provide a specific answer.
As for the state of the office in general, due to the pandemic and the exponential growth of remote work the business world has changed, and we don’t need so many offices. The lower office attendance (around 50% in New York) is why you see the turmoil in so many cities which rely upon office employees for the vital spending they generate for the local business ecosystem. Further, reduced rent rolls lead to lower property values, which in turn reduce tax revenues. I don’t see a doom loop as NYC’s economy is so diversified with robust neighborhoods and retail, but the conversion to what comes next will have a tremendous impact on urban life. Over three years into the pandemic, it is still early days as real estate markets move at a glacial pace. We’ll know more as leases continue to roll off the books, but the increased loan default rates are concerning for the big picture.
Returning to WeWork, assuming it files for bankruptcy, there will be more specifics to assess. But looking at the big picture today, bankruptcy offers the company yet another of its many opportunities to reorganize by identifying a core group of profitable leases and reducing its debt load substantially. If in fact the bondholders are willing to exchange some of their debt for equity, this will afford WeWork a fresh start to finally achieve the goal of a profitable business which has thus far proved unattainable. We’ll see if the company can take advantage of it.