By Charlie Innis · 2023-11-09 19:13:15 -0500 ·
Over $1.85 billion in commercial mortgage-backed securities loans stand to face immediate impacts from WeWork‘s Chapter 11 filing this week, yet some experts stress that while the bankruptcy will create ripples for the commercial real estate market, it won’t be a harbinger of doom for the wider economy.
Flexible-workspace operator WeWork filed for Chapter 11 in New Jersey bankruptcy court with more than $10 billion in debt and widespread support from secured noteholders for restructuring, just hours after trading of its shares was halted amid reports that the company had doubts about its ability to continue as a going concern.
WeWork finally caved to office market pressures, filing for Chapter 11 bankruptcy Monday with $10 billion in debt. Law360 charted a timeline of the company’s descent amid unrelenting pandemic pressures.
WeWork’s Chapter 11 filing was caused by the societal shifts wrought by the COVID-19 pandemic, but the operation is poised to take advantage of expected growth in the flexible office space market post-bankruptcy, its CEO David Tolley said in court documents.
As WeWork’s bankruptcy further strains the troubled office sector, commercial real estate legal experts say some assets will suffer, but savvy property owners have long prepared for the flameout.
Counsel for WeWork told a New Jersey bankruptcy judge that talks with the workspace provider’s landlords are now the key to its hopes of emerging from Chapter 11 by early next year.
WeWork Inc. isn’t big enough for a bankruptcy to spell disaster for the broader economy, but the undoing of one of the largest private providers of office space in the U.S. will reverberate in the commercial mortgage-backed securities market and the already-challenged commercial real estate sector, attorneys and analysts told Law360.
Nearly $6.5 billion of CMBS loans are exposed to a WeWork location, recent estimates by Kroll Bond Rating Agency show. Within that amount, at least $1.85 billion of such loans are for WeWork-leased properties the company plans to immediately abandon through Chapter 11 proceedings, according to court papers and KBRA. The coworking space business filed a motion to reject 69 of its leases, over half of which are in New York City.
The number of CMBS loans affected by the bankruptcy may also jump higher if WeWork decides to shed more leases, which seems likely. The company said in an early restructuring plan filed with regulators that it intends to ditch 163 properties, or 32% of its footprint. The exits are part of a “preliminary long-range strategic plan” for getting its business to a steady state, according to a filing with the U.S. Securities and Exchange Commission.
The bankruptcy of a major tenant of office buildings will impact numerous commercial landlords across the country and the holders of CMBS debt, including hedge funds, pension funds, and regional and community banks, Thad Wilson, a partner in King & Spalding LLP’s corporate, finance and investments practice group, explained. While the Chapter 11 proceedings will have some big impacts, they could be much worse, according to Wilson.
“If the question is, is this a canary in the coal mine moment? I don’t believe so,” he said.
The fallout is unlikely to be as extensive as what the U.S. economy experienced when banks failed in 2008, Wilson added.
“I don’t think WeWork was such a big enough player that it will create the type of catastrophe that the failure of Bear Stearns or Lehman Brothers had on the economy, in terms of the spiral,” he said.
Impact on CMBS
Whatever events unfold in the coming months with respect to CMBS loans tied to properties WeWork dumps by rejecting leases depends on a variety of factors, attorneys said.
If the company leased a small fraction of space in a building with CMBS debt, and the rest of the space is rented out to tenants, the loss of WeWork shouldn’t cripple the property owner’s situation. But if the company took up most of a building’s space, and it rejects the lease, operations of that building will suffer — and the landlord may not be able to pay its debt service to the CMBS trustee, Wilson said.
If the latter occurs, a special servicer will likely be appointed to handle the loan and recover as much money as it can for the trust. The special servicer’s remedies will range depending on how the CMBS is structured.
“The landlords who have CMBS debt, their workout options are going to be a lot more limited than if you had a traditional bank or even a regional bank that is your lender on a particular property,” Wilson said.
A significant challenge facing the CMBS market in general — beyond WeWork’s specific situation — is that interest rates are much higher now than they were a year and a half ago, and the added costs could make refinancing unfeasible for some property owners, according to Morris Missry, a managing partner at Wachtel Missry LLP.
“Your interest rates are now double. You can’t afford the refinance because you’d have to put in millions and millions of dollars of capital to pay down the loan. You may lose that property,” Missry said.
CMBS loans are generally non-recourse, which means the lender is allowed to seize only the collateral specified in the loan agreement; the borrower has no personal liability.
If office landlords with CMBS loans see their cash flow dwindle significantly because of WeWork’s lease rejections, the default risk could influence them to walk away from their properties entirely and cede ownership to the CMBS trust, Patrick Czupryna, a managing director at KBRA, noted.
“The bankruptcy situation will exacerbate an already-challenging environment for property owners in which borrowing costs have increased and office demand has fallen off amid the increasing adoption of remote work following the pandemic,” Czupryna wrote in an email.
Effects on an Already-Reeling Market
What might be more significant than the bankruptcy’s impact on CMBS loans is the pressure WeWork’s downfall will put on the commercial real estate industry, which is already facing a reckoning over office property valuations in a post-COVID landscape.
“The pressure will be significant in terms of putting more troubled product on the market and giving more landlords the challenge of what to do with these properties,” Andrew Raines, a founding partner at Raines Feldman Littrell LLP, said in an interview.
One of the country’s largest workspace providers filing for Chapter 11 also sends a clear message: People may not need places to work out of as much as they used to, and companies that do use office space may need less than they used to, Raines said.
“You have this significant change in demand that’s hitting a market that’s already stressed by higher interest rates,” he explained.
Czupryna, of KBRA, said the bankruptcy could broadly impact how well Class A office assets perform compared to Class B or C assets, with the former being better-positioned to secure tenants, Czupryna said.
“The retreat of WeWork from downtown office markets could hasten the trend towards obsolescence for older-vintage, less-amenitized inventory,” he wrote.
“It’s also unclear to what extent the build-out and configuration for WeWork spaces will hinder landlords’ ability to re-lease space to conventional office users; it doesn’t seem likely that competing co-working companies will come close to absorbing the [square footage] left behind as WeWork radically right-sizes its footprint,” Czupryna added.
Despite the challenges, some may stand to gain from the situation. The WeWork bankruptcy could further impact valuations on CMBS debt and lead to more depressed prices trading on the market, Wilson said.
“Almost every gold-plated real estate sponsor out there has already raised a significant distressed real estate fund, whether they can hold debt or equity investments will depend on the fund,” he said. “But there’s a lot of dry powder sitting on the sidelines, waiting for opportunities that come as a result of the WeWork bankruptcy or other large tenant defaults that might be on the horizon.”
–Editing by Philip Shea and Covey Son.