Wework's Troubles Darken the Outlook for the Embattled Office Market

The challenges facing the co-working giant WeWork are casting a shadow over the prospects of the world's largest business centers. These centers are already experiencing increasing office vacancies, which are putting additional pressure on investors preparing to refinance significant mortgages in the coming year.

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Recent reports have suggested that WeWork, a flexible workspace provider listed on the New York Stock Exchange, once privately valued at $47 billion, is contemplating a bankruptcy filing next week. WeWork, backed by Japan's SoftBank, initially aimed to disrupt the office market by signing long-term leases on large properties and subleasing space to multiple smaller businesses on more flexible, shorter terms.

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However, like other landlords, WeWork has struggled to convince some customers to return to the office at its 650-plus global locations since the pandemic, as remote work remains a prevailing trend, which has eroded confidence in the co-working sector.

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This trend is expected to lead to an increase in global office vacancies, impacting rental prospects in major cities such as New York and London, according to industry executives, investors, lenders, and analysts.

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For some leveraged property investors, it may become challenging to generate sufficient rental income to cover rising debt costs. Moody's Analytics' Commercial Real Estate Industry Practice Lead, Jeffrey Havsy, noted that "the loss of any tenant, especially during a time of relatively slow office leasing, will have a negative impact on office building cash flows and values." This could further complicate financing, particularly for buildings needing to refinance in the next 12-18 months.

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WeWork has been in discussions with landlords to address "high-cost and inflexible lease terms" while striving to maintain its presence in the majority of its locations and markets.

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The number and volume of real estate loans due for refinancing in 2024 remain uncertain, as many deals are negotiated privately between borrowers and lenders.

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Real estate experts predict that 2024 will be a year of reckoning for property investors and lenders, particularly for assets that could breach key lending terms when revalued today.

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Real estate prices have also been affected by a drop in transactions, which are essential for assessing changes in asset values. MSCI's Capital Trends report for Europe showed third-quarter transaction volumes down 57% compared to 2022, the lowest level since 2010.

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Additionally, there is a significant gap between the perceived value of assets by investors and what prospective buyers are willing to pay, particularly in core office markets, with estimates indicating a 20-35% difference.

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The challenges faced by WeWork serve as a cautionary tale for lenders, who may require borrowers to inject more equity into their properties to reduce loan-to-value ratios, a request that could be problematic given the uncertainty surrounding rental income.

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London, in particular, has seen a surge in office vacancies to a 30-year high, and average lease lengths for central London offices have significantly decreased. The co-working trend has also highlighted issues with under-occupied urban offices, which not only generate lower rental income but are also aging quickly, raising concerns about carbon consumption.

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The real estate investment market is at a turning point globally, where property returns will increasingly rely on growth in the 2020s, according to Jose Pellicer, head of real estate strategy at M&G Real Estate.

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