The entire realm of labor has been anticipating the next occurrence for years, ever since the pandemic cleared America’s downtowns and central business districts. In line with an earlier report this year by Real Estate, the rate of vacant offices is almost 1.5 times greater than at the close of 2019 — and by the end of the decade, there may very well be up to a billion square feet of unused office space in the United States. The organization Cushman & Wakefield. New York University and Columbia University researchers have estimated that by 2029, $49 billion worth of New York City commercial properties will be wiped out, which is part of a nationwide “office real estate apocalypse” amounting to $500 billion. On Monday evening, a significant portion of this disaster unfolded in a New Jersey bankruptcy court.Thank you for reading this post, don't forget to subscribe!
Even when shared office spaces appeared to be a brilliant concept during pre-pandemic times, WeWork founder and former CEO Adam Neumann saw it that way too. Nonetheless, the shift to a remote work environment has transformed the office’s requirements as we knew it. Moody’s Analytics referred to this quarter’s office vacancy rate of 19.2% as extremely close to the record-high vacancy rate of 19.3% achieved in 1986 and 1991. Interestingly, WeWork declared bankruptcy and most of its New York offices entered Chapter 11 right around the same time.
According to Luck’s vice president at property consultancy Savills, Gabe Marans, WeWork has currently leased almost 7 million square feet of office space in NYC as of the first quarter of 2023, which represents 61.4% of the co-working market. (WeWork based its bankruptcy-related court files on Savills’ data.)
Moreover, with respect to New York landlords, WeWork’s initial action in response to bankruptcy was to begin abandoning unprofitable, “mainly non-operating” leases. WeWork’s plan to advance post-bankruptcy includes a list of around 70 leases that it intends to terminate—35 of which are in New York City alone. As of June, the co-working space provider had 700 locations worldwide, while WeWork possessed assets of over $15 billion and over $18 billion in liabilities.
In court documents, WeWork CEO David Tolley stated that this is just the beginning. Tolley explained that the company’s real-estate advisors are actively negotiating with over 400 landlords to modify lease agreements on office buildings. He also disclosed that WeWork has already revised more than 590 of its existing leases, resulting in future rent obligations amounting to $12 billion.
Why did WeWork go bankrupt?
WeWork attributes its downfall to “historically rapid increases in interest rates” and a slower-than-expected return to the office setup. It claims that due to the crisis in the commercial real estate market, landlords are more inclined to decrease rents and provide flexible lease terms. Additionally, companies worldwide have transitioned to a hybrid work model, resulting in a reduction in office space demand.
In Tolley’s words, WeWork lacks the “financial maneuverability necessary to adapt to the rapidly changing commercial real estate market.” He believes that the company’s current business model is undermined by “unsustainable leases” and recommends its reevaluation. He emphasized that despite its “extraordinary efforts,” the company couldn’t overcome the limitations posed by legacy real estate and industry constraints.
“As a consequence, commercial office space, particularly in the large cities where WeWork operates, has become available and accessible at unprecedented prices and in significant quantities,” Tolley writes in the bankruptcy announcement. “This has created intense competition in WeWork’s target market.” In other words, tenants now have more options than just WeWork, thereby affecting their vacancy rates.
WeWork’s vacancy rates exceed the national average by a significant margin. As of the second quarter of 2023, WeWork had a vacancy rate of 28% and an occupancy rate of 72%. Given the well-documented challenges experienced by the fallen unicorn, it is no surprise that its initial attempt to go public failed due to Wall Street’s scrutiny of its unorthodox accounting methods. (Despite its 13-year existence and a staggering valuation of $47 billion, WeWork has yet to report a profitable quarter.)
In July 2023, Neumann publicly appeared at Fortune Brainstorm Tech, discussing his new startup Flow, which, as Luck’s senior writer Jessica Matthews puts it, sounded remarkably similar to WeWork 2.0. It is worth mentioning that Flow had already secured $350 million in funding from a16z, a venture capital firm established by Marc Andreessen and Ben Horowitz. During his presentation, Neumann stated that Flow, a “consumer-facing residential brand,” had two options available as its non-compete and non-obligation agreements were approaching expiration at year-end. He asserted that those choices were either partnering with WeWork or competing against it.
“Now is the time to proactively address our legacy leases and significantly improve our balance sheet,” declared WeWork CEO David Tolley in a statement. Nevertheless, there is still much work ahead: WeWork’s bankruptcy filing discloses the existence of over 100,000 creditors.
Will the impending wave of commercial real estate collapse?
“Remote and hybrid work schedules have become possible due to technology,” stated Ermengard Jabir, senior economist at Moody’s Analytics, in a report published on Tuesday. She continued, “Office properties, which were already grappling with financial difficulties and declining values, are now confronted with the potential for unexpected vacancies.”
“If WeWork fails, other properties won’t have adequate space for all their occupants,” remarked Savills’ Marans. He asserted that the co-working business model is here to stay, but WeWork’s bankruptcy represents a blow to the third-party model, where entities or individuals share common office space.
Jeffrey Havasi, the head of the commercial real estate industry practice at Moody’s Analytics, expressed in a statement reported by Luck that “WeWork’s bankruptcy will undoubtedly have an adverse effect on the market and its ability to finance those buildings, but the pain won’t be evenly distributed.”
He acknowledged the negative aspect but argued that it does not amount to complete loss. According to Havasi, while flexible office space may not survive in the current economic climate, it still serves a purpose.
WeWork primarily occupies Class A and A+ office spaces, and Jabir mentioned in a report that the sudden availability of high-quality office space presents an opportunity for potential office tenants to acquire their area at more competitive prices. She discussed it in terms of a shift in preference towards “trophy office properties” possessed by WeWork rather than older, less modernized Class B/C offices.
Nevertheless, Jabir pointed out that Class B properties will continue to be in demand for specific office tenant groups. She stated, “In locations where WeWork possesses stable, high-quality tenants (e.g., large international consulting firms), office owners may take solace in realizing that such lessees will not exit the premises due to relocation costs they are unwilling to bear.”
Despite the projected wave of office spaces returning to the market as a result of WeWork’s downsizing, Maran highlighted several challenges that stakeholders will confront in the aftermath.
“Not all of the 6.9 million square feet occupied by WeWork in New York City will return to the market, and some tenants will remain in their current locations under new management. On the other hand, certain WeWork members may seek more traditional office leases,” he explained. “WeWork owners should immediately establish contingency plans to prevent being left empty-handed in this musical chairs scenario.”
[This headline and report have been corrected to clarify that WeWork represents over 60% of New York City’s coworking market.]