Each WeWork office has an SPE that's just for that lease. Every landload wants WeWork on the lease, but won't get it, as WeWork tends to have significant leverage with either the space that they're going after or the desire to have WeWork on the rent roll.

When things are booming, WeWork is advantageous for landlords, and appraisers/the market/potential buyers will underwrite that space positively.

However, there's minimal guarantees that WeWork will actually pay long term, or that you'll have any legal recourse. On top of that there are significant capital costs to a WeWork lease that landlords have to shell out up front. Their leases are typically structured with a lot of free rent up front, so the break even point for a landlord may be many months or years farther out than a typical tenant leasing comparable space.

The losers in the WeWork deal are the landlords, as they're bearing a lot of the risk, and get minimal upside. I'd expect to see a high degree of correlation between WeWork's IPO/stock price and REIT valuations. Underwriting will push the value of a WeWork lease if they can, which will only give more momentum to the bubble.

Source: Worked at a nationally invested REIT that had several WeWork leases in our portfolio

> The losers in the WeWork deal are the landlords, as they're bearing a lot of the risk, and get minimal upside.

Couldn't this be interpreted differently? That is, landlords are having less and less choice. Something from WW is better than an empty building. Is WW a canary of sorts? It tells us about changes in the economy (less growing small to mid-size companies in major metro area?), as well as the health and strength there of?

And if building owners are own details space their choices are less robust. WW might not pay out well, but it's better than nothing.

Yes and No. Part of the No answer is that as an real estate investment company your building's worth is effectively present value of future rent, so sometimes it's better to preserve the valuation of your building rather than set a new market rent which will negatively affect your building valuation which in turn affects the cost of financing your building etc etc etc

So you get an extra $1m in rent but it now costs you an additional $2m in interest costs financing your building and your share price (or the building capital valuation) has now dropped 15%.

Sorry totally simplified example...

Very true. In Calgary for example, following the drop in oil price there’s a rumor that over 50% of the downtown office space is empty, but landlords won’t drop rents for this very reason.

In such times you see all kinds of shenanigans such as landlords giving massive concessions and tenant improvements, effectively dropping the economic price of the rent drastically but preserving the “headline” rent number. Go figure.

"so sometimes it's better to preserve the valuation of your building rather than set a new market rent which will negatively affect your building valuation "

I understand that, and thus the question about WW being a canary in the economic coal mine. If there are more and more building owners who literally can't afford to "preserve the valuation" - and WW's success seems to hint at that - then doesn't that say something about the economy that aggregate numbers aren't seeing?

I understand the theory of "preserve the valuation", what I suggesting is that in reality less and less building owners are able to preserve that theory. And some of that is direct result of demand (read: the lack there of) not being in parity with demand.

Yes precisely, if things become systematic then there is no avoiding the new reality.

I am no expert on real estate I used to be a property accountant at an international commercial property company and so used to compute out growth rates on rent and valuations for owners.

I do find WW's business model difficult to follow, there maybe something I fail to appreciate, I guess time will tell.

There's several components to unpack here, but at a high level your right.

>Something from WW is better than an empty building...WW might not pay out well, but it's better than nothing.

The deals, if they go through to the end of the lease, are a net positive for the landlord, and they are better than sitting on the empty space. One of the benefits to a WeWork lease is that sometimes they can aggregate hard to lease space under a single lease where the individual spaces might be hard to lease, or there might not be a tenant in the market to take all the space.

The flip side is that WeWork spends a LOT of money on their build outs, and expects the landlord to subsidize that through high TIs (tenant improvements) and a lot of free rent. This means that a WeWork lease will generally wind up costing a landlord a lot of money up front, and it will take longer for that lease to break even.

Yes it might be great to have a tenant like WeWork in the later stages of their lease, but it's always a question of whether they'll have the income in those later years to make it pay off. The other aspect of this is that if WeWork goes dark, your left with space that's like too big for the market (WeWork will take a lot of space off your hands) which is problematic, but their build outs will likely not be very useful for the next tenant. This means capital outlays by the landlord to break up and possibly "whitebox" the space.

The valuation side gets more complicated, so I'll just put that aside for now.

>Couldn't this be interpreted differently? That is, landlords are having less and less choice... It tells us about changes in the economy, as well as the health and strength there of?

I think it does, in a similar way to Uber and Lyft ushering in the "gig economy", but as a company, WeWork doesn't have the tech side of it to back it up. Landlords having less choice is partially of their own doing, and partially a response from companies themselves. Landlords have been pushing rents like crazy, and in many markets tenants are just tapped out. Some of the rent growth seen several years after the recession has moderated, but it's still out of the reach of many tenants that don't have the kind of credit or strong balance sheets that landlords love.

Companies, on the other hand, are changing their strategies and thinking about the utilization of real estate much differently than they were 10 years ago. Open floor plans are the biggest indicator of this, as it allows for more employees to be places in the same square footage. With the high rents of class A office in the city and significant commute times in many metros, companies are now more likely to entertain the idea of having multiple offices, with secondary offices leveraging cheaper spaces either in the suburbs or cheaper markets. Remote work and remote only companies go along with that, in that you need less space if you have a portion of your workforce that is never in the office.

In a way, WeWork is supposed to assist companies by providing them this flex space or their remote employees with a place to work. The problem is that it trades flexibility for cost in a way takes away a good amount of it's value proposition.

Yeah like is it even really downside?

Tenant defaults on their lease? OK, kick them out and get someone else in. What's the big deal?

Well, you have forgone rent you could have collected from a different tenant and reduced the quality of the tenant you have accepted.

So for an investor who looks at your rent roll, they will see that you have an increased rent arrears and they will value your asset at a reduced rate.

And as the sibling comment has mentioned, if you discount up front you haven't received any money.

Or worse still you provide a rent incentive in the case of a capex fitout and are now left with an office fit out a future tenant may or may not want but you have spent significant amounts of money on.

If they've discounted upfront there going down overall...?

I believe you, but in markets like Austin, TX (where I live) it seems odd that a landlord would not just hold out for a more orthodox lease, since there is some shortage of retail space and rental rates are high. What am I missing as to why they would lease to such an SPE?

I agree with both the other answers (reletting space and branding), but there's another one that's just as important; increasing rent.

If there's a shortage of space, having WeWork take a chunk of it off the market is only going to move rents higher. Also, whatever you sign WeWork at is going to set a significant comp in the market, which can again push rents. Businesses do like the idea of being close to a WeWork, so that's going to put more pressure on rents.

There are tenants that are great in bull markets, some that are great in bear markets, and others that are great in both. I would very much describe WeWork as a tenant that is a great bull market tenant, but that's about it.

Confidence of rapid re-leasing in the event of WeWork default (which makes sense in a high demand area like Austin).

Disclaimer: Landlord

The branding. You can hold out for a high "orthodox" lease like storefronts in the West Village in NYC are doing (lots of famously ritzy streets dotted with vacancies) or you can hand the problem to We and use their network effect as leadgen.

Are those SPEs durable against legal challenges that pierce the veil and eliminate the protections for We?

It's not an uncommon business practice to have SPEs for ventures like this. In fact, nearly each of our investments were backed by SPEs that held the property. If you had some sort of evidence to WeWork was trying to defraud or break the lease in some substantial way, then I guess you'd have some legal recourse, but the whole purpose for the SPE is to limit legal exposure (which is exactly why we did it).

The thing is that the SPE is absolute requirement for WeWork. They will walk away if you try to challenge them on it. It's ultimately not an issue unless shit hits the fan. Smart underwriters will recognize that and price it accordingly. Unfortunately, there will be many that don't and execs that are trying to push value, so won't want a conservative view on those leases.

The biggest risk (outside of WeWork itself) is bullish investors buying properties at inflated values due to WeWork being on the rent roll, not doing their due diligence on the WeWork lease, and the bottom dropping out.

Generally speaking courts are much more reluctant to look behind special purpose vehicles in contract than they are in tort, especially so when dealing with sophisticated parties.

As polygotdomain wrote landlords know that want We on the lease, ask for it, don't get it, and sign anyway. Short of a smoking gun showing outright fraud courts are unlikely to disregard that bargain.

Sure, assuming you assume away the reputational risk. They’re going to have a tough time finding future counterparties if they walk on a lot of leases.

If any of their special purpose vehicles default nobody is going to renew a lease with them ever again (at least not without a crushing risk premium).

I guess the problem is that the defaults will come in several years from now, but when they come they will be frequent.

Shed properties...and merge any remaining tenants into other locations.