The recent financial troubles of WeWork, the largest U.S. provider of shared office space, are raising questions about how banks’ commercial real estate portfolios might fare if the coworking sector implodes.
Though the risks to banks appear to be minimal now, the rapid expansion of shared office space has alarmed at least one banking regulator, who fears that the short-term nature of coworking leases could leave some commercial properties with high vacancy rates if the economy weakens and leases aren’t renewed.
“This also raises the issue of whether bank loans to property owners in cities with major penetration by coworking models could experience a higher incidence of default and greater loss-given-defaults,” Boston Federal Reserve Bank President Eric Rosengren said in a speech last month.
Bank investors and analysts are also starting to pay close attention to coworking trends. They are fairly confident that banks’ commercial real estate portfolios are diverse enough to withstand a sudden surge in coworking vacancies, but they would like more information about banks’ level of exposure and intend to ask executives about it on upcoming earnings calls, said David Chiaverini, an analyst at Wedbush Securities.
Banks begin reporting third-quarter results next week.
Coworking space represents only about 2% of the total U.S. office market, according to the commercial real estate data provider CoStar. It is most prevalent in large cities with lots of high-tech employers, but still only has 3% to 4% of the office markets in New York and San Francisco, CoStar said.
Market share is likely to grow, though, as coworking properties continue to proliferate. Since 2010, coworking space has grown at an average of 29.2% annually, according to CoStar. At that rate, its market share would double in three years.
Office space occupied by coworking tenants has risen tenfold since the end of 2010 to 54.2 million square feet, according to CoStar.
The popularity of coworking is spreading. The office-products retailer
WeWork is the largest of the flex-space providers and it appeared to be flying high until last month, when it abruptly canceled its planned initial public offering and said it was looking for funding to prevent running out of cash later this year.
JPMorgan Chase has made commercial loans to WeWork, personal loans to its founder and former CEO, Adam Neumann, and was underwriter on its now-canceled IPO, The Wall Street Journal reported on Sept. 24. A JPMorgan spokesman said the bank’s relationship to WeWork is not financially significant. He declined to specify the bank’s broader exposure to the coworking sector.
Analysts say that WeWork’s struggles are a result of its own unique business model and should not be seen as a bellwether for the coworking industry.
WeWork pays all expenses to renovate buildings to its specifications and assumes financial responsibility for its tenants’ long-term leases.
In contrast, some of WeWork’s largest competitors, including Convene, Industrious and Knotel, partner with landlords to share financial responsibilities. Coworking companies pay only a fraction of renovation costs and landlords are on the hook for leases.
“WeWork has to put up 100% of the capital,” said Ryan Tomasello, an analyst at Keefe, Bruyette & Woods. “Companies like Industrious tend to put up no more than 5% of the capital.”
Executives at large and regional banks have said virtually nothing in recent earnings conference calls and at investor conferences about the coworking market, and that’s probably because they don’t see the sector as being all that risky, said Chiaverini.
“Banks have well-diversified [commercial real estate] portfolios across construction, land, office, retail and multifamily,” Chiaverini said. “Any negative ripple effects from the challenges that coworking companies are facing should be manageable by banks.”
Still, what worries the Boston Fed’s Rosengren is the leasing model of coworking spaces. Many firms in coworking spaces are in short-term leases, and that raises the possibility of multiple tenants exiting in a short period of time and causing cash-flow problems for landlords that have loans to repay.
The model of coworking “could ultimately make runs and vacancies more likely,” Rosengren said.
Coworking is also heavily reliant on the high-tech sector, so if the funding for tech startups slows, lenders could suffer, said Jade Rahmani, an analyst at KBW.
“There has been a very liquid funding environment for tech startups,” Rahmani said. “Coworking’s growth has been fed by the same thing that’s driving tech growth.”
Brian Foran, an analyst at Autonomous Research, compared the situation to banks’ lending arrangements with shopping mall owners and operators.
“One retailer goes bad, it’s the mall owner’s problem,” Foran said. “Ten retailers go bad and it’s the bank’s problem.”
