New York City’s real-estate market is usually relatively resilient during recessions. But today, its largest renter of commercial space is a single “co-working” office manager, which could add extra risks for the city’s landlords when the next recession hits, according to S&P Ratings.
The growth of WeWork and similar co-working spaces since the financial crisis has added risk to the market for commercial mortgage-backed securities, according to the credit-ratings firm. About $3.1 billion of U.S. commercial mortgage debt has...
New York City’s real-estate market is usually relatively resilient during recessions. But today, its largest renter of commercial space is a single “co-working” office manager, which could add extra risks for the city’s landlords when the next recession hits, according to S&P Ratings.
The growth of WeWork and similar co-working spaces since the financial crisis has added risk to the market for commercial mortgage-backed securities, according to the credit-ratings firm. About $3.1 billion of U.S. commercial mortgage debt has exposure to WeWork, the analysts found.
The back story. While the financial crisis crippled the residential real-estate market, the U.S. market for office space held up relatively well. The market has strengthened steadily since the financial crisis; nationwide, the commercial vacancy rate has dropped to 12.6% from its financial-crisis peak of 16.5%, according to S&P.
Some of the biggest new renters of space have been co-working spaces like WeWork, which take out long-term leases on office space and then rent out that space to individuals and companies.
WeWork is now the biggest commercial tenant in New York, which matters because investors and analysts have questioned the sustainability of the cash-burning unicorn’s business model.
What’s new. The fundamental risks of the co-working business model have been covered thoroughly. One danger is that co-working freelancers and small-business employees will cancel their leases in a recession. Another is that established property companies will start trying to compete by providing the same services.
But S&P says co-working tenants create extra risks for landlords and investors in commercial mortgage debt (including many fixed-income fund managers).
There are added risks for landlords, write the analysts. First, there is “a potential conflict of interest between the property landlord and the co-working lessee, who is essentially another competing landlord,” says S&P. Second, the company keeps its leases in special purpose vehicles, which means landlords don’t have recourse to the company in case of a default, according to the ratings firm.
Looking ahead. These risks are important for commercial real-estate investors because co-working spaces have become such large tenants, says S&P. In fact, WeWork may pay more than $150 million of annual rent in midtown alone, according to the note.
If these companies hit trouble in a recession, they could end up affecting the broader market. And there is a precedent for that. Regus, which is owned by IWG plc (IWG.LN), filed for bankruptcy after the dot-com bust.
S&P takes special care to reflect the risks of co-working tenants in its ratings of commercial mortgage-backed securities. For example, it may assign lower probabilities of lease renewal for those tenants.
“Our overall credit view of co-working tenants, all else equal, is negative relative to traditional ones,” says S&P.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com