WeWork's collapse: how leases became debt

WeWork has filed for Chapter 11 bankruptcy, ending one of the most extravagant valuation bubbles venture capital has produced. SoftBank's Vision Fund once valued the flexible office provider at $47 billion. It went into court restructuring with billions of dollars of debt and, more important, $13 billion of future lease liabilities. Its history is a textbook case of mismatched maturities on a balance sheet.

From unicorn to court filing

The decline took four years. WeWork's attempt to list its shares in 2019 collapsed after its prospectus exposed heavy losses and unusual governance, and its founder, Adam Neumann, was pushed out as chief executive that September. SoftBank, its largest backer, rescued the company with fresh money. It finally reached the stockmarket in October 2021 by merging with a special-purpose acquisition company, at a valuation far below the private peak. The shares then slid almost continuously. In August this year the company warned that there was substantial doubt about its ability to continue as a going concern, and in October it skipped interest payments on its bonds.

Leases that behaved like debt

WeWork's basic flaw was simple. It borrowed long and lent short. It signed long, non-cancellable leases with commercial landlords and sublet the desks to freelancers and tech start-ups on flexible month-to-month terms. When remote work became normal and funding dried up, its short-term revenue collapsed while its long-term lease bills stayed exactly where they were. Bankruptcy lets WeWork walk away from its costliest leases, and landlords will take a loss running into billions of dollars.

Accountants had already recognised what the business model implied. Since 2019, American rules have required public companies to put most operating leases on their balance sheets as liabilities, alongside the right to use the property as an asset. For a company like WeWork, whose main obligations were rent rather than bonds, that change showed investors what creditors already knew: the leases were the debt. A fixed obligation to pay rent for fifteen years is, in economic terms, much the same as a fifteen-year loan.

What Chapter 11 does to landlords

The bankruptcy code gives WeWork a powerful tool. Under Chapter 11 a debtor can reject unexpired leases, handing the space back to the landlord and ceasing to pay rent. The landlord's claim for the lost future rent is then capped: it is limited to the greater of one year's rent or 15 per cent of the remaining rent, up to a maximum of three years' worth. That claim ranks alongside other unsecured creditors, who typically recover only a fraction of what they are owed.

The cap turns a long lease into a short option for the tenant in bankruptcy. A landlord owed ten years of rent can end up with a claim worth far less, paid at a heavy discount. WeWork has asked the court to reject leases at dozens of locations and is negotiating cuts at others, using the threat of rejection to force landlords to accept lower rents. Landlords who agree keep a paying tenant; those who refuse get an empty floor and an unsecured claim.

Who else pays

The timing is poor for office owners. Vacancy rates in American office markets are at or near record highs as companies shrink their footprints for hybrid work, and higher interest rates have cut the value of commercial property while making it harder to refinance. Landlords that relied on WeWork to fill space will struggle to replace it, and some carry mortgages that were underwritten on WeWork's rent. Holders of commercial mortgage-backed securities and the banks that lend to office owners sit behind them.

SoftBank is the other big loser. It invested billions in equity and provided debt and credit support over the years, most of which is now worth little. WeWork's bondholders face a restructuring in which some are expected to swap their claims for equity in the reorganised company, while existing shareholders are likely to be wiped out.

A precedent from the dotcom bust

The model has failed before. Regus, the serviced-office company, put its American arm through Chapter 11 in 2003 after the dotcom bust emptied its centres, leaving it with long leases and falling demand. The parent survived, partly by shifting over time towards management and franchise agreements in which landlords share the risk. The lesson was that flexible office space works as a business only if the operator does not carry all the long-term rent on its own balance sheet.

The case for flexible offices

The counterargument is that demand for flexible space is real and may grow. Companies moving to hybrid work want shorter commitments and the ability to scale up or down, and many start-ups and satellite teams prefer not to sign long leases. On this view, WeWork's problem was its cost base and debt, not its product, and a slimmed-down company with fewer, cheaper leases could survive. That may be right. It does not rescue the original structure, which assumed that short-term customers would fill long-term commitments in every economic climate.

The indicators to watch are how many leases WeWork rejects, the rent cuts it wins from those it keeps, recoveries for its secured lenders, and whether other flexible-office operators with similar structures come under pressure from their own landlords.

Without the tech-company gloss, WeWork was a reckless bet on the gap between long leases and short rentals. Its landlords will now bear much of the cost, and lenders to other flexible-office firms should take note, since the same lease cap will apply to any operator that follows WeWork into court.