Fed official warns companies like WeWork could pose systemic risk in downturn

Boston Fed President Eric Rosengren warned on Friday that co-working companies, like WeWork, are at risk during the next economic downturn.

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“This segment of the economy is likely to be particularly susceptible to an economic downturn, potentially resulting in office vacancies rising more quickly than they have historically,” Rosengren said during a speech at New York University’s Stern School of Business.

“Thus, in a downturn, the co-working company would be exposed to the loss of tenant income, which puts both them and the property owner at risk if they cannot make lease payments to the owner of the building.” The company signs long-term leases and then subleases them to tenants through a shorter contract.

Rosengren noted these companies could potentially utilize bankruptcy-remote special purpose entities for leases, potentially letting them off the hook from unprofitable lease arrangements during a downturn.

He concluded that now is an important time to be thinking about "structures and situations that could challenge financial stability in a downturn" and to think about the "potential for runs on commercial real estate stemming from a situation where short-term leases might not be renewed in recession, and long-term leases are no longer economically viable."

WeWork on Monday shelved plans for its initial public offering, until next month at the earliest, due to concerns investor concerns over its business model, valuation and governance standards, which allow CEO Adam Neumann’s shares to have 20 times the voting power of ordinary shareholders’.

The office-space provider last week was reported to be seeking a valuation of $10 billion to $12 billion, according to Reuters, a steep discount from the $47 billion worth it achieved in January.

“The growth model is heavily dependent on an expanding economy along with positive job growth,” Barry Oxford, senior vice president and senior research analyst at DA Davidson, wrote on Sept. 17. ”Given the shorter-term leases, vacancy can move rather dramatically based on an expanding or contracting economy.”

Oxford thinks a valuation of $8 billion is fair value and suggests investors look at Regus as a case study.

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“IWG’s Regus, which we believe is The We Company’s closest comparable, experienced a significant decline in profits during the last downturn, going from $140M in 2008 to $22M in 2010. We would also point out that publicly-traded IWG is bigger, more profitable, and has a market capitalization lower than $4B.”