WeWork taps CMBS market to finance S.F. office acquisition

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Though WeWork’s recent initial public offering launch raised some eyebrows, the company is moving ahead with plans to court institutional investors in commercial mortgage-backed securities.

According to ratings agency presale reports, an investment joint venture controlled by the collaborative workspace provider will sponsor a $240 million commercial mortgage bond sale to partially finance the purchase of an office building in San Francisco's central business district. WeWork already leases space in that building used to service its flexible-office clients on a short-term basis.

In taking over the ownership and management of the building through its Ark Capital Advisors JV, New York-based WeWork plans to expand its occupancy in the building to as much as 70% of the net rentable area of the 359,154-square-foot tower at 600 California St.

WeWork leases 51.8% of the building to stand as the largest tenant, according to Morningstar Credit Ratings and S&P Global Ratings reports. Currently housed in most of the upper floors of the 20-story building, WeWork plans to expand into three lower floors previously occupied by the Federal Home Loan Bank of San Francisco, according to Morningstar.

WeWork will be paying a substantially higher base rent for the new space, despite taking over the building's ownership through its real estate investment platform. WeWork will pay $87.50 per square foot, compared to $68.96-$75.19 per square foot for its existing space, Morningstar reported. WeWork’s new lease rate is approximately 15.9% above the rent of the most recently signed lease at the property in April ($75.50 per square foot).

The higher rent will help Ark fund $11.6 million in planned capital improvements; the ratings agencies detailed Ark's plans to modernize elevators, waterproof the exterior of the building and perform upgrades including the HVAC system and the replacement of cooling towers.

To avoid a conflict of interest with the same entity being the property owner and the prime tenant, WeWork's Ark Capital Advisors will be operate independently from The We Co., WeWork’s parent company. Any WeWork transaction such as lease amendments will require the consent of co-investor The Rhône Group of New York.

The large loan securitization (titled GSCG Trust 2019-600C) will be secured by a five-year, $240 million mortgage loan. Given the $370 million appraised value of the building listed by the issuer, its loan-to-value ratio is 64.8%, according to Morningstar. (The sponsor is contributing $123.4 million of the $363.4 million purchase price of the building.)

The interest-only loan carries a 4% interest rate and was originated by Goldman Sachs Bank USA and Citi Real Estate Funding. The loan is being taken out by Ark Capital Advisors as well as an undisclosed Eurasian sovereign wealth fund as the co-borrower.

The 600 California St. building, built in 1991 and extensively renovated in 2009 and 2016, is fully leased to 18 businesses.

But WeWork is renting out most of the building’s net rentable area for use as workstation and office space for WeWork’s coworking lease clients, according to S&P and Morningstar. It won’t begin to occupy the new space until Oct. 1, and the company will only begin paying rent on the expanded space in March 2020.

That plan creates two risks for investors: the concentration risk of WeWork’s expanded lease space as a single tenant, as well as the mismatch of WeWork’s long-term, 15-year leases supported by monthly membership contracts that WeWork clients can withdraw from at any time.

“There is inherent risk to the sustainability of the coworking business model in an economic downturn, during which tenants may rapidly cancel their memberships as employment dynamics shift,” stated S&P’s report.

The acquisition is the first real estate deal closed by the Ark Capital Advisors platform that WeWork established in May with Canadian institutional fund manager Ivanhoe Cambridge and Rhône. The Ark platform was set up for the acquisition and development of real estate sites where WeWork will build out flexible working office space to lease to member clients, according to an Ivanhoe announcement.

WeWork’s IPO, launched through a prospectus published last week, was greeted with some skepticism because it involved a so-called unicorn weighed down by several years of losses. The company did not disclose the amount it wants to raise, but it is forecast to be the second-largest offering of the year behind Uber Technologies' $8.1 billion opening. Despite producing $1.8 billion in revenue in 2018, WeWork reported losses of $2.9 billion over the last three years; that figure includes a $690 million loss in the first half of 2019 as it burned cash to fuel growth.

The amount of the offering was undisclosed, but the company is looking to borrow up to $6 billion through loan facilities alongside the offering; it needed to raise at least $3 billion in an IPO to obtain bank commitments, according to Bloomberg. The company's largest backer, Softbank Group Corp., has estimated WeWork's value at $47 billion.

Both ratings agencies point out the risk in WeWork’s long-term lease being supported by monthly membership contracts of WeWork clients.

Morningstar and S&P Global Ratings have each applied preliminary AAA ratings to the senior notes in the offering, an $84.9 million Class A tranche, but each diverged on the ratings for three subordinate tranches due to differences in expected net cash flows estimated by each agency.

Morningstar, which estimates $16.42 million in annual net cash flow from rent income, affixed a triple-A to an $18.87 million Class B note tranche that S&P is limiting to an AA- rating. S&P estimated lower cash flow of $14.3 million, or a debt-service coverage ratio of 1.48x.

The Class C tranche totaling $14.15 million has an early AA grade from Morningstar but a two-notch lower rating of A- from S&P, while a $17.37 million Class D tranche has split ratings of A-/BBB- from Morningstar and S&P, respectively.

Morningstar rated the Class E, F, and H tranches totaling $75.5 million at BBB-, BB-, and B-; S&P did not rate those classes.

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