It Was Once A Flagship Deal. Now WeWork And Partners Restructure Huge London Lease And Keep Eye On Debt Covenant

The deal was supposed to herald a new model for WeWork. But the flexible office company and a group of institutional investors have restructured one of its largest global leases, and could need to make payments to cure a covenant breach on a loan secured against a massive London office asset. 

In spring 2018, WeWork Property Investors, the investment arm of WeWork, teamed up with Nuveen to buy Devonshire Square, a 637K SF, 13-building estate in the City of London, from Blackstone for £580M. 

The deal was funded with a £235M loan from Bank of America Merrill Lynch, which was then securitised, and £345M of equity, with WeWork providing 10%, Nuveen parent TIAA providing 45% and Danish pension fund PFA Global Real Estate the other 45%. BAML also provided a £40M capital expenditure loan.

At that point WeWork occupied about 20K SF on the campus, but the plan was to increase that occupancy beyond 200K SF, which would make the scheme fully let. It was supposed to be the first of many deals in which WeWork would team up with institutions to buy buildings, then occupy and manage vacant space, making them more valuable.

Rather than take a standard lease, WeWork agreed a revenue-sharing deal with its partners. After the headline gross revenue is derived from membership sales by WeWork, it pays rates and service charges estimated at £30 per SF, according to S&P; a priority rent reflecting £50 per SF to the landlords; and WeWork building-related operating expenses, which are capped at £27.50 per SF.

WeWork is paid a 10% management fee based on gross revenue, and the remaining revenue is split 50% to the landlords and 50% to WeWork as tenant.

WeWork did indeed increase its occupancy, to about 36% of the estate, according to a notice from Mount Street, the servicer of the securitised loan. That is roughly 230K SF, one of its largest single global leases. And the intention was to take more space. But then the world changed. 

Even before the coronavirus crisis, the performance of the estate was suffering. In March, before lockdown, the Devonshire Club, a members’ club installed at the estate by previous owner Blackstone and backed by Tory peer Lord Ashcroft, went into administration. It occupied 58K SF. 

Its departure took the vacancy rate at the scheme from 10.3% to 17.5%, according to S&P, and meant the weighted average lease length dropped from 7.2 years to 2.7 years. The space it occupied will be converted to offices. The 72K SF building seven at Devonshire Square will also shortly become vacant, S&P said, leaving 130K SF of freshly vacated space to fill.

Once, WeWork would have been hungry to fill that space. But no more, given it is looking to reduce its own costs. WeWork is exiting 15K SF of the space it occupies at Devonshire Square, reducing its occupancy from 36% of the estate to 34%, according to a notice from Mount Street.

WeWork has given up its exclusive naming rights to the estate, and it can now only display signage on the buildings it occupies. It is also giving up its right to first refusal on occupying other space on the estate. Mount Street’s notice said the owners would now be pursuing a “direct leasing strategy” to third parties on vacant space over the next two years.

The notice said the owners expect the strategy to increase the headline rent on the estate. S&P said rents at Devonshire Square average £52 per SF, compared to an average of £62 per SF in the surrounding area. 

Nuveen and its equity partners have given WeWork a three-month rent-free period on the priority rent it pays, and returned £435K to it, payment for the space it no longer occupies. 

The owners had sought a request from lenders to waive a debt-yield covenant, but have now withdrawn that request. Instead they will cure the covenant breach using a cash facility they have set aside in case of breach. The investors who bought the securitised bonds secured against Devonshire Square also have to vote to approve the loan modifications.

All told, annual income since the deal closed has fallen 35% to £23M, S&P said.

“We believe this is largely due to increased vacancy on the estate and reduced income levels from WeWork,” it wrote in a note on the transaction. “Given the current uncertainties in the market and the deteriorating occupancy levels of the estate as a whole, we have revised our long-term operating and cash flow assumptions.”

In a deal that was once held up as a potential blueprint, WeWork and its partners now have a fight on their hands.