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Weekly Market Report - December 5, 2019

The Fallout of WeWork & How Other Co-working Firms Follow – The largest tenant in NYC with approximately 7 million square feet

Last week, WeWork announced it was cutting 2,400 employees – a fifth of its staff – and that is just the latest news on them. Since its failed IPO, WeWork forced out former CEO Adam Neumann, was bought out by SoftBank, and State Attorney General Letitia James launched an investigation on WeWork. And just in October, the company only leased 55,000 sf, which is a huge drop from the hundreds of thousands of square feet it leased per months in the past few years. Stepping away from WeWork, other coworking spaces are starting to see the fallout. Knotel, which modeled its business challenging WeWork’s model, has over 780,000 sf of available space, which is a third of its 2.5 million sf NYC portfolio. In August, Knotel was give $400 million from investors led by Kuwaiti sovereign wealth fund Wafra. This was right before WeWork’s failed IPO. Some say that if it happened after WeWork’s fall, Knotel might have not been able to raise the money. Several coworking spaces, including Industrious and Convene, have started focusing on management arrangements instead of conventional leases with landlords, which will minimize the risk of rent fluctuations. When these companies use conventional leases, it then charges a markup to tenants who pay a premium for the amenities and flexibility they provide. But during a recession, people are concerned that the tenants will not pay rents, depart the space and leaving coworking spaces on the hook for collections. For example, Regus filed bankruptcy in 2003 after a recession. Since then, the company has bounced back. The management agreements “allow a firm to operate a space for little to no rent or upfront capital costs in exchange for a profit share with the landlord”. If there is a recession, the workspace may not make any profit, but it will be protected from rent liability.


Will Your Building Make the Grade? (This cost will be passed on to the tenants if not negotiated upfront)

Starting next year, office and residential buildings will be required to report how energy efficient or not they are, as well as, placing letter grades issued by the city on their buildings. This new system comes from Local Law 33, which was passed in 2017 and signed in 2018 when NYC passed its Climate Mobilization Act. The grades will apply to buildings larger than 25,000 sf, which is 40,000 of the one million building we have in the city. The buildings can appeal and take steps to bring up their grades for next year. By May 2020, these buildings must submit their latest annual energy-use data. Failure to submit their data will be a violation and subjected to a fine. These grades, however, are just the first step before stricter rules are enforced. By 2024, buildings will be required to meet emission limits, or they will face big fines.


Ground-Lease Deals are Growing in Popularity

Instead of buying buildings, commercial real estate investors are currently only after the ground beneath them. “The practice of separating a property from land, and then renting out that ground to a developer on a long-term basis, is known as creating a ground lease”.This process is viewed as safer than owning the property because real estate risks mostly fall on building owners. In most recent years, more investors have been doing this as the prices of most major properties are starting to get expensive. In 2019, at least seven ground lease deals have been made for major NYC buildings, including an H&M anchored office building on Fifth Avenue. These deals still carry some risks for the ground owner. Over the term of the lease, ground rents typically rise, however, they could fall behind inflation over the decades and will cause the ground lease to lose value. Owners of these buildings are finding it hard to finance their properties on someone else’s land, and when the lease is over, land owners own the buildings. According to a source, investors have barely scratched the surface.


Neighborhoods Lose if Commercial Rent Bill Passes

City Council members have come up with a new way of helping small businesses after failing to do so last year. They want to create a new rent regulation onto smaller retail, manufacturing and office spaces. According to a source, the real estate world is “terrified” if this regulation passes while some others say they are just frustrated on “how little council members understand the proposals consequences”. This bill would be protecting big companies as well as small businesses that rent fewer than 10,000 sf. This would lead commercial rent control to disinvestment and the overall physical degradation of commercial properties. Because of capping the rents, owners have no incentive to improve their properties, so eventually the buildings will be falling apart. Rent regulation will also hurt growing neighborhood businesses. Some say this bill is unlikely to gain any traction, but if it does pass, the US Supreme Court will be hearing certain legal challenges on commercial rent regulation.

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