Some lessons from WeWork?

Some news about the Cities of Paris and London’s Office markets, following the aborted WeWork’s IPO and the release of end market figures (Immostat, Paris, and Savills, London).

City of Paris

The co-working business model absorbed a third of the take-up of all the above 5,000 sqm units in H1 19 in the region of the City of Paris. This amounted to 119,000 sqm or 10% of the full H1 19 take-up vs. 130,000 sqm for the full 2018 in an annual overall market of a 2.5m sqm in the region of the City of Paris (c. 55m sqm of existing Offices’ ground – please read our 11 July 2019 Sector Latest: ”Some facts before the earnings season”).
Co-working concerned 8% of the transactions within Paris in 2017 (on or above 5,000 sqm units), 25% in 2018 and 62% in H1 19 (see Gecina’s Latest from 19 July 2019).

City of London

Co-working weighed one fifth of the 2016-19 take-up in the City of London, o/w 6% from WeWork itself. The latter becoming therefore… the first private tenant in the City of London. The FT today reminded that “almost 7% of London’s office space is “flexible,” compared with less than 4% in New York”.

Our take

Any collapse of WeWork will not immediately nor directly nor materially impact on any listed company we cover in itself: co-working has never weighed more than 1.5% of a consolidated portfolio. However, we are very concerned by the indirect and postponed consequences of it.

Due to the absolute weight of co-working (< 400,000 sqm around the City of Paris) vs. the market size (Offices in the region of the City of Paris: 54m sqm), we do not identify any systemic risk. The proportion is probably higher in London, where Brexit could be a specific issue. The impact could be concentrated on the dense CBDs areas by reducing the hard pressure they had contributed to input in the past two years.

On the day to day market and following WeWork’s aborted IPO, once a big systemic risk is excluded, landlords’ greater cautiousness by now asking for real payment guarantees (and no new assets located in non-recourse SPV…) could temporarily (at least) remove the engine of the great co-working appetite, or a very significant portion of the current take-up. Instantaneous demand for Offices in both London and Paris could now return to classical components and the end market could now go back to fundamentals (GDP: slowdown, Brexit…).

Although open-ended, the market is waiting for some Office deliveries in 2020-22 (London + Paris). Assuming a lower take-up from co-working, this could increase both markets’ vulnerability, or progressively weigh on valuations per sqm through marginal vacancy / yields. We believe that the co-working phenomenon could overflow into other issues. Without being in itself the source of a crisis, it could retrospectively have been one of its signals if the latter occurs.

At pixel time (or figures before WeWork aborted its IPO and Brexit), Paris Offices’ valuations increased strongly in Q3 19 (see chart below, valuation €/sqm). They are now reaching new record levels and saw something like a new bump in Q3 19 within the premium areas, where the co-working sites are located.

Yields in both the City of London (chart below) and the West End stabilised at low levels when transactions diminished.

We only detect some first tiny signs of feverishness in the City (MSCI index), or the most volatile market there, but no big material negative news. Until now… However, the transaction began to collapse from the beginning of 2019 (Sector Latest from 15 July 2019, London Offices: the crack (not krach) now looks clear) and speculative offers will be pretty high along 2021-22 vs. take-up, especially when restated from the coworking demand.

Some Office markets could now enter their high risky phase as the disconnection could become worrisome: low GDP growth (lower classical demand) + lower demand from co-working + Brexit vs. high or increasing both prices and rents + low stable yields. How can one find this reassuring? As the ECB mentioned recently, monetary policy is not omnipotent and low interest rates cannot only justify high values. Shopping malls were sufficient examples of that.

Conclusion

Due to Brexit, just stay away from all UK Offices (Land Securities / British Land, c. 50% of GAV). Some discounts vs. NNNAV are high, but this is partly attributable to their respective exposure to retail in the UK. It maybe the last call for exit now.

None of the French Property companies (Covivio, Icade, Gecina, Inmobiliaria Colonial) have reacted negatively to WeWork’s aborted IPO as recent news from the end market has been pretty bright (until 31 August). None showed strong discounts vs. NNNAV. We continue to believe that the Office market will become more fragile in Paris in the coming half, especially in La Défense. Maybe not a big short, but greater cautiousness is now required from a fundamental point of view. We do not identify strong upside in any of the Offices Property companies we cover and WeWork was adding a new pinch of risk.

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