The Impact of WeWork's Bankruptcy on the Office Sector

WeWork's recent bankruptcy has dealt yet another blow to an already struggling office sector. However, industry analysts argue that the outlook for the economy and interest rates will play a far more significant role in driving stock performance.

Incremental Negative Impact for the Office Sector

According to Dylan Burzinski, head of office sector research at Green Street, a commercial real estate analytics firm, WeWork's bankruptcy is undoubtedly a setback for the office sector. However, he also believes that it serves as an incremental negative factor for an industry already grappling with significant obstacles.

Headwinds Faced by the Office Sector

The challenges faced by the office sector extend beyond WeWork's bankruptcy. Factors such as hybrid office arrangements, the growing work-from-home trend, and ongoing debates about a potential recession in 2024 and the Federal Reserve's approach to interest rates are all contributing to the industry's struggles.

Richard Anderson, a managing director at Wedbush Securities specializing in real estate investment trusts (REITs), states, "WeWork is just another mole to whack for the office industry." This statement highlights the sector's need to confront and address various issues simultaneously.

Decreased Demand and Reduced Occupancy

Post-pandemic work environments have resulted in many companies requiring less physical office space, leading to a decrease in demand. Additionally, technology companies, which were previously experiencing steady growth, have started laying off employees and relinquishing substantial amounts of office space.

Statistics from security company Kastle Systems reveal that office buildings across ten major cities are only 49.6% occupied by workers. Notably, in New York, this figure drops to 48.9%, while San Francisco experiences a mere 41.9% occupancy rate.

Excess Supply in Major Cities

Vikram Malhotra, co-head of U.S. REITs research at Mizuho Americas, warns that major cities like New York City, San Francisco, and Washington, D.C., will likely face an excess supply of office space as a result of WeWork's bankruptcy. He estimates that WeWork represents approximately 1%-2% of occupied office stock in these cities.

The Role of Interest Rates and Economic Growth

For office REITs, such as BXP (BXP) and Vornado (VNO), the nation's largest players, share performance is primarily driven by interest rates and economic growth. These factors outweigh the immediate impact of WeWork's bankruptcy on the market.

In conclusion, while WeWork's bankruptcy poses challenges for the already struggling office sector, factors like economic growth and interest rates will ultimately have a more substantial influence on the industry's future.

The Impact of Office Jobs and Remote Work on Office Space Demand

According to industry experts, the demand for office space is primarily driven by the growth of office-using jobs in the economy. In order to see an increase in demand for office space, there needs to be a rise in the number of office jobs being created.

However, another factor that is currently playing a major role in the office space market is the concept of remote work and the return-to-work theme. This trend is seen as even more significant than the well-known coworking company WeWork.

Recently, the shares of office real estate investment trusts (REITs) experienced a surge in value as bond yields decreased. Over the course of three consecutive trading days, the yield on 10-year Treasury notes fell by 0.122 percentage point to 4.668%, which marked the longest decline since August.

Lower interest rates have a significant impact on the office sector, as tenants and customers of REITs tend to evaluate economic and interest rate uncertainties before making long-term commitments for office space. Many potential tenants are hesitant to commit to space or may choose to downsize when their lease expires due to uncertainty in economic conditions and interest rate trends.

For landlords, high interest rates pose a problem. Large office owners often have substantial outstanding floating- and low-interest-rate mortgages that will require refinancing at significantly higher rates in the coming years.

Once there is more clarity regarding the macroeconomic environment, especially interest rates, it is anticipated that tenants will feel more confident and at ease when committing to office space. This will directly benefit REITs, as they require financing to invest in building capital. Ultimately, everyone in the market stands to gain from having a better understanding of future interest rate movements.

REITs are favored by income investors due to their obligation to distribute a minimum of 90% of their taxable income to shareholders, making them attractive with bond-like characteristics. However, the sector has underperformed and faces the challenges of being capital-intensive. Therefore, a pause in the Federal Reserve's rate hikes would provide a welcome relief for the REIT industry.