A Federal Reserve Bank president who has been warning about prices rising too high in the commercial real-estate market has a new source of concern: co-working.
In an interview, Boston Fed President
highlighted a potential misalignment in the property market. He noted that landlords are offering long-term leases to co-working firms, which then spend money to build out the space and rent it on a short-term basis.
Many analysts have also worried about how co-working firms would make rent payments, especially during an economic downturn, if their tenants chose not to renew leases. But Mr. Rosengren’s comments could bring more attention to the issue because he tied his co-working concerns to broader risk in the real-estate market, and the debate over whether the Fed should cut interest rates further.
“My concern is basically structural,” Mr. Rosengren said. “You’re getting longer-term leases and then you’re renting out the space short-term. So you have an asset-liability-mix problem.”
He has become increasingly vocal with his concerns about co-working since We Co., WeWork’s parent, shelved its initial public offering. Founder Adam Neumann stepped down as chief executive late last month as investors raised concerns about valuation, governance and other issues.
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Mr. Rosengren noted that demand for space from WeWork and others has been so strong many landlords turn to co-working as “an easy model to fill your space with.” He added that these leases can be lucrative for building owners because co-working firms “pay a higher rent,” but those high yields come with greater risk.
Another risk, Mr. Rosengren said, is the way the leases are structured: Many co-working firms sign individual leases through separate shell companies. This makes it harder for the landlord to sue the parent company if a shell company misses a payment.
The Boston Fed president has for several years warned about inflating commercial property prices. He isn’t worried that the commercial real-estate market could trigger a recession. But he has warned that a real-estate bubble could make a downturn worse.
He isn’t the only Fed official to point to commercial property as a potential trouble spot. Cleveland Fed President
said on a Brookings Institution panel last week that there are some issues related to high levels of corporate debt and elevated pricing of commercial real estate. Fed governor
also noted that values are high in her testimony before a House subcommittee late last month.
But Mr. Rosengren has voiced the most worries. In the past, he has pointed out to visitors the many construction cranes rising above downtown Boston to illustrate what he has said could be signs of overbuilding and unsustainable development.
Mr. Rosengren has also been one of the most vocal Fed officials in opposing the central bank’s recent interest-rate cuts. He believed they were unnecessary and could contribute to asset bubbles or excessive risk-taking.
In the commercial-property market, low rates have helped push real-estate values higher partly because most property investors rely heavily on leverage. Real-estate yields also look increasingly attractive compared with those in the bond market.
Mr. Rosengren is speaking out about co-working at a time when many landlords have stopped leasing to WeWork while the firm tries to raise the capital it had hoped to get with an IPO.
Lenders are also wary of a scenario where a co-working firm might default on a lease and put financial pressure on a landlord and its lender. WeWork is one of the top-five tenants at 36 office properties backing more than $3.3 billion in debt that was converted into commercial mortgage-backed securities, according to Trepp LLC.
Still, some real-estate executives suggest Mr. Rosengren’s concerns are overblown. While co-working is growing at an annual rate of more than 30%, it accounts for less than 2% of the total office space leased in the U.S., according to a report by
CBRE Group Inc.
And if a co-working firm defaults on a lease during a healthy market, a landlord could take over the operation and cut deals with the subtenants. Some analysts think that co-working operations may benefit in an economic downturn because tenants might prefer shorter-term obligations.
“If a firm is downsizing, shifting from larger spaces to a smaller, more flexible space that they can right-size as they go, could be attractive for tenants,” said Matthew Anderson, managing director at Trepp.
Mr. Rosengren said that the dangers related to co-working won’t be known until an economic slump. “The truthful answer is we don’t know until we actually have that downturn,” he said.
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