WeWork just warned it might fail, signaling commercial real estate is in serious trouble

• WeWork says there's "substantial doubt" that it can stay in business given its financial problems.
• The shared-workspace giant's woes may spell trouble for commercial real estate as a whole.

WeWork is in serious trouble, and it could be the canary in the coal mine for the US commercial real estate sector.

What's going on at WeWork?

WeWork dropped a bomb in in its second-quarter earnings on Tuesday.

"As a result of the company's losses and projected cash needs, combined with increased member churn and current liquidity levels, substantial doubt exists about the company's ability to continue as a going concern," it said.

The shared-workspace giant said it can only stay in business if it improves its liquidity and profitability over the next 12 months. Its bosses plans to lower its rent and tenancy costs by restructuring and negotiating better lease terms, and boost its revenue by attracting and retaining members. They also intend to control its costs and raise fresh capital, it said.

Investors have balked at the situation. WeWork's stock price is down 95% in the past year alone, and fell sharply in premarket trading on Wednesday. As a result, the company's market capitalization has dropped below $500 million — a fraction of the $40 billion valuation it once commanded as a private company.

Why is WeWork in trouble?

WeWork's interim CEO, David Tolley, shone a light on WeWork's challenges in the earnings release.

"Excess supply in commercial real estate, increasing competition in flexible space and macroeconomic volatility drove higher member churn and softer demand than we anticipated, resulting in a slight decline in memberships," he said.

In other words, there were too many available commercial spaces relative to demand last quarter. WeWork's rivals also fought hard to win customers, and economic headwinds such as steeper interest rates and recession fears meant more WeWork members quit and fewer people signed up than expected.

Those headwinds dragged on WeWork's financials last quarter. It reported a net loss of $1.1 billion on revenues of $1.6 billion last quarter, and its operating cash outflow exceeded $500 million in the first half of this year. It also had less than $700 million of liquidity at the end of June, comprising $205 million of cash, and $475 million of borrowing capacity. That compares to nearly $900 million of current lease obligations, and over $13 billion in long-term lease obligations.

What does this mean for commercial real estate?

Commercial real estate has been one of the hardest-hit sectors of the US economy over the last year. Developers rely heavily on debt, and their loan payments have soared due to the Federal Reserve hiking interest rates from nearly zero to north of 5% since last spring, in response to historic inflation.

Moreover, a combination of higher rates and the remote-working boom have pushed down prices of offices and other commercial spaces in cities. The blow to asset values, and the failure of several regional banks this year, have led to smaller banks pulling back from lending to commercial developers.

The upshot is the industry is navigating steeper debt costs, reduced access to credit, and big declines in the value of their properties, not to mention the prospect of a wider economic downturn or recession.

Everyone from Elon Musk and Charlie Munger to Jeff Greene and Ross Perot Jr. have raised the alarm on the embattled sector in recent months.

WeWork rents close to 20 million square feet of office space, making it a key player in the space. Its failure could be a "systematic shock" to commercial real estate in many American cities, Stijn Van Nieuwerburgh told The New York Times in June.

"It would pour more cold water on the office market, which is struggling direly," the Columbia Business School professor and real-estate expert added. He recently warned that troubles in the office segment could hammer cities, spark a credit crunch, and weigh on overall economic growth.

It's worth emphasizing that WeWork's turnaround plan might work, and it might avoid collapse. Moreover, its problems might not be shared by other developers.

However, the company's doubts about its viability, the financial strains on its business, and cooling demand for its workspaces are still warning signs for a big part of commercial real estate, and underscore the sector's current challenges.