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Failed Boston Coworking Deal Shines Light On Volatile Special Purpose Entity Leases

A common coworking lease structure has turned into a $2.9M headache for one Boston landlord.

Failed Boston Coworking Deal Shines Light On Volatile Special Purpose Entity Leases
68 Harrison Ave.

New York-based coworking provider Coalition Space was evicted from its branch at 68 Harrison Ave. in Boston's Chinatown neighborhood Jan. 14 after not paying rent in November and December, according to court records.

The coworking company, through a dedicated special purpose entity it set up for the space, had paid less rent than it owed for 14 months prior to that, lawyers for landlord Mai Luo claimed in a Boston Municipal Court filing late last year. 

Luo was awarded $2.9M in damages, but he says the special purpose entity, Coalition Downtown LLC, which is legally a separate business than Coalition Space, is making it tough to collect the money he is owed. 

“They can just pack up and leave and not be responsible,” Luo told Bisnow this week. “Their offices in New York and Chicago are completely separate entities. Don’t they care about their reputation?”

The landlord admitted he took a risk when signing a lease with Coalition’s Boston co-founder, Farhan Abbasi. In a lease dated Dec. 5, 2016, Coalition Downtown LLC — wholly owned by another special entity called Boston Link Space LLC — committed to a 10-year, 8,709 SF deal at 68 Harrison.

After eight months of free rent and up to $200K in build-out costs provided by Luo, Coalition Downtown was expected to begin paying nearly $24K/month in rent with annual increases ending with $30,481/month its final year, according to a lease Bisnow obtained in Boston Municipal Court. Later documents showed the company received 12 months in free rent.

Luo said he was excited to ink a deal with a coworking company since the industry was growing its profile in Boston’s office sector. WeWork was expanding at a pace expected to eventually make it Boston’s largest office tenant, and local coworking company Workbar, which had toured 68 Harrison, was also growing significantly in the market. 

At the time of Coalition’s lease commitment in late 2016, there was 1.4M SF of coworking space in Boston and Cambridge — 900K SF of that concentrated in downtown Boston, according to Newmark Knight Frank

But signing a deal for Coalition Downtown didn’t mean Coalition Space would be offering a letter of guarantee in case the Boston office operator couldn’t pay rent. Instead, Luo was signing a deal with a one-off entity without a corporate guarantee. 

“I took a big risk on them,” Luo said. “They seemed nice, and I’m a risk-taker.”

Failed Boston Coworking Deal Shines Light On Volatile Special Purpose Entity Leases

Three years later, the professional relationship unraveled. Luo filed a financial statement in Boston Municipal Court showing Coalition Downtown fell behind on rent payments beginning in September 2018, by paying $20K in rent when it owed more than $24K. The trend continued through October 2019 and then Coalition stopped paying rent altogether, according to Luo’s filing. Coalition was more than $136K behind on rent when Luo filed a lawsuit against Coalition Downtown LLC on Dec. 23, according to court documents. 

Luo’s lawyers also sought overdue invoices, legal fees, rent for the remainder of the lease, and back pay of the tenant improvement allowance and free rent, which all added up to nearly $2.9M. 

“They were collecting money from their members,” Luo said. “I have a mortgage to pay and a family to raise. I’m not running a charity.”

Bisnow reached out to Holly Hines, the lawyer who represented Coalition Downtown LLC, as well as Coalition Space’s home office in New York City and a number listed for the Boston special entity. None responded to requests for comment. 

But Coalition Space has offered a different reason for its Boston departure. CEO Spencer Rothschild told the Boston Globe last month it closed its 68 Harrison Ave. location due to elevator repairs hindering business at its sixth-floor office. 

Coalition Downtown LLC filed a countersuit, claiming the lease was wrongfully terminated and that Luo breached several lease provisions. The filing denies Coalition owed more than $2.5M in rent and said rent arrears totaled $125K. The counterclaim also accuses Luo of not maintaining common areas like the HVAC system, elevator and roof and that the landlord failed to provide retail signage. 

Coalition claims Luo’s failure to maintain these items added up to nearly $583K in lost business income. It also accused Luo of turning off the elevator as a way to enforce rent, talking to Coalition customers about the lease termination and entering into the sixth-floor office “with chains in his hands” and making threats.

Luo denied all these charges and said Coalition’s business grew from 40% occupancy to 85% occupancy during the months of elevator modernization, according to monthly financial statements the company was required to provide him. Bisnow couldn't independently verify this claim.

“We could have had a much more decent transaction,” he said. “I gave them many chances.”

Coalition’s counterclaim against Luo was dismissed in court in early January. 

Failed Boston Coworking Deal Shines Light On Volatile Special Purpose Entity Leases
Real estate attorney and former Boston City Council President Larry DiCara

For now, Luo is still awaiting the $2.9M payment, but real estate experts said he shouldn't hold his breath. Such is the downside of accepting special purpose entity coworking deals. 

“If I were representing the landlord, I wouldn’t rent to anybody unless they put down some type of personal guarantee or letter of credit so you don’t wind up with a company with no assets. Good luck collecting it,” former Boston City Council President and real estate attorney Larry DiCara said. “These folks may take off on you, which is why you need some other entity to protect you.”

Coworking deals were initially attractive to Boston landlords when vacancies were higher and the industry was willing to take up space nobody else wanted, DiCara said. At the time of Luo’s late 2016 deal with Coalition, Financial District office vacancy was nearly 12%, according to Colliers. Now it is sitting below 8.7%. 

As coworking became increasingly attractive — and as WeWork surged to become Boston’s second-largest office tenant — brokers and developers debated whether the industry was this cycle’s real estate bubble, especially due to the SPE lease structures.

WeWork protected itself financially through special purpose entities, where limited liability corporations were usually established for an individual office rather than the parent company guaranteeing the credit of each piece of its rapidly growing coworking empire. It even cited the SPE structure in its now-infamous IPO prospectus as a reason its $40B lease obligation was not as risky as it seemed. 

WeWork did not respond to Bisnow’s request for comment in time for publication. 

"It's common practice with the larger coworking companies," Workbar CEO Sarah Travers said. "It's an exit strategy that adds an element of risk for the landlord."

Workbar signs all its leases under Workbar LLC, Travers said, which provides a cross-company guarantee, helping to reduce the stigma attached to coworking since WeWork’s collapse.

While the special entity measure added risk to deals with WeWork, Coalition and others, the trade-off was landlords were inking long-term leases as many companies were shying away from 10-year deals.

But the lease structure isn't entirely unique to coworking, Seven Oaks Co. principal Robert Voyles said. The Atlanta-based landlord handles about 3.5M SF of Class-A, B and C office space, and tenants almost always use single-purpose entities when entering into a lease.

"It's very common for tenants who want to set up a separate LLC in case there might be a slip and fall or some locally generated liability event," Voyles said. "The tenant wants to limit a parent company’s legal exposure to what may happen on the individual property."

Usually, landlords will look beyond the SPE to the parent company for some level of securitization, like a letter of credit that could decline over time with on-time lease payments. But coworking was often a different animal, given the questionable path to profitability and limited collateral a firm like WeWork was willing to offer. 

DiCara cautions landlords against these kinds of deals going forward — even if the courts side with building owners. 

“Any landlord can secure a judgment,” DiCara said. “The challenge is often to locate the tenant who can satisfy that judgement.”