Tequila-fueled staff meetings and investor pitches, pot-smoking on board Gulfstream jets, and wild-eyed declarations of the ability to change the world (and even to live forever) may have found ready media outlets seeking to present salacious tidbits regarding the behavior of Adam Neumann – the co-founder, chairman, and now-former CEO of sometime-before-yesterday's momentum darling, The We Company, and its better-known subsidiary WeWork.
Putting aside that such antics would be better suited to the chief of something called The Me Company, than its communitarian alter ego, they are a distraction in comparison with the prank that is WeWork itself.
So let's then skip past the beer and kombucha taps in the common area and discover why this confusing company has turned from foamy-headed to flat, in the span of just a few months after announcing its intentions to go public.
Two reasons why WeWork's business model doesn't work
The first reason for WeWork's fall from grace is that the business model on which WeWork relies amounts to attempting to globalize a chain of sidewalk lemonade stands by signing a full-faith-and-credit forward contract for $34 billion of Crystal Light with Kraft Foods. And then counting on the world being both infinitely thirsty and that its purchasing power will never be dented by recession.
For what WeWork has undertaken, as disclosed in the prospectus for its erstwhile IPO, is – in fact — $34 billion (yes, that's billions) of rent obligations to landlords around the world over the next 15 year, highly concentrated in centers of commerce such as New York and London.
It had to shell out $1.2 billion in 2018 alone, when it was still in wildly rapid growth – and in the first six months of 2019, on an annualized basis, was paying rent of $2.5 billion per annum, and still rising.
It has also taken on $1.4 billion of corporate indebtedness (a daunting sum for a start-up to be sure, but a drop in the bucket compared to its lease liabilities). This for a company that grossed less than $2.6 billion in sales for the 12 months through June 2019, and in that period had only $232 million – after other cash operating expenses – before paying its rent bills of $2.1 billion.
The second bit of nonsense emanates from the business in which WeWork is engaged in the first place – leasing other people's real estate to tenant-"members" with essentially no credit-capacity and in a business with minimal barriers to entry, other than a willingness to pay rent.
Essentially, to revert to the lemonade stand analogy, WeWork is trading from the curb – albeit with a very expensive permit. The problem is, that everyone in commercial office real estate has a curb of its own. The very landlords that actually own the space from which WeWork is plying its wares can set up – and are setting up – their own "lemonade stands" in the form of short term, flexible occupancy co-working space with copious support services and tie-ins.
WeWork is, to its customers, the Uber of commercial real estate (it has tried residential too, which has proven disappointing). The just-in-time, Johnny-on-the-spot solution that avoids one having to work out of their home or neighborhood Starbucks – or setting up costly support services.
The problem is that this form of "Uber" is one that has guaranteed all its drivers' pay and leased multiple fleets of cars for the next decade and a half, and then some. Long term liabilities against short term income streams would make no more sense to the ride-hail industry than they do to commercial real estate – even less so for the latter as real estate is far more expensive and rigid a commodity than cars and, yes, people. Landlords can provide a small fraction of their inventory for co-working, short occupancy without burying their business model in risk.
For WeWork, apparently, undertaking risk IS the business model.
WeWork poses risks for the real estate industry
Thus far, I have expressed my dismay in terms of relevant to existing and potential shareholders of, and lenders to, WeWork. But there is more at stake here.
WeWork has become a dominant player in the office market in many major cities. In New York and London, WeWork is the largest private sector office tenant – something they actually crow about. In Manhattan, the company has over 5.3 million square feet of office space – more than the entire enclosed space of the Mall of America, the largest mall in the US.
Now, this is – to be fair – only about 1% of the total market. But that is not the relevant metric where WeWork is concerned.
By my calculations, two years ago, in mid-2017, WeWork had about 2.4 million of space in Manhattan (2.8 million in all of New York City), and therefore added nearly 3 million square feet in Manhattan over the past 24 months.
Total leasing volume in Manhattan during that period was about 55 million square feet – the vast majority of which were lease rollovers or tenants moving from one space to another, as opposed to net new absorption (the difference between space coming to market and newly leased space). Even so, WeWork was itself 5.5% of gross leasing volume – an enormous amount for a single tenant.
But, in terms of net absorption, according to data from industry sources and my calculations, if WeWork were removed from the equation, the Manhattan market would have experienced negative absorption of roughly -700,000 square feet of leased space, as opposed to the just over 2.3 million square feet of net absorption that it experienced over the 24 months ended June. This, folks, means that at the margin WeWork is moving markets – bigly.
Therefore, the precarious nature of the firm's business model not only endangers the landlords that are directly exposed to the company, but the market at large.
Were the demand represented by WeWork to disappear (either in a recession, a collapse of "tech bubble 2.0," and/or because other landlords move in to service such co-working demand as remains after others return to their homes or Starbucks), rents across the commercial office market would be negatively impacted – to the detriment of all participants therein (except, of course, tenants).
So, yes, Adam Neumann showed incredible chutzpah with his clowning about and his self-dealing (buying and leasing space to the company, concentration of voting rights, even claiming personal trademark rights to the word "WE"). But don't let all that be a distraction from what is really going on behind the curtain (wall). The business model itself defies both common sense and market realities.
Dan Alpert is an adjunct professor at Cornell Law School, a senior fellow in macroeconomics and finance at the school's Jack C. Clarke Business Law Institute and founding managing partner of the New York investment bank, Westwood Capital, LLC. He has been active in commercial real estate banking and finance since 1982.