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You would have to have had a heart of stone not to be at least mildly amused by the collapse of the WeWork initial public offering (IPO).
You had a founder spouting New-Age, pseudo-hippy, utopian-tech-overlord, “have-you-seen-my-Ted-talk?” drivel about community-adjusted Ebitda, all while sucking $700m out of the company and smashing every corporate governance standard in the guidebook.
No sympathy for him.
However – unfortunately, by the time a vanity project gets to this scale, it’s carried a lot of innocent people and a lot of misallocated capital with it.
So I do feel sorry for the employees who are going to get laid off. And I do wonder what’s going to happen to all that office space that was dependent on WeWork’s ongoing wild expansion plans.
How WeWork went from prime property to dodgy do-er-upper
Here’s the story so far.
WeWork is an office space provider. It rents office space for a long period of time. It kits the space out with wifi and free beer. It then rents the space out over shorter periods to companies and individuals.
Now, clearly this business model is risky. To fuel your expansion, you keep taking on more long-term leases. That’s debt you have to pay. To do that, you need people to keep renting your office space.
The bull case is that you allow companies to “dematerialise” their office space requirements. In effect, you become a corporate landlord to the world. You’re selling “office space as a service” in much the same way as no one owns their own servers these days, they just rent them from Amazon. This is how you “tech-wash” a standard real estate company.
The obvious bear case is: what happens during a recession? What happens if no one wants to rent your offices and existing tenants go bust and can’t afford to pay your rents? You still need to pay those long leases.
And that, in a nutshell, is WeWork’s business model.
So what happened is that WeWork’s private valuation was essentially propped up by Japanese billionaire tech investor Masayoshi Son, via his SoftBank Vision Fund. The Vision Fund in turn is backed by an awful lot of money from Saudi Arabia.
The problem for WeWork and all connected to it is that Son’s opinion of how much WeWork was worth – $47bn at the most recent fundraising – was at odds with the opinion of almost everyone else on the planet.
Even if you agreed that WeWork deserved to be priced at a premium to its nearest rival – office space group IWG, formerly Regus – the premium was so spectacularly high that no one would swallow it (for perspective, Regus makes a profit and is valued at about £3.6bn – WeWork makes a loss and was trying to go for about 20 times that). Not to mention the rampant corporate governance issues that you can read about elsewhere.
Anyway, despite all this, Son (via the investment bankers who tried to dress WeWork up for an IPO) thought that the company was worth about $60bn. In the end, markets weren’t even willing to touch it at $10bn.
And so the IPO was pulled, and the founder and CEO, Adam Neumann, was demoted.
What happens when a fast-growing “tech” company hits a wall
Trouble is, WeWork needed the IPO to secure more money to continue its expansion.
WeWork has been growing fast. If you’re a real estate company, that takes a lot of money. You pump borrowed money in at one end, buy lots of space, and eventually profits come out at the other. But there’s a delay between the money going in and the money coming out.
When a company has been running on leverage (borrowed money), it can’t simply stop in a controlled manner. It borrows money to grow, and the lenders keep lending because they believe that the more the company grows, the more valuable it will become, and eventually it will make lots of lovely profits, and pay them back.
If the funds stop going in at one end, the whole thing hits the wall. And this is exactly what’s happening now. WeWork has stopped expanding altogether and clearly the focus is now on proving that it can make money in a coherent manner, before it considers returning to market for another crack at an IPO.
One issue giving landlords palpitations is that WeWork has a lot of office space in both New York and London. It’s the largest private tenant in both cities. According to the FT, WeWork is on the hook for $47bn in rent across the life of its leases. And about $2.3bn is due next year.
Not only that, but as the FT’s property correspondent Judith Evans points out, a lot of these leases are structured in such a way that WeWork can essentially walk away if necessary.
That said, “any such collapse is not seen as imminent”. Credit rating agency Fitch has expressed concerns about the business but adds that “WeWork had enough cash for at least four quarters.”
However, a much more immediate problem is that WeWork by itself has accounted for about 6% of demand for office space in London. If you knock that demand out of the market, then rents are going to struggle.
Be aware of what your commercial property funds are exposed to
What’s the upshot?
For now, I’d be surprised if WeWork doesn’t get the minimum of support it needs from SoftBank. It would be extraordinarily embarrassing for Son if nothing else.
There are risks further down the road – eg, at what level of service is a WeWork location actually profitable? Is that level of service of a high enough standard to differentiate the premises from any other old office space provider? Etc.
But for now the main issue for any investor in commercial property is the pressure this will put on London rents, given that yields are already low.
Long story short, if you’re investing in real estate investment trusts (Reits) – some of which look very appealing – make sure you look at what they’re exposed to, and what assumptions they are making.
At the very least, even if we avoid a recession, London office property will be a much tougher market in the near future. If your Reit investments are heavily exposed to the capital, have a think about how that might impact your overall portfolio.