WeWork business mess, threat to real estate in New York

We work; Eduardo Munoz / REUTERS; Samantha Lee / Business Insider

• Adam Neumann stepped down as CEO of WeWork on Tuesday, citing public scrutiny following the filing of the We Company's IPO.
• Despite Neumann's excesses as CEO and his decision to resign, WeWork still has serious problems with his business.
• The rapid expansion of WeWork and its commercial problems mean that the company now represents a serious threat to the New York and London real estate markets.
• Dan Alpert is Adjunct Professor at Cornell Law School and Founding Managing Partner of New York Investment Bank Westwood Capital LLC.

• Visit the Business Insider home page for more stories.

Staff meetings and investor speeches propelled by tequila, smoking pots on board Gulfstream jets and unbridled declarations of the ability to change the world (and live forever) may have found media willing to present salacious information on the behavior of Adam Neumann, co-founder, president and former CEO of We We, and its best-known subsidiary, WeWork, have already taken the momentum .

Putting aside that such antics would best suit the leader of something called The Me Company at his community alter ego, they are a distraction from the farce that is WeWork.

So let's go past the beer and kombucha taps in the common areas and find out why this confusing company has become flat in a few months after announcing its intention to go public.

2 reasons why WeWork's business model does not work

The first reason for WeWork's loss of grace is that the business model weWork supports is tantamount to trying to globalize a chain of lemonade stands on the sidewalk by signing a full-faith futures contract for $ 34 billion. dollars of Crystal Light with Kraft Foods. And then relying on an infinitely thirsty world and the fact that its purchasing power will never be affected by the recession.

For what WeWork has undertaken, as indicated in the IPO prospectus, it's actually $ 34 billion (yes, that's right. Billions) lease obligations to homeowners around the world over the next 15 years, heavily concentrated in shopping centers such as New York and London.

It had to pay out $ 1.2 billion in 2018 alone, while it was growing extremely fast. In the first six months of 2019, the annualized annual rent paid rent of $ 2.5 billion and continued to grow.

It also took $ 1.4 billion in corporate debt (a considerable sum for a start-up, of course, but a drop in the bucket compared to its rental liabilities). This for a company with less than $ 2.6 billion in sales for the 12-month period ending in June and only $ 232 million – after other operating expenses – before to pay $ 2.1 billion in rent.

The second absurd element arises from the activity in which WeWork is engaged – leasing real estate owned by others to tenant "members" with essentially no credit capacity and in a business with minimal hurdles to entry, other than willingness to pay. rental.

To return to the analogy of lemonade, WeWork is trading on the sidewalk even with a very expensive license. The problem is that everyone in the commercial office real estate has its own brake. The very owners who actually own the space from which WeWork buys its products can install and create their own "lemonade kiosk" in the form of a coworking space with flexible and short-term occupation with many support services and links.

WeWork is, for its clients, the Uber of commercial real estate (he also tried the residential, which proved disappointing), the Johnny-on-the-Spot solution that avoids working from home, in the Starbucks neighborhood, or expensive support services.

The problem is that this form of "Uber" is the one that has guaranteed the wages of all its drivers and has rented several car parks for the next fifteen years, and even more. Long-term commitments to short-term revenue streams would not make more sense for industry than for commercial real estate, let alone for commercial real estate, real estate being much more expensive and rigid than cars, yes, people. Homeowners can provide a small fraction of their inventory for coworking, short occupation without burying their business model in risk.

For WeWork, apparently, taking risks is the business model.

WeWork presents risks for the real estate sector

Until now, I have expressed my dismay in terms of relevance to existing and potential shareholders of WeWork and for the lenders. But there is more at stake here.

WeWork has become a dominant player in the office market in many large cities. In New York and London, WeWork is the largest tenant in the private sector, a subject that is close to their heart. In Manhattan, the company has more than 5.3 million square feet of office space, more than the closed spaces of the Mall of America, the largest shopping center in the United States.

To be fair, this represents only about 1% of the total market. But this is not the relevant metric regarding WeWork.

According to my calculations, two years ago, in mid-2017, WeWork had about 2.4 million space in Manhattan (2.8 million throughout New York City). York) and has added nearly 3 million square feet to Manhattan in the last 24 months.

The total lease volume in Manhattan during this period was approximately 55 million square feet, the vast majority of which were lease renewals or tenants moving from one space to another, as opposed to a new net absorption (difference between the space sold on the market and the newly rented spaces). Nevertheless, WeWork alone accounted for 5.5% of gross rental volume, a huge amount for a single tenant.

But, in terms of net absorption, according to data from industrial sources and my calculations, if WeWork were removed from the equation, the Manhattan market would have had a negative absorption of about 700,000 square feet of leased space, by compared to just over 2.3 million square feet net absorption recorded in the 24-month period ended June. That means, gentlemen, that at the sidelines, WeWork is moving markets – tremendously.

Therefore, the precarious nature of the enterprise business model not only endangers the owners directly exposed to the business, but also the wider market.

If the demand represented by WeWork disappeared (either in a recession, with the collapse of the "technology bubble 2.0" and / or because other owners were installing to meet the request for coworking such as it remained after the return of others at home or Starbucks), rents the commercial office market would be negatively affected, to the detriment of all participants (except, of course, tenants).

So, yes, Adam Neumann has shown incredible enthusiasm in clowning and doing business with himself (buying and renting space at the company, concentration of voting rights, even claiming the right to mark for the word "WE"). But do not let all this distract from what is really happening behind the curtain (wall). The business model itself defies common sense and the realities of the market.

Dan Alpert is associate professor at Cornell Law School, senior researcher in macroeconomics and finance at the Jack C. Clarke Business Law Institute of this school and founding managing partner of the New York investment bank Westwood. Capital LLC. He has been active in banking and commercial real estate finance since 1982.