WeWorked

The fall of WeWork has hints of schadenfreude

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• WeWork showed that, for a time, technology and real estate made poor bedfellows in the serviced office industry ?
• The demise of WeWork was fundamentally down to a perennial business killer: a misalignment between assets and liabilities
• The great irony of WeWork’s bankruptcy is that it comes at the exact moment when the flex industry should be performing well

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Steve Jobs famously remarked that “The most powerful person in the world is the storyteller,” and tech executives took that business strategy to heart. So did some real estate companies, and its chief exponent was Adam Neumann. At The Wall Street Journal for example, a front-page story goes through five editors whose chief task is to eliminate jargon, and WeWork’s now defunct catchphrase promising to "elevate the world’s consciousness," was guilty of misdirection and hubris. “The WeWork Manifesto: First, Office Space. Next, the World” was The New York Times feature article in 2018. WeWork stands as a quintessential example of a non-tech entity parading itself as a tech-based company and it was a by-product of the zeitgeist. In September 2016 Prince Mohammed bin Salman of Saudi Arabia aimed to position Saudi Arabia at the epicentre of the technological revolution, and when Masayoshi Son of Softbank asked for $100 billion for Softbank Vison Fund 1, MBS agreed to give him $45 billion, just as one of his other hybrid real estate / tech ventures, OYO, was experiencing the same challenges WeWork later would. The demise of WeWork has been a spectacle with undertones of schadenfreude as we argue in the conclusion.

"WeWill" and "WeWon’t" do not spell the end of entrepreneurship or IPOs. Newcomers like Zoom Video Communications and Datadog, software firms showing tangible cash generation, have witnessed soaring stock values. Similarly, Airbnb, backed by positive EBITDA, still makes investors swoon. The salutary lesson here is the discerning nature of public markets. They reward firms demonstrating cash flow or profits while shunning those that lack such credentials. This marks a departure from the era where venture capitalists seemed omnipotent in dictating a company's value; it is refreshing to see public investors shouting when an entrepreneur, for all his chutzpah, has no clothes. In Reeves Weideman's book ‘Billion Dollar Loser, The Epic Rise and Fall of Adam Neumann and WeWork’ he mentions that whenever a team brought forecasts to Adam, he would always tell them to increase projections two to three times before he was inclined to show investors. Global fund manager Fidelity, who decided not to invest on a Series D round thinking the business was overvalued, liked the deal just a short time later when the valuation was artificially doubled and then invested in the Series E round; which was three times higher than where IWG was trading at the time. The WeWork saga underscores the significance of substance over flamboyance. It’s a testament to the evolving scrutiny applied by investors who are no longer swayed solely by grand visions and promises but are instead demanding fiscal viability and tangible returns. Masa was quoted in another book about WeWork‘The Cult of We’ by authors Eliot Brown and Maureen Farrell, that “feeling is more important than just looking at the numbers.”

In 2016, Neumann met Masayoshi Son and after a now famous episode in which Son sketched the valuation on an iPad in the back seat of his chauffeured Maybach, which eventually led to SoftBank committing $3.1 billion in new funding for WeWork in 2017. What followed was a governance disaster. By the time Neumann was fired in September 2019, SoftBank had invested $10.3 billion; a few months later it wrote off $9.2 billion of that. Neumann’s compensation for this value destruction was complicated by his ousting and subsequent lawsuit, but it is estimated he made off with around $1.023 billion, most of it coming out of SoftBank’s pockets. That’s $1.5 million per day during those two years. It only recently transpired that SoftBank lent Neumann $430 million, collateralised against his WeWork shares, and when the shares crashed, Neumann was able to walk away with the cash sans claim from Softbank.

Ultimately, the demise of WeWork stemmed from a perennial business killer: a misalignment between assets and liabilities. This disconnect has historically brought down financial institutions, entire nations, and even historical companies like the Dutch East India Company. Paradoxically, WeWork had a promising setup. The burgeoning demand for flexible office space was in their favour, complemented by a strong brand presence. However, their fundamental business model was flawed. According to filings, WeWork’s typical lease with landlords started with 15-year terms. At the same time, it said its customers had average “membership agreements” of around a year and a half. About 75% of WeWork revenue — set to be just under $4 billion this year — now goes to paying leases. This paradox was already evident early on its evolution, as quoted in The Cult of We: “if you had to position this as a real estate company, it wouldn't be worth this” the renowned real estate investor Barry Sternlicht of Starwood Capital told the Wall Street Journal in 2017. “Neuman dressed it up and made it into a community, and that turned it into a tech play.” The emperor has no clothes analogy didn’t stop Starwood becoming a significant shareholder in WeWork’s IPO. Heavy interest expenses and even slimmed-down overhead costs, left the company with almost no ability to be profitable. WeWork chief executive David Tolley said in the company’s bankruptcy filing that it had amended 590 leases and cut future rent obligations by $12 billion, but could “not overcome the legacy real estate costs and industry headwinds.”

WeWork’s occupancy rates this year have hovered just above 70%. Stock prices of two large office space landlords, Vornado and SL Green, are down around 60% from their pre-pandemic levels. The pair would be down even more if it was not for tenants stuck in long-term leases, so on an objective level, WeWork by no means suffered a different fate.The biggest unsecured claim of a NYC landlord is Unibail-Rodamco-Westfield, but few institutional investors are immune. Brookfield is listed as owed $3 million for unpaid rent and a lease termination fee, Nuveen is owed $2.8 million for unpaid rent. While WeWork made up less than 2% of the overall office market in Manhattan, its leases are concentrated in a particularly strained area: Class-B and C buildings. More than 60% of WeWork’s leases were in those kinds of buildings, Bisnow reported, marking this particularly bitter pill for many owners. The company’s restructuring may have implications for its London operations too, where it is one of the biggest tenants. According to CoStar, the company has 36 offices in London, spanning more than 2.89 million sq ft. Either way, debt refinancings for buildings where WeWork occupies or used to occupy space are likely to be tricky. There are $7.9 billion of CMBS loans with exposure to WeWork, according to Barclays, and likely billions more in the wider debt market. Like Neumann, the only other beneficiaries in this story are some lenders: SoftBank was forced to wire $1.5 billion to Goldman Sachs and other lenders days before WeWork filed for bankruptcy.

The bankruptcy process should allow WeWork to shed some portion of its $13 billion in long-term leases it does not want or, more critically, strong-arm its landlords into better terms. A slimmer, humbler WeWork can now emerge. Neumann, now relegated to sniping from the sidelines, laments the company's failure to capitalise on a product that is more relevant today than ever before.“The great irony of WeWork’s bankruptcy is that it comes at the exact moment when the flex industry in general has been seeing record performance,” said Jamie Hodari, Industrious’s chief executive. He said many companies were moving out of “oversized-headquarter space…?into more flexible space at a more modest size”. “WeWork’s bankruptcy has been less about the lack of demand than the specifics of their business model.” AEW think that concerns about the office occupier market are overstated pointing to long term trends in office space per worker “the long term trend of reduced office space per office employee since the early 2000s can be seen as confirmation of the long term viability of WFH.” Over the last two decades, the shift to more flexible office layouts has led to a reduction in the average space per employee. According to CBRE's historical data, this space per worker has decreased from 10.8 sqm in 2004 to 9.8 sqm in 2023. Despite an annual office stock growth of 1.1%, the rate of office-based employment increase at 1.7% annually has outpaced it, thus diminishing the space available per employee. However, projections suggest that from 2024 onward, the ratio of office space per worker is expected to stabilise as both office stock and employment are set to grow at a slower rate of 0.9% yearly.

Ironically, WeWork recently announced they operate from 777 locations across the globe. In Hebrew numerology, the number 777 is associated with the symbols the completeness of God's work in establishing the heavens and the earth. Similarly in Christian theology, 777 holds significance as a representation of the threefold perfection of the Trinity. Perhaps now that the portfolio has been rightsized, this was always the appropriate number of leases, not global real estate hegemony. Francis Frei, a Harvard Business School professor and later a WeWork board member, gave a talk at one of WeWork’s early events, about her belief that companies often get in trouble in one of three areas: authenticity, logic, and empathy. The business of WeWork lacked all three, but the business of serviced offices, which WeWork indefatigably promoted but failed to execute on, was sound. As Brown and Farrell recount, the serviced office sector's most notable pioneer heretofore was a flamboyant Southern Californian attorney named Paul Fegen, who rapidly created a giant collection of office space centres for small law firms in the 1970s. He threw massive parties Hollywood style, but his expansion proved wobbly during the real estate bust in the 1980’s and he claimed bankruptcy in 1982; later becoming a magician showcasing his card tricks on America's Got Talent. Neumann wont suffer the same fate as a contestant on AGT, but you must credit him for promoting and improving upon an increasingly consequential sector in the family of real estate asset classes.