WeWork Watch – Event Driven (IPO)

Is there any Justification for Valuing WeWork’s Leased Space at $1,000 Per Square Foot?

WeWork (new name: The We Company) leases spaces from some very sophisticated landlords including TIAA-CREF, Boston Properties, Beacon Capital Partners and Moinian Group.  In theory, WeWork has a simple business model, leasing office space and then subleasing the space to businesses ranging from start-ups to Fortune 500 companies.

A substantial part of the business model is buying/leasing wholesale and then selling/subleasing retail.  More specifically, WeWork enters into long-term leases for substantial tracts of space, then subsequently divides the space, subleasing small portions to each tenant for relatively short periods of time.  There are obvious problems with the business model, not the least of which is a mismatch between WeWork’s $47.2 billion in lease obligations and its much smaller right to short-term cash flow from sublessees.  Setting this and other structural problems aside, there is also a valuation problem.

Although WeWork loses an incredible amount of money ($1.9 billion in 2018), it has been very successful at scaling the number of square feet under its control as well convincing venture capitalists to ascribe an inordinately high valuation to negative cash flow generated from leased space.  WeWork’s losses have been incurred in spite of a generous dollop of tenant improvement allowance (TIA) money from landlords. WeWork uses TIA money to transform leased space for the use of its subtenants. During the first six months of 2019 alone, WeWork received approximately $455 million in TIA funding.  

With the emergence of companies such as Knotel (Industrious, Tech Space…), there is more competition for coworking space.  Moreover, competition from new entrants is making a dent in the market, with brokerage firms (e.g., CBRE/Hana) and landlords each vying for a piece of the proverbial pie (e.g., Tishman Speyer/Studio).

Coworking firms cannot count on landlords to leave money on the table by leasing at rates and on terms that allow substantial profits to be earned on the back end of the transaction, the sublease of the leased space.

Landlords will insist on more favorable terms, for example reducing the generous TIA funding.  WeWork already loses substantial amounts of money.  Can WeWork survive higher losses triggered by lower TIA concessions and higher rents?  In fact, many landlords are already negotiating for a bigger piece of the coworking pie, retaining coworking companies as managers, rather than leasing the space while funding improvements by dint of TIA funding.

WeWork’s Leased Space is Valued at $1,000 Per Square Foot

WeWork boasts a valuation of $47 billion, amortized over the 46.64 million square feet under its control.  The $47 billion valuation means that every square foot of space leased by WeWork is valued at $1,000.  WeWork’s leases typically last 15 years.  Of course, such a short duration stands in sharp contrast with the infinite duration of an ownership interest.  Yet, inexplicably, a square foot of space leased by WeWork for a finite duration is valued the same as an ownership stake on prestigious Fifth Avenue office space in New York City.  That’s right, office space on Fifth Avenue in NYC is valued at about $1,000 per square foot, the same as WeWork’s leased space.

WeWork Does Not Utilize an Asset Light Model

Some would argue that WeWork’s high valuation is justified, using companies like airbnb as a benchmark.  There are a number of reasons why such a comparison is inappropriate; there are major differences between WeWork and asset light phenoms.  For example, Airbnb uses properties owned or leased by others, and is not burdened by carrying costs to buy or rent the properties. Therefore, airbnb has no recurring expenses, and bears no burden for the maintenance of the properties.  Airbnb makes money when hosts rent space, but bears no expense when space remains vacant.

In sharp contrast, WeWork is responsible for substantial and recurring expenses, including Rent and Additional Rent, regardless of whether or not it is able to sublease at a higher rate.

Conclusion

WeWork isn’t worth anywhere close to the current valuation of $1,000 per square foot of leased space.  However, the inflated valuation and WeWork’s impending IPO has repercussions, including making competitors such as Knotel and IWG look inexpensive by comparison.  Not surprisingly, Knotel was able to raise $400 million (making it a unicorn), while IWG considers an IPO for its US-based operations. Plenty more to come as the industry grows and morphs.

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Author: Randy Airst, CEO at Exceedant and Team.

Based in the Greater New York region and Tampa, Florida region of the USA, The Exceedant Group is an asset management and financial services firm. Exceedant specializes in private equity, credit and hedge fund investment strategies. Exceedant’s clients have included NYSE and NASDAQ traded companies, hedge funds, private equity firms, commercial real estate firms and other entities.

Randy has been involved in asset strategy and management with clients/investors for many years at Exceedant and its predecessors.

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