Tuesday, July 14, 2015

This Is Astounding...

WeWork-Golden-Gate-Lounge-3

When was irrational exuberance upgraded to the first class lounge? When did delusional insanity take over the valuations of start-up companies? For WeWork Companies, Inc., the old-fashioned executive suites concept reimagined as the coolest place to have your office ever, it happened on June 24th when it was valued at ten billion dollars by some admittedly very smart guys.
To get a sense of how truly astonishing this valuation is, you need to know a little about WeWork; fortunately, you don’t have to be Marc Andreessen to understand the company—your father-in-law would get it. WeWork is simply a real estate middleman that throws in some cool stuff and almost hotel-like services. It owns nothing; rather, it leases large blocks of raw office space in top cities, spends its investors’ capital to turn these into the hippest co-worker offices in the country, and then rents the space by the hour, by the day or by the month for say triple what it’s paying the landlords. (Loosely, a “co-worker office” means a space with few private offices, a big communal kitchen and an open-ceilinged, gymnasium-like hall at which headphoned employees sit across from one another on long picnic tables and stare at their computer screens. Some millennials grudgingly admit this environment is to work what a Marine Corps barracks is to sleep, but they rave about its amenities: everything from couches and beanbag chairs to dogs, fresh fruit, free coffee and oolong tea, ping pong and pool tables and of course the opportunity to rub shoulders—literally—with cutting-edgers.) WeWork even has free beer at happy hour.Forget about the fact that, at ten billion, WeWork is worth more than almost every publicly-traded office building landlord in the country (companies so old-school theyown their buildings). Consider this instead: According to a profile of WeWork published by Forbes on November 5th, 2014, the company anticipates having leased 3,615,000 square feet of office space spread over 60 buildings by year end. Divide ten billion dollars by 3,615,000 square feet and you get $2,778 per square foot or roughly 400 percent more than the value of any 3.6 million square feet of office buildings in New York City or San Francisco.
WeWork makes all the sense in the world for its users—it fills a need. For a $100 a month, you get your own desk one day a month at its offices, a mailing address, package handling and the right to book a conference room for $25 an hour (more impressive than meeting clients at your Starbucks office). And, in some situations, the concept resonates from a landlord’s perspective. Faced with a choice between a lease with a single no-credit start-up and one with WeWork—which will in turn be leasing to 500 no-credit start-ups—a landlord might conclude she would prefer WeWork’s diversified approach. And a landlord looking to make her building cool could do worse than WeWork.
WeWork’s problem lies not with its users or landlords, but in itself. It has a business model that flies in the face of the advice that, had he understood business, Shakespeare would have written instead of that anti-capitalist rant about neither a borrower nor a lender be. A savvier bard would have declaimed: “Never borrow long while lending short.*” Or, put another way, don’t make WeWork’s mistake. WeWork is signing fixed 10+ year leases with its landlords at market rents (borrowing long) while signing month-to-month leases with its tenants (lending short). As with Shakespeare, there is little chance of a happy ending.
Either this white-hot office leasing market lasts—it won’t—until the WeWork leases ultimately expire and its landlords devour the company’s sandwich position by tripling its rent or—what will really happen—our next recession rolls in, the office market gluts, the millennials slump back to Starbucks and WeWork learns about the limits of human kindness (and Chapter 11) when it attempts to renegotiate its empty space with its landlords.
But those unhappy endings are years away.
Which brings us back to the company’s valuation today. Because your father-in-law’s dog knows a ten-year sandwich position is worth a fraction—not a multiple—of a building itself, something else is driving this ridiculous valuation. Perhaps WeWork’s investors believe they can “scale up” its model so as to have 3.6 billionsquare feet under lease in a few years; i.e. the Amazon syndrome—ignore past performance and present reality for the sake of untold future wealth. (In justifying its stock price vis-à-vis its on-going hemorrhaging, one Amazon shill recently pontificated, “it’s the price the shareholders are willing to pay to transform the market in the future.”)
That’s the easy answer, the one probably true in a public market, but as mentioned previously, WeWork is a private company and its investors are more than shrewd. It could be they are fully aware that ten billion dollars is absurd and that they—the investors, if not the management—have no intention of ever taking the company public. They may have set this valuation with a relatively small investment for their own purposes, possibly to impress would-be landlords into giving them more favorable deals—tenant improvement allowances, lower rent, waiving guarantees—all the while knowing that WeWork, as currently structured, will not be in it for the long haul.
Real estate can be a tough business.
*Had Shakespeare been writing about banking, however, he would have penned, “Never lend long while borrowing short.” Or had his character been an economist, he would have pontificated, “Match assets to liabilities.”
John E. McNellis is a Principal at McNellis Partners in Palo Alto, Calif.