As WeWork Reveals IPO, CRE Listens For Alarm Bells
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The health of the nation's commercial real estate market could be closely tied to how well coworking company WeWork fares on the public market, several market watchers said late Wednesday.
The We Company's relentless investment has led to the large scale it is at today and is based on the huge growth potential it outlines in its recent filing. WeWork had 528 locations in 111 cities as of June 30, with a current membership of 527,000 people, but the company estimates a total potential membership of 149 million people. In its 10 largest markets, The We Company believes it has only captured 0.6% of that, according to its prospectus.
In the U.S., WeWork accounts for most of the coworking industry, which itself accounts for 1.6% of office inventory in major markets but about one-third of all office leasing in those markets in the last 18 months, according to Colliers International.
WeWork has buoyed the wider CRE market in general, and its prospectus and imminent public offering are seen as important beyond the still-young coworking industry.
“If the IPO is successful, there will be incremental demand increases around commercial real estate,” CenterSquare analyst Alex Snyder said. “WeWork tends to grow like a weed and the only thing stopping them from doing that is capital.”
If WeWork's public offering is unsuccessful, Snyder and others see the entire CRE market taking a hit, given the sector's weighty contributions to much of CRE's most recent growth.
Some of the country's booming CRE centers, gateway markets with large WeWork footprints like New York, would likely see occupancy drop if the coworking behemoth's growth tanked and profitability plunged. If skittish markets continue to whipsaw, and growth slows, WeWork’s valuation is almost certain to wobble.
“That would definitely present a risk, especially in WeWork's largest markets like New York and San Francisco,” Bloomberg Intelligence analyst Jeffrey Langbaum said. “WeWork has become the incremental tenant of existing office space, helping to house smaller companies that historically wouldn't have been long-term renters. This has helped boost market occupancy rates.”
The company’s established business model of taking long-term leases for its locations, spending money to build and market them, then lease them out on short-term deals, has been raising eyebrows, and details from the IPO prospectus increased those concerns.
“Two things stood out for me,” Langbaum said. “The difference between their committed lease obligations, where they're on the hook for $47B, and their committed rents are $4B. Clearly, there's a mismatch there. The average length of [WeWork’s] leases is 15 years, but the average length of their tenants is 15 months. Another big mismatch.”
If WeWork stops expanding, then that incremental tenant goes away, he said, leading to shuttered locations and negative absorption.
“What remains uncertain is how much of a cushion they have built in where they can afford to lose some occupancy within their portfolio, but keep locations open, and therefore keep paying rent on the spaces they lease from traditional office landlords,” Langbaum said.
How important The We Company's prospectus is to commercial real estate might largely depend on how important coworking, and its biggest player, have become to commercial real estate.
If it does poorly, it depends on why it does poorly — and who that could hurt. A recession would hurt the entire sector, and a cooling of coworking could similarly pinch markets and owners.
“If WeWork itself breaks, that'll affect the market, but coworking could still be a good concept. If coworking itself goes away, that vacuum of space that's left behind will be hard for the CRE market,” Snyder said.
That failure from atop the nascent but potentially trillion-dollar coworking industry could set the industry back in a similar but more high-profile way another coworking failure did, according to Servcorp Senior Vice President Charles Robinson.
After a vast expansion, Regus, which has often been a cautionary tale for the industry, was forced to file for bankruptcy in 2003.
“WeWork has been great for the sector overall,” Robinson said. “There is a broad awareness of flexible workspace now here in the U.S. and globally. If WeWork were to head south significantly that wouldn’t be great for other players. When Regus went bust, it put a taint on the industry.”
The impact of WeWork also will vary depending on the health of individual markets. For example, in San Francisco, the outlook could likely stay rosy whether WeWork continues gobbling up space or whether it doesn't, according to Vanguard Properties Director of Investment Sales Alexander Kolovyansky.
“For the Bay Area, it won't make one bit of difference because people will take the open space in a heartbeat,” he said, citing the sub-6% office vacancy rate and the region's millions of square feet of pre-leased, under-construction office space.
Other sources of concern — or hope — come from WeWork's financial performance in the cities it has invested in most heavily and for the longest time.
“The real existential question for the business is its operating leverage in mature markets,” said Horizon Partners Managing Director Sandy Kory, a Bay Area investment adviser.
In that regard, some concerns have been allayed, Kory said. The We Company's filings reveal better margins in its bigger markets, where through early, aggressive investment it gained the foothold it has today.
Other fundamentals, like the company's valuation and doubt about the kind of company it considers itself, still worry experts. The company's massive $47B valuation is once again under fire, with analysts pointing out WeWork has been burning cash at an unsustainable rate as it attempts to entrench itself in markets outside of New York, San Francisco and London. It posted combined losses of $2.6B in the last year and a half and said it expects to continue losing money “in the foreseeable future.”
“I'm not defending a $47B valuation,” Kory said. “I think that's crazy.”
How effective its prospectus was at convincing investors — and global market players — that it is a tech company, not a real estate company, remains to be seen. WeWork didn't disclose a targeted share price, but the market’s failure to accept its creative tech company metrics could lead to a brisk market correction after the IPO.
“Right now, it's trading at a 40X multiple,” said Alejandro Ortiz of SharesPost, which provides research on pre-IPO stock. “The market has to decide what it is, and real estate companies typically trade at a much lower multiple than tech companies.”
Ortiz said WeWork is looking to capitalize on elevated multiples associated with late-stage, VC-backed companies, despite much more closely resembling real estate company.
“Elements of its business are very tech-enabled, but it’s not readily apparent from the filing that it is a tech company,” Ortiz said. “Time will tell.”