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WeWork: London’s Soon-To-Be Biggest Property Renter Makes Massive Bet On Office Market Despite Brexit

Courtesy of ZeroHedge. View original post here.

The rationale for creating WeWork, the eco-friendly serviced workspace provider, was simple as co-founder Adam Neumann explained to the New York Daily News.

“During the economic crises, there were these empty buildings and these people freelancing or starting companies. I knew there was a way to match the two. What separates us, though, is community.

It wasn’t a bad idea since the company was recently valued at $20 billion. The first WeWork location was established in New York’s fashionable SoHo district (above) in 2010. Only four years later, Wikipedia notes that WeWork was the “fastest growing lessee of new office space in New York”. The company currently manages office space in 23 cities across the United States and in 21 other countries including China, Hong Kong, India, Japan, France, Germany and the UK.

WeWork’s growth has been little short of stratospheric, and investors have included heavyweight financial names such as JP Morgan. T. Rowe Price, Goldman, Wellington Management and Softbank. As Bloomberg reports, WeWork is about to repeat its success in New York and other cities by becoming the largest private lessee of office space in London. However, some old-school property developers are predicting that WeWork’s break-neck expansion is ill-timed.

A seven-year-old U.S. startup is set to become the biggest private tenant in London just as the U.K.’s economic outlook worsens. Three years after entering the British capital, WeWork Cos. has signed leases that will make it the city’s No. 1 private-sector user of office space, according to data compiled by CoStar Group Inc. for Bloomberg. The rapid growth makes WeWork, valued at $20 billion, increasingly important to the health of the city’s property market as well as more vulnerable to any future decline in rents.

“A downturn of some description has to happen at some point, and when it does the serviced office business will suffer very quickly,” said Michael Marx, the veteran developer who ran Development Securities Plc for 21 years through 2015. “In the present uncertain market many people are hoping that the WeWork model works — but we have no idea whether it does on a sustainable basis or for how long. It appears to be a well-capitalized business, but if the cycle turns down, then the model looks vulnerable.”

As the chart below shows, WeWork’s expansion is occurring after the bull market in London office space is more than two decades into an upturn.

The company currently has 17 locations in London, with two more about to be opened, as shown on this map of the city. The majority of the office space is in the eastern part of the city, in and around the City of London.

The addition of the two about-to-open properties and another ten in the planning stage – one of which is the 620,000 square foot 12-building campus of Devonshire Square which the company is negotiating to buy outright from Blackstone Group (for $785 million) – will catapult WeWork into the number one position in London.

In short, WeWork is making a massive bet on the office market in London in spite of the risks posed by Brexit. From accounts filed by WeWork’s UK business, Bloomberg learned that the company has committed to £815 million ($1.09 billion) of rent payments in the future, of which £231 million ($309 million) is due over the next five years. Income in 2016 was £61 million ($81.7 million) and the company posted a loss of £11.1 million. Some anecdotal evidence unearthed by Bloomberg raises concern.

WeWork’s most basic membership plan, which allows access to the company’s offices two days a month and use of the firm’s app, starts at $45 a month, according to its website. The company ran a promotion this summer offering tenants half of their lease for free in an attempt to fill that space. In some cases, it has also paid brokers fees of as much as 20 percent for bringing in tenants, double the industry norm, people with knowledge of the matter said. WeWork’s standard broker payment is 10 percent, another person said.

WeWork is exposing itself to a classic case of liquidity mismatch. This is normally associated with the banking sector and banks being caught out in a crisis from borrowing short to lend long. In the property sector, the equivalent is borrowing long to rent short. Bloomberg reports the contrasting view of one of WeWork’s competitors, which shuns this strategy.

Jamie Hopkins, CEO of WeWork competitor Workspace Group Plc, said he prefers a business based on purchasing the properties the company rents out as short-term offices. “Buying long-term leases and selling short ones at a profit is not a model we are comfortable with at all,” Hopkins said in an interview. Owning its buildings gives Workspace “much more flexibility in terms of pricing if we need it,” he said.

Not surprisingly, WeWork sees things differently and Bloomberg relays its take.

While the company has acknowledged that Brexit poses economic risks, it also said that uncertainty surrounding the move will support its business as companies remain wary of long-term commitments. WeWork has secured deals with firms including International Business Machines Corp. and Inc. in its U.S. business and is seeking similar deals with blue-chip tenants in London.

Some companies have as many as 600 people in WeWork sites, McKelvey, the chief creative officer, told Bloomberg in an interview in July. “Our approach appeals to companies of all shapes and sizes,” he said, discussing a plan to expand rapidly in Latin America. The chief creative officer also described WeWork’s approach to growing quickly.

“To build out locations is a challenge,” he said. “But we came out with a very sophisticated platform of how we manage that whole process and it allows us to run it like a software development process, and it gives us a lot of confidence in our ability to execute.”

In WeWork’s defence, Softbank invested $4.4 billion in the company, which is what established the $20 billion valuation. While that is reassuring, the story behind Softbank’s investment is bizarre and doesn’t inspire confidence in WeWork’s prospects.

Before the deal was announced SoftBank Vice Chairman Ron Fisher — who led the investment — met with executives at IWG Plc, a competitor with a much lower valuation and more than 10 times as many sites, people with direct knowledge of the matter said. The meeting was held to better understand the temporary office business model and address the investor’s concerns over WeWork’s valuation, they said.

IWG, in its former incarnation as Regus, filed for bankruptcy protection for its U.S. business in 2003 after it expanded too rapidly in the dot-com boom. IWG has a market value of just 1.8 billion pounds despite having nearly 3,000 locations worldwide compared to WeWork’s 235. More recently, the Swiss company has seen the value of its shares drop almost 40 percent since Oct. 19 when it issued a profit warning, citing in part weakness in the London market.

IWG is “the same business, the returns are the same and there is no difference — there’s no alchemy in it,” CEO Mark Dixon said in an interview about half-year earnings, comparing his company to WeWork.

Some old hands in UK real estate are pointing out how WeWork’s expansion across London is merely transferring risk, not reducing it. Indeed, by bidding up for office space, WeWork is taking on the risk previously in the hands of landlords, since it needs to rent out the office space. The CEO of the UK’s largest REIT, Land Securities, noted “You are effectively transferring risk from a landlord to an intermediary, that space still needs to be let out.”

Meanwhile, the jury on WeWork’s rapid late-cycle expansion is still out and we sympathise with the tone of the feedback reported by Bloomberg. Either WeWork is going to blow-up, or it’s the work of genius. If  pushed, we’d probably side with the former.

Despite the risks, WeWork has its backers in the London property market. “I hear people say it is going to blow up any minute now, but they have got major investors,” Tony Gibbon, founder of broker GM Real Estate said at the Bisnow event. “People question the valuation but so what, it is a considerable scale and it is a trend that isn’t going to disappear.”

“There are clearly risks associated with the speed of expansion of WeWork,” Toby Courtauld, CEO of London office landlord Great Portland Estates Plc, said in an interview. “It is probably too early to call whether that’s a systemic problem or in fact is a fantastic call by them.”

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