Despite Valuation Concerns, WeWork’s S-1 Filing Is a Glimpse into the Office Market of the Future

Since the We Company (which I will call WeWork going forward) released their S-1 investor prospectus, Wall Street pundits and the financial press have had a field day tearing the company apart. It’s true, WeWork’s business model sounds inherently risky: a mismatch between long-term lease commitments with expensive tenant improvements, and revenue from monthly memberships with little to no commitment. The company’s own prospectus provides plenty of ammunition to the critics, stating: “we cannot predict whether we will achieve profitability for the foreseeable future.” 

WeWork is wildly popular with its users, they are opening locations a breakneck pace and seem to have an endless supply of members joining space-as-a-service revolution they pioneered. Browsing WeWork’s website for the Los Angeles market, I found 29 locations that are either currently open or coming soon. At open locations, many had at least one membership type (hot desk, dedicated desk or dedicated office) that was unavailable. Potential investors are wary, but from a user perspective they must be doing something right. One of the most anticipated IPOs of 2019 may have served company kool-aid to the wolves of Wall Street, but did the CRE industry get the recipe to their secret sauce?

As WeWork struggles to find their way during its IPO process, let’s take a look past the speculation, hyperbole and downright outrage around its valuation. Buried within their S-1 there are important themes that have major implications for future office markets. 

Workplace delivered at scale

WeWork revealed some eye-popping statistics in terms of its growth trajectory and what it considers its total addressable market. Having opened its first co-working location in New York City in 2011, it had expanded to 111 cities around the world by mid-2019. In addition, the company has identified a total of 280 target markets where they believe there is a demand for space-as-a-service (SPaaS). 

WeWork considers anyone working in an occupation that requires a desk as a potential member.

WeWork considers anyone working in an occupation that requires a desk as a potential member. That translates into a total addressable market of 149 million in the markets it is already in, and 255 million within its 280 target markets. By lowering the barrier to entry down to a single monthly membership, the company has exponentially increased its market opportunity. 

WeWork says it had leased 35 million square feet of office space by the end of 2018 and by mid-2019 was under negotiation for an additional 40 million square feet. This high velocity of transactions across a wide geography provides the company with significant experience, allowing it to develop systems and processes which they say “automates the flow of approvals, due diligence, budgets, negotiations and closings.” 

In a short time, WeWork has become the largest office tenant in markets such as Manhattan, London and Washington D.C. Of course this gives it a deep understanding of the local market and additional clout in lease negotiations. The S-1 also describes another benefit, “The more locations we strategically cluster in a given city, the larger and more dynamic our community becomes.” This positive network effect is the holy grail in terms of demand-side economies of scale, with more locations and more members the value of a WeWork membership increases.

What does this mean for office markets?

There is a huge and growing market opportunity for SPaaS, and the industry will need to expand its idea of client/tenant to include a wider and more diverse market. Success will require a strong brand and inclusive marketing that is both B-to-B and B-to-C. According to JLL, coworking is set to be the top lessor of office space in the US in 2019. As it gains an increasing share of the office market, landlords will compete for SPaaS and we can expect more management agreements and participating leases. Large operators will use their scale to deliver higher levels of service at a lower marginal cost. This will further siphon tenant demand away from traditional leases.

As the popular saying goes, all real estate is local, but for the businesses that actually use office space, their workplace needs are increasingly global. This means that SPaaS providers will need global breadth, especially to attract large enterprise members. There will be value generated by the network of locations, and pricing of space will move beyond individual location and amenities to include the network of locations that the membership gives access to. When expanding into a new market, rather than working with a broker to find a suitable location and negotiate a lease, a member would simply select from one of the available locations in their network. This gives WeWork, with its global scale, a distinct advantage over its smaller, local competitors.

Data driven decision making 

In addition to the beneficial economics of scale, WeWork generates a significant amount of data, both from its own operations and on its members utilization of its space and services. The S-1 describes some of the ways the company has been able to use this data to drive its decision making. Starting with site selection, the company has developed, “a centralized repository of data, analytics and underwriting models that allow us to better predict member demand and the financial risks and attractiveness of a potential space.” 

The company also, “developed technology to automate many aspects of the design and layout of a raw space,” during the buildout phase. As a result, WeWork says that it is able to open a location in an average of 5 months from the date they take possession of the space. This is compared to an industry average of 9 months for the buildout of a typical office space. Once the location is ready to be marketed, the company uses data science and machine learning to set membership prices and optimize revenue in real-time. Scale and data driven decision making provides the company with two competitive advantages over a traditional office landlords. 

First, taking a cue from the tech industry, it enables WeWork to approach workplace through iteration. Scale provides many opportunities to repeat processes, test what works and what doesn’t, and then quickly adapt. Iteration drives continual process improvement and increase efficiency of its operations. For example, the company says that it was able to reduce its CAPEX per workstation by 50% over five years, from $7,289 in 2014 to $3,661 per workstation added in 1H 2019.

The second competitive advantage is that it has allowed the company to develop its own proprietary enterprise technologies. One that they call Workplace Analytics, “…provides a deeper understanding of space utilization, future space needs and associated costs for enterprises.” Other proprietary software generates seating charts, manage moves, and track facility maintenance requests. These help the company deliver its own services more efficiently to members, but can also be a value add product or additional revenue stream for enterprise members and Powered by We clients.

Commercial real estate data is notoriously limited and often of poor quality, often leading to decision making through intuition or concensus. In the future, office occupiers of all sizes will expect high quality data and tools to support their decision making process. The net effect is that inefficiencies will be wrung from the entire lifecycle of tenancy, from location selection, and outfitting of space, to moves and maintenance requests.

We can expect sensors and IoT technology to provide real-time occupancy data, allowing space to be used more efficiently. This could lead to an overall reduction in space used per employee, while also allowing office tenants to more quickly respond to changes in headcount. SPaaS providers could introduce more dynamic pricing models that respond to demand in real-time, for example the WeWorkGo pilot in China allows non-members access to WeWork locations and pay per minute of use depending on real-time occupancy. This will result in increased revenue for flexible spaces, and higher NOI and valuations for the buildings that have them.

As SPaaS comprises a larger share of the office market and the quality and quantity of data improves, market participants will be able to respond to changing macro and micro-economic conditions quickly and decisively. The ability to expand or contract as business dictates converts real estate from a fixed to a variable cost, lowering cost and for occupiers and providing liquidity for space providers

Tenant Experience (TeX) 

The tenant experience is at the core of WeWork’s success, something that WeWork has done better than any other landlord to date. It is managed to become achieve such high levels of tenant satisfaction through three main member touchpoints. First is its well known design philosophy of “bringing happiness and comfort to the workplace.” The company aims to promote a collaborative culture through design that increases interactions among its members. Real-time data from each location is used to improve the effectiveness of design and construction. 

Community Managers who “program local experiences and events, recommend services and make introductions among members” form the second touchpoint. These staff are key to fostering the community and tenant experience. The high level of service they provide also helps to retain and grow the membership base.

The WeWork app is the third touchpoint. This customer facing technology allows “members to easily book space, connect with other members for advice or services and discover events and activities.” The app is a central feature of the tenant experience, helping to foster a sense of community and acts as a feedback loop measuring the success of programing and events which the company uses to improve its service. The size and breadth of the WeWork member base gives them the power to command discounts and perks that make their offerings all the more enticing. Members complete a profile within the app, providing WeWork with data on member interests and expertise. This data is then used by the Community Managers to program relevant events that would be of interest to the members at each location. It also gives WeWork valuable data if the want to move into other verticals, as was likely the case with its acquisition of Flatiron School, a vocational coding academy 

Since technology has enabled work to be done from anywhere, coming into the office has increasingly been viewed as optional. In addition, many workers are essentially on call virtually 24 hours per day, so the workplace has become an additional benefit, a place to collaborate, socialize and be inspired. In a tight labor market, quality of the work environment has become another tool that companies use to attract and retain the best employees. WeWork has been a pioneer in raising the bar in terms of the quality of the tenant experience, while at the same time lowering the barrier to entry.

Employees of companies of all sizes now expect WeWork-like amenities and services, and this will only gain importance in the future.

Employees of companies of all sizes now expect WeWork-like amenities and services, and this will only gain importance in the future. Landlords are forced to add high-touch amenities in a bid to attract tenants. This has caused the many large commercial real estate landlords to decide whether to take on the improvements and management themselves or persue partnerships with outside firms such as WeWork, Convene or Knotel, which specializes in building and operating hospitality-like meeting and shared workspaces. Service and quality of amenities will become a major driver in pricing for SPaaS memberships, and at the asset level will drive occupancy and NOI. Maintaining a high level of service in the modern, quickly changing business landscape requires a high level of management that can only be achieved with a large, highly skilled team. This makes outsourcing a more and more enticing offering to landlords who often view themselves more as asset managers than hospitality service providers.

TeX includes not only the occupied space and building itself, but extends into the experience of the surrounding neighborhood. As such, prime locations in vibrant neighborhoods will become even more desirable in the future. Following WeWork, programming and events that give employees a chance to network or learn will help to build a sense of community.

As WeWork has shown, technology will play an outsized role in the tenant experience. The ability to personalize the space, services and programing through an app or online will be expected, and this will enable landlords and SPaaS operators to know their tenants at the individual level. New entrants will emerge to capitalize on all of the data that will be generated by IoT and sensors, further improving efficiency of space and reducing operating costs.

What happens next?

Negative press on WeWork’s IPO has already taken a toll, sources have reported that the company and its stakeholders are considering a lower initial price, somewhere around $15 billion at time of publication, and some doubt the company will go public at all. This isn’t necessarily a bad thing, and could relieve some of the pressure to grow and allow it to focus on making its existing business profitable. The company has made significant investments in technology, and it has proven its ability to use its scale to iterate, improve processes and optimize its space-as-a-service offering. Until now private equity, namely Softbank has funded these endeavors, it remains to be seen if the public markets will be as generous. 

In a short time, WeWork has been able to grow its network of locations to rival many industry juggernauts. It has a wealth of leasing experience not only as a landlord to its members but as a tenant, it is one of the biggest corporate occupiers in most of the markets that it focuses on. With such an extensive number of deals under its belt and in the pipeline, the company has gained expertise in site selection, lease negotiation, transactions, space planning and space build outs. It has developed standard processes, and technology solutions that reduce costs, and speed the delivery of space. The company can deliver a higher level of service, at a lower cost than competitors. This translates to a strong competitive advantage for its entire suite of workplace services. 

While still doubt surrounds the IPO, there is no doubt about the influence WeWork has had on office markets around the globe. Its strong brand and space design resonates with its members, and its popularity has caused landlords and CRE service providers to imitate the design. The space-as-a-service model allows its members to scale up or down as needed and reduces the complexity of leasing office space. This flexibility has been good for the economy, allowing tenants to focus on their business, and absorption of a significant amount of vacant space has benefited landlords. Its network of global locations help facilitate international expansion, manage global teams and employee satisfaction.

The SPaaS industry is still in its infancy, and has yet to weather an economic downturn. As the market matures, some companies will fail and new ones will rise through their ashes. There will be mergers and spinoffs, likely consolidation, and we shall see if WeWork still maintains its market-leading position. No matter what happens, it will likely be an entertaining show.

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