How will WeWork work out?

Unicorns are mythical creatures whose horns are said to possess magical healing properties.

However, in 2013, the term took on a whole new meaning when it was used by venture capitalist Aileen Lee to describe start-up companies valued at more than $1bn (£770m).

Lee coined the phrase to reflect the rarity of such successes, but rarer still are ‘decacorns’ - companies with a valuation of more than $10bn. Uber is one, as is Snapchat - and one surprising addition to this list is co-working operator WeWork.

Since the company was founded by Adam Neumann and Miguel McKelvey in the US in 2010, it has enjoyed stratospheric growth, signing leases on 10m sq ft of office space across the globe.

In London alone, the company occupies circa 1.2m sq ft and is on the lookout for more space. It also plans to expand its office network into the UK regions.

But how sustainable is the company’s current growth trajectory as it heads towards an IPO that could see its decacorn valuation of around $17bn realised?

WeWork opened its first London location at Sea Containers House in October 2014. The 37,500 sq ft deal on a rumoured rent of £50/sq ft over 10 years marked a rather modest entry into the capital considering some of the subsequent lettings it secured.

The most significant of WeWork’s early deals was the 167,900 sq ft it took in 2015 at Moor Place on a 20-year lease. It was one of 10 deals completing in just a year in the City, the City fringe, Midtown, the South Bank and Soho. The bulk of these were on leases of 10 years or more and were struck with some of the UK’s biggest landlords - Brookfield, Blackstone, British Land and Hermes, to name but a few.

The upshot is that WeWork currently has 14 operational locations, with three more due to come on stream in 2017. Membership levels have grown accordingly. At the end of 2016, WeWork was operating from 11 centres and had 12,000 UK members - today the company boasts close to 15,000 members and it claims it has occupancy rates of 90% across its portfolio.

WeWork deals since entering the UK market

The cost of membership varies depending on the location and amount of space available. For instance, at Aldwych House in WC2, the price of a hotdesk starts at £500 per month, dedicated desks cost £650 upwards and private offices are available from £930. Across in E1, at Aldgate Tower, hotdesks are available from £250, dedicated desks from £325 and private offices from £660.

Members get access to high-speed internet, cleaning services and conferencing and breakout space, in addition to free freshly micro-roasted coffee and beer (in some locations).

They can also access a series of regular on-site professional and social events, in addition to the global WeWork member network through the WeWork app, which allows them to connect with other members and trade services.

Such benefits are particularly attractive to entrepreneur and SME occupiers, according to James Townsend, founder of boutique property agency Kontor, which has acted for WeWork on many of its deals in the UK to date.

You’ve got a network where you can create huge economies of scale - James Townsend, Kontor

“The ability to connect to people digitally through an app that allows them to connect with other businesses and trade goods and services has been really popular,” he says. “I believe many members trade goods and services between themselves, creating a powerful network.

“You’ve also got a network where you can create huge economies of scale, which they’ve proven in New York by partnering up with various service providers to offer discounted corporate banking rates, healthcare insurance and discounted gym memberships. So as one person taking a hotdesk you get the power of effectively being part of a 100,000-person company and getting the discounts accordingly.”

Like all co-working or flexible workspace providers, WeWork aggressively ‘sweats’ its space, generating healthy profits from the mark-up it charges members for square footage.

Historically, offices have allocated 100 sq ft of desk space to each person, but in recent years this has fallen to around 80 sq ft for conventional office occupiers. For workspace operators such as WeWork, this figure can fall to as low as 50 sq ft - hence the ability to ramp up the margins.

No one knows the exact multiplier that workspace providers use per square foot, but one property source estimates that while other providers are working on profits of under 20%, WeWork is looking to more than double that number where it can.

“From a business model perspective, it runs very large spaces with very good economies of scale, so its profit margin is significantly more than any other competitor,” says an office agency source.

Positive vibe

Then again, the company does have high overheads. It is renowned for its hip, ultra-cool fit-outs and those don’t come cheap - according to some estimates, the company spends as much as 40% more than other office occupiers on fit-out costs. That is partly why in some London locations, WeWork has taken its rent‑free incentive as cash up front.

The quality of office fit-out coupled with WeWork’s overall business offer and brand experience have attracted plenty of admirers in the UK. As one rival flexible workspace provider says: “What it has done is brought co-working into the mindset of everyone and everyone now knows what that offer is.

“We used to have to explain to people what we do and now when we go and tell people, they say: ‘Oh, so you’re like WeWork.’ The fanfare that’s come with WeWork has brought a lot of positive awareness to the wider industry.”

John Williams, head of marketing at Instant Offices, is equally effusive. “WeWork is very cleverly tailoring its offer to where demand is,” he says.

“It started off with an entrepreneurial appeal to SMEs, but now it wants to drive its corporate base. It has recognised that larger corporate occupiers have started to be in that type of space to attract the right staff, so it’s massively expanding the offer into that area.”

WeWork is very cleverly tailoring its offer to where demand is - John Williams, Instant Offices

WeWork calls these corporate occupiers “enterprise” members - essentially, companies with more than 500 employees around the world.

According to figures provided by the company, WeWork’s 800 enterprise members currently make up more than 20% of global membership and represent the company’s fastest-growing segment.

WeWork has struck deals with the likes of Dell, KPMG, Compass and Red Bull. Last year, it embarked on a ‘city as a campus’ deal with Microsoft in New York, giving members of the tech company’s sales team access to WeWork locations across the city. But this new focus is not to everyone’s taste.

“When it started out its aim was to support start-ups, but since then the company has taken more than 1m sq ft in London and now it’s got to fill that space, so it’s dressed up the addition of corporate occupiers as beneficial to its member audience,” says an office agency source.

“However, everything that it came over promising and everything that it appears to be is kind of losing a little bit of its sparkle. It’s a bit more corporate cool now rather than being the edgy newcomer.”

Reservations

That is not the only reservation some members of the UK property industry have about WeWork’s modus operandi. One source likens the company to Uber and says its business model is “punchy - they’ve signed a lot of leases at the top of the market”.

It is a view shared by a source at a large UK investment company. “One of the worries we have - and it’s unproven to date - is what happens if we go through a stickier patch with the economy. The company’s business model is predicated on full occupancy, or as close to full occupancy as possible, and in a downsize scenario where occupancy rates fall to 50%, there is a question mark about how viable this model becomes,” he says.

The obvious question they will be asked about WeWork is: ‘How safe is this business model?’

“When you get into an investment committee situation, you can just imagine the scene where the fund manager is proposing to buy a building that has WeWork as a tenant. The purpose of an investment committee is to grill that fund manager and make absolutely sure they understand the risks involved and can articulate those risks.

“The obvious question they will be asked about WeWork is: ‘How safe is this business model?’ That’s a tough one to answer because it is a new, relatively unproven model and hasn’t gone through a notable downturn yet.”

Another property insider also expresses reservations about the speed of the company’s growth: “I have a horrible feeling WeWork are going to hit some rocky times because they have grown so quickly and taken great big chunks of space at enormous rents with rent-free periods that are starting to come off soon and it does worry me that this could be like the dotcom bubble.”

Keeping occupancy up

He cites the cautionary example of Regus, which filed for chapter 11 bankruptcy in the US in 2003, and a huge factor many analysts cite as the root cause of the firm’s downfall was the number of long leases on empty serviced office space it was left holding.

This is clearly not a concern keeping the WeWork team awake at night. “We are comfortable with how we’ve structured our real estate in London and globally,” says a spokesperson. “Our model is designed with flexibility in mind. Regardless of the economic climate, businesses are looking for a model that is flexible and that accommodates a business that is expanding or contracting.”

If estimates of WeWork’s profit margins are correct, it has good reason to be confident because even if occupancy rates fall off a cliff, the company has built itself more of a buffer than some of its rivals.

Moreover, for the time being at least, it does not appear to have a problem filling up space in the majority of its locations. The company has even been able to increase desk rates in venues where it has a waiting list.

As for occupancy rates, it is making sure it remains competitive on rent to maintain those 90%-plus levels, with one London office agency source claiming he lined up a deal for a client who wanted to come out of a WeWork centre, but at the last minute the co-working company “significantly reduced” the desk rate so it no longer made financial sense for the client to leave.

This is perhaps the biggest challenge facing the company as it prepares to IPO, which some financial experts reckon will occur within 18 months to two years. WeWork needs to maintain its high occupancy rates if it is to make itself as attractive as possible to investors and hit that $17bn decacorn valuation.

That could be a big ask in a subsector that is seeing new entrants - including landlords - introducing exciting new concepts to the market all the time.

On the flipside, WeWork has rapidly become the byword for co-working space. It has built a strong brand and there is a tangible energy and spirit of collaboration in its offices so it’s clearly doing something right. Time will tell if that equates to a $17bn valuation.

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