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. 

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.