WeWork’s new corporate life

When WeWork approached venture capital firms to raise $355 million in late 2014, it painted a detailed picture of the kind of company it wanted to become in the next two years.

The plan was to morph into a global “physical social network” that connected like-minded professionals through shared office spaces and a smartphone app that allowed members to network and organize events. A pitch deck that was later leaked to the press and published by Buzzfeed in October 2015 outlined network effects and “proprietary, mobile-centric technology.” The company would use those to expand at a rapid pace, the leaked document proposed. By the end of 2016, WeWork [TRDataCustom] would make $1 billion in “run-rate revenue” at a 33 percent profit margin. WeLive, its co-living brand, would account for 11.6 percent of its revenues and have 6,500 members, per the company’s executives.

The implicit message was clear: WeWork isn’t just a co-working giant peddling office space — it’s also a tech company in the mold of Uber, Snapchat and Facebook. And it would grow (almost) as quickly.

The Manhattan-based enterprise, founded by Adam Neumann and Miguel McKelvey in 2010, got its way. Between late 2014 and late 2016, WeWork raised more than $1 billion from investors, most recently at a $16.9 billion valuation.

But although the fundraising went according to plan, little else did.

Over the course of 2016, the company cut its profit projections dramatically — by a whopping 78 percent. It all but stalled the expansion of its WeLive line, which has just two locations running in Lower Manhattan and Crystal City, Va., and it battled data leaks while taking a whistle-blower to court.

Still, beyond the headlines on leaks, lawsuits and profit numbers, some have overlooked a more profound trend: Over the course of a single year, WeWork, managed to steer its business model away from Silicon Valley and directly toward Wall Street.

The company is now growing more cautiously. It is still adding locations at a rapid clip, but is no longer looking to cash in on each location as aggressively as it once did, and its executives are preparing a fund to invest in real estate rather than renting every square foot of space the company offers. In 2017, WeWork looks a lot less like the tech company it once claimed to be and much more like a boring corporation. And that’s not necessarily a bad thing.

“From our perspective, they continue to grow and expand,” said Bill Rudin, Rudin Management’s vice chairman and CEO, who has invested in WeWork and partnered with the firm at 110 Wall Street and the Brooklyn Navy Yard. “As a casual observer, I also think they continue to bring in more seasoned professionals to run their business and get involved with the operation.”

Moving money

Nothing signals WeWork’s strategic shift from Silicon Valley to Wall Street more starkly than its recently announced plans to launch a real estate investment fund.

The firm’s vice chair, Michael Gross, said at a real estate panel in October 2016 that the company is working on a “vehicle” that would use outside investors’ money to buy properties for WeWork and WeLive.

“We’re looking at multiple companies where we’re looking at sale-leasebacks,” Gross said. “They’re looking to sell us buildings. We would come, refit it out and give it back to them.”

WeWork has been mum about the fund since then, citing SEC regulations. But sources told The Real Deal that the firm has been in talks with institutional investors about buying into the fund. For a self-styled tech company, this is unusual. Silicon Valley startups almost never invest in tangible assets on a massive scale. Uber, the car-ride-hailing app, doesn’t even buy the bulk of its cars. “Asset light” — or growing quickly without having to invest much money — is the catchphrase that warms venture capitalists’ hearts. WeWork’s president, Artie Minson, has used the term to talk up WeWork’s business model.

So why the shift? For one, WeWork never really was that asset light to begin with. The company invests a lot of money building out its spaces for its customers — even if landlords typically share the burden. That investment impacts a property’s price.

“The moment WeWork comes into a building, you’re creating value,” Gross said in October.

But others have voiced concerns about the risk that some of WeWork’s tenants bring with them. “When these things go down, they do not go from 16 to 14, they go from 16 to 2,” Starwood Capital Group’s Barry Sternlicht said at a conference in September 2016, speaking of WeWork’s $16 billion valuation. “There is no elevator down, you hit the floor.”

Nonetheless, owning properties outright would allow WeWork to benefit from appreciation of those assets. Moreover, buying real estate through a fund means the company won’t actually have to spend its own money on the investment.

“Their view is ‘If we’re the biggest tenant in the building, then why aren’t we participating in the ownership of the building?’” said Glenn Brill of the business advisory firm FTI Consulting.

From leases to JVs

WeWork’s core business model has always been simple: Lease office space from landlords on a long-term basis and sublet it to firms and individuals on short, flexible terms for a markup. But in 2016, the company began to increasingly diversify that approach. It still signs plenty of traditional leases in buildings such as 135 East 57th Street, 2 Herald Square and office properties outside the U.S., but it’s also been doing more joint-venture and profit-sharing deals with landlords.

In India, for example, news broke in September that the company had signed a partnership agreement with the local real estate firm Embassy Group. Rather than merely rent out space, WeWork will design, staff and manage office space in properties owned by Embassy and other India-based sponsors. In the deal with Embassy, the landlord will pay for the buildout and split revenues with WeWork.

In China, the co-working giant is partnering with the state-owned real estate company Sino-Ocean Group to open new locations in Beijing and Shanghai this year. Sino-Ocean will assume all buildout costs, while revenues will be split 50-50. WeWork launched its first China location in Shanghai in November 2016.

Christian Lee, WeWork’s head of global development, told TRD in December that the company had looked at the best ways to expand globally, “and that naturally leads you to those partnerships.”

Entering a foreign office market with its own laws and customs is risky for any American firm — not to mention a young company like WeWork. Partnering with a local business that knows the market can help circumvent many of those challenges, Lee noted.

Still, several hurdles remain.

“The challenges will mainly come from the local competitors and the adoption of local culture,” said Joe Zhou, head of research at JLL China. He pointed to the example of Uber, which failed to win over market dominance in China and ultimately sold its operations there to local rival Didi Chuxing. And hitching your wagon to a local partner carries its own risks if that partner turns out to be the wrong fit or comes with its own problems.

But WeWork’s increasing reliance on partnership agreements with landlords isn’t just a function of its expansion abroad. The firm has also been signing more of these agreements in the U.S.

For example, the firm will open two Detroit locations under a profit-sharing deal with the local landlord Bedrock. The obvious advantage of lower rent payments in exchange for profit sharing is that it reduces WeWork’s risk in the face of a potential office market downturn.

Under these deals, WeWork “would have a little more flexibility when it comes to pricing, whereas in a normal lease agreement you’d have a specific floor in how you could respond to the needs to change pricing,” the co-working giant’s co-founder McKelvey told Fast Company in September.

Rudin said profit sharing leaves the landlord with more risk compared to mere leases. “For some owners it may make sense,” he explained. “It’s like a hotel: You’re buying a brand.”

The profit-sharing approach also means that WeWork will need to invest less capital in each new location, as building owners typically pick up the tab for buildouts. WeWork’s Lee, however, noted that landlords have been giving the company hefty subsidies to pay for the revamping of WeWork’s spaces even under traditional leases.

In another leaked document from April 2016, WeWork blamed its downward revision of 2016 revenue projections on higher than expected buildout costs and lower than expected landlord concessions. Profit-sharing agreements could help address that problem.

The flip side is that these deals will make it harder for WeWork to boast the kind of dizzying cash-flow growth that’s so effective at winning over investors. The company tends to push expenses and lease payments back, meaning new locations look extremely profitable on paper at first, according to the tech business news site the Information. But with revenues per location shrinking under revenue splits, the cash flow picture for each new location will appear less rosy on first sight.

Zach Aarons, a venture investor and co-founder of tech accelerator and advisory firm MetaProp NYC, said WeWork’s real estate fund and the new focus on revenue sharing remind him of a hotel company.

“They’re taking the hotel flag and putting it into a commercial office model,” he said. “If you look at the leading [hotel brands], some of them have deals with landlords that are just a revenue share and some deals where they own the property.”

WeLive another day

Meanwhile, WeWork’s executives have high hopes for the company’s WeLive co-living service, which offers beds in shared rooms or studio apartments with flexible lease terms and plenty of common areas. But growth in that department has been notably slow.

Since opening its first two locations at Crystal City, near Washington, D.C., and 110 Wall Street in Manhattan earlier this year, WeLive has announced only one more location, in Seattle. Its initial projections were far more bullish: 6,500 members by the end of 2016 and 16,800 by the end of 2017 — numbers that are virtually impossible to achieve with roughly 400 units divided between two buildings.

The Wall Street Journal reported in August 2016 that WeWork underestimated the cost of converting office buildings like 110 Wall Street into residential space. And co-living spaces converted from office buildings, through a process called adaptive reuse, are notoriously hard to finance, Brill of FTI noted. The typical lender “doesn’t like mixed use that much and likes adaptive reuse even less,” he said, arguing that the risks of cost overruns and delays during construction typically make debt expensive, especially if the ultimate use is a business model as new and untested and potentially risky as WeLive.

Faced with that challenge, WeWork appears increasingly keen on putting WeLive spaces into new developments, where it can design spaces for co-living from the start. In June 2016, TRD reported that the firm was considering launching a WeLive location at Kushner Companies’ One Journal Square project in Jersey City. Representatives for WeWork and Kushner would not comment on the matter when asked again last month.

WeWork’s Lee noted in December 2016 that the company still views WeLive as a big part of its future, and sources close to the firm said it is planning additional WeLive locations in the U.S. and abroad. But no new spaces have been announced.

Pitching the Fortune 500

In the minds of most real estate executives, WeWork is, first and foremost, a home for tech startups in need of small, flexible offices. The implication is that the company’s reliance on less stable enterprises makes it a risky bet.

“People blow in and out of WeWork,” Empire State Realty Trust CEO Anthony Malkin said during an earnings call in April. “They beat the hell out of buildings, bathrooms, systems…Why should we take a venture capital risk when our only upside is to collect rent?”

But the co-working company’s executives maintain that smaller startups account for only a small portion of their customers, while over the past year WeWork has increasingly targeted blue chip companies. Major corporations, including PepsiCo and Facebook, now use WeWork spaces to house some of their employees, and in November 2016, the firm signed a deal with Microsoft to give 300 of its salespeople access to all Manhattan and Brooklyn locations.

But perhaps more importantly, WeWork is in talks to bring its services to major U.S. corporate headquarters, which could open a huge potential revenue source.

David Fano, the firm’s chief development officer, referred to the business model as “WeWork on site.” Depending on a firm’s needs, the co-working company could build out the offices of a major firm and manage them for a flat fee, he noted. Fano said WeWork is in advanced talks with several corporations, but he would not specify which firms.

Apart from offering other companies a work environment their employees may like, WeWork also claims it can use its knowledge and data to reduce the amount of space a firm needs to set aside for each employee. “The value proposition is running the space more efficiently,” Fano said.

New money

On the face of it, WeWork is still the same company it was three years ago. The business has grown, of course, yet its spaces look more or less the same, the same people are still in charge (and still running around in t-shirts) and the company still indulges in Marc Andreessen-esque talk of changing the world through technology.

And the company is still small by many standards. It is expected to have pulled in $532 million in revenue in 2016 and employed just over 1,000 people, as of June. Facebook, by comparison, saw annual revenues of $17.93 billion in 2015 and employed more than 15,724 people at the end of September.

But last year brought some clear signs that WeWork is starting to look increasingly like a good old-fashioned American corporation.

Although WeWork’s initial funding rounds involved major American financial firms, including JPMorgan Chase and Goldman Sachs, they also included Benchmark Capital of Menlo Park, Calif., and fellow venture capital firms Aleph VC and Duff Ackerman & Goodrich, according to the research firm PitchBook. In its 2016 funding rounds, however, WeWork left the venture capital crowd behind. In March, it raised $430 million from the Beijing-based private equity firm Hony Capital and its parent, Legend Holdings. And in October, it added another $260 million from the Chinese hotel company Shanghai Jin Jiang International Hotels, as well as family offices and existing investors.

Foreign institutional investors tend to be more patient and less insistent on breakneck growth than Silicon Valley investors, industry sources say.

To be fair, WeWork was never a pure tech startup and never claimed to be. It is based in Manhattan, some of its early backers are real estate developers, and software engineering does not take the same central role as it does at Uber or Facebook.

“We were a New York City company that was always extremely different from a Silicon Valley company,” Jennifer Berrent, the company’s chief culture officer, told TRD in reference to WeWork’s early days.

Still, with all the company’s talk of network effects, mobile technology and run-rate revenue, most media outlets treated it as such — assigning tech reporters to cover the company and often placing it in “unicorn” rankings.

But as the co-working giant starts buying properties and signs more joint-venture agreements with landlords, that narrative will be harder to keep up. And as WeWork grows, it will also be harder to keep up the company’s early self-proclaimed image as a company that’s more interested in doing good than in making money.

“I’m surprised from the amount of talk I heard about valuation, and raising money, and bubble and building big companies — that is not the goal,” Neumann said in January 2016 at the Startup India initiative in New Delhi. “The goal is finding something you truly love. Make sure it has intention behind it. Make sure it’s going to make the world a better place.”

The question now is if this kind of talk will still fly if the company manages a real estate investment fund on behalf of institutions that want to make money first and foremost?

Ryan Fix, founder of the co-living company Pure House, who said he knows Neumann from his early Brooklyn days, said he has his doubts.

“While I think [Adam] started with the idea of building a community, the profit incentive just doesn’t go hand in hand with it,” Fix told TRD. “I think that he’s a visionary and that he’s extremely charismatic, and I think that he wants to take over the world.”