Every mistake has its price. But what if the price is millions of dollars and your brand? This is exactly the story of the American coworking startup WeWork. It’s a rollercoaster ride from rapid success to a dramatic downfall, marking it one of the biggest failures in US commercial real estate history.
And it’s not just WeWork; many real estate leasing firms are in similar conditions today. How will this situation affect investors and the real estate sector in general? And what lessons can we all learn from this?
Source: The Registry
The story of WeWork’s rise and fall
How it all began: The spectacular rise
Ever heard of WeWork? It burst onto the global commercial real estate scene back in 2010. It was a new and promising American startup that quickly went viral in a good way, revolutionizing the commercial real estate market.
Who’s behind all this? Adam Neumann, his wife Rebecca Keith, and Miguel McKelvey. Neumann and McKelvey established GreenDesk, an “eco-friendly coworking space” in Brooklyn in 2008. This was like their first step, a warm-up for the big leagues. After they sold GreenDesk, they put everything into WeWork, setting off on a journey that would take them to the heights of success.
Source: BusinessInsider. Left to right: Adam Neumann and Miguel McKelvey
Unpacking WeWork: Their business model explained
So, what’s the deal with WeWork, and how does it work? WeWork took a simple idea and ran with it. They started renting out office spaces and co-working areas to businesses on flexible terms for a short period. But here is the catch – WeWork didn’t own those spaces; they were tenants themselves, subleasing to others. This is what made them more sustainable in the market.
How did they make a profit? The answer comes down to the classic buy low, sell high strategy. The startup rented the premises, cleaned them up, provided all the work essentials, and rented them out at a slightly higher price. It was very convenient for the clients to rent spaces with excellent and comfortable working conditions. Everyone was benefiting in this story.
The startup’s idea resonated with consumers, and very quickly, WeWork found its way to expanding worldwide. By 2021, the company already had 764 coworking locations in over 100 cities across the globe. Can you believe they were managing about 15 million square feet of space? From large business offices to cozy coworking spots for freelancers or small groups – WeWork offered it all.
Back then, WeWork had grown to around 490,000 members, and almost half were corporate clients. WeWork quickly became one of the most expensive US startups, reaching over $47 billion in value. They got a 1.7% share of the global serviced office space market in 2019, which was more than a significant achievement for an ambitious and fast-growing startup.
But WeWork’s story isn’t all about success. Recently, WeWork reported total debts of $18.65 billion against total assets of $15.06 billion in an initial filing. Yes, the situation could be better, but what led to this?
The end of an era
2019 marked the beginning of a challenging chapter for WeWork. By then, WeWork was at its peak and still developing. This was the year they planned to go public with an Initial Public Offering (IPO), intending to list their shares on the stock exchange for public purchase. But things didn’t go as planned.
That same year, Adam Neumann’s credibility rapidly declined in the eyes of the leading investors. Why? In 2019, WeWork’s expenses exceeded its revenue. They lost a huge $1.25 billion on profit of $934 million, while demand dropped by a staggering 79%! Many investors were concerned about this and questioned Neumann’s management approach, leading to his resignation as CEO.
To stay afloat, WeWork had to carry out massive layoffs to reduce its internal costs. Just imagine, out of 12,500 employees, 2,500 were let go – that’s 19% of their team! These layoffs and the declining use of WeWork’s services took a heavy toll on their image.
Source: WeWork. Sandeep Mathrani, CEO
Under new CEO Sandeep Mathrani, WeWork hoped for a turnaround. But then 2020 brought a new challenge: COVID-19. The pandemic hit the US in early 2020 and significantly affected the commercial rental market.
As the quarantine restrictions began, people were forced into isolation, and many moved to remote work. Online conferencing boomed, but office space providers suffered huge losses. And it wasn’t just WeWork. No one really saw a pandemic coming, and it hit hard.
Despite that, WeWork managed to go public in 2021. But the victory was short-lived. The demand for office space was still low due to the pandemic, and the losses kept mounting. By 2023, the firm’s debt reached almost $3 billion.
Remember when WeWork was a booming $47 billion commercial real estate startup? Now, its value has fallen by 98%, resulting in a market capitalization of less than $50 million. Such conditions forced them to declare bankruptcy – a striking contrast to its earlier success. These swift rise and fall are almost unbelievable. But let’s take a closer look at what really caused this dramatic change.
What’s behind WeWork’s collapse, and why is it important?
Reason 1: Ineffective corporate management
Central to WeWork’s fall is Adam Neumann and his ‘Game of Thrones’ level of control. He held the reins over the board, made all major calls and decisions, controlled the fate of the shares, and even planned for his wife Rebecca to step in as the next CEO after him. That’s a ton of power in one person’s hands, right?
But here’s more: WeWork’s original plan didn’t involve buying real estate. It was about renting spaces cheaply, renovating them, and leasing at higher prices. Neumann, though, thought to squeeze the most out of this startup. He bought properties himself and then rented them out to WeWork. Essentially, WeWork was paying him rent and for his loans, plus regular revenue from the business. It may sound ridiculous, but that’s how it worked for quite a while.
In addition, Neumann’s board domination allowed him to employ some controversial financial practices. Many saw them as a conflict of interest. These internal games and the power of one man made investors nervous about Neumann’s leadership. We already know where it all led.
Reason 2: A snowballing debt
The more money WeWork made, the more it spent. Thus, the expenses would far exceed the gains at some point. Ideally, as a company grows, profits should outpace expenses. Yet the paradox of WeWork is that it worked the other way around.
A huge 65% of their spending went on rent. This is normal for a company expanding in commercial real estate. But it was growing too fast. After all, the profitability of existing outlets was not enough to cover the costs of opening new ones. Thus, WeWork’s debts grew like a snowball, becoming too big for investors, the board, and management to ignore.
Taking too much debt is nothing new for real estate. This WeWork example slightly resembles Evergrande’s case. This Chinese real estate giant accumulated over $300 billion in debt, which created many issues far beyond China. Why? It’s a long story, so check out this video on our channel to find all the answers.
Reason 3: Shifting focus and workplace culture issues
According to former employees, WeWork’s internal atmosphere was far from being perfect. Let’s start with the board of directors – until 2019, not a single woman had a seat. Frances Frei was the first, and her appointment seemed timed with WeWork’s attempt to enter the stock market, especially since having female board members was the norm for S&P500 companies.
Then there was the company culture. WeWork had an interesting way of rewarding employees and clients – free beer and wine right in the office. While this might sound fun, it wasn’t always great for maintaining a professional work environment. Not surprisingly, this approach raised some eyebrows.
By the way, many businesses, including tech startups, practice the so-called ‘happy hours’. This is when, on certain days, employees can discuss work issues in a non-work environment over a glass of anything. This can work well if it’s an occasional thing. Yet, if you flood the office with unlimited free alcohol, as was the case with WeWork, it is unlikely to do any good.
Reason 4: Pandemic renting collapse
Well, the situation inside WeWork was already controversial when COVID-19 hit, forcing people to work remotely. No one needed offices anymore. Companies like WeWork could only watch silently as their business model collapsed. Here’s a snapshot of the situation: Even before COVID-19, about 56% of global jobs had tasks that could be done remotely. When the pandemic struck, many lost or changed their positions to homeworking. Surveys show that 55% of them see no difference in office and remote effectiveness; 90% of remote workers want to keep it that way. And there’s probably no need to speculate on the benefits of such a decision. It’s crystal clear.
Now, consider these figures. In 2019, 42% of Americans were working remotely. Today, it has reached as much as 49% and is still growing. Now, let’s remember that WeWork is a US startup, so the largest number of offices were in the US, with about 60 locations in New York City alone out of 850 spaces worldwide pre-pandemic. The decline seemed almost inevitable.
Knotel Inc., another American co-working firm, faced a similar problem. A few years ago, it was valued at $1.6 billion and actively developing. Yet, in 2021, the business was sold for only $70 million.
What should we expect in the American real estate sector?
Luckily, COVID-19 is now a thing of the past, but many real estate leasing firms still feel its aftershocks. It’s too early for the commercial real estate space to relax. The pandemic era introduced many to the benefits of remote work – employees enjoyed the flexibility, and companies saved on office rent. In 2022, this shift led to a nearly 6% drop in rental values in the US. And it’s not just an American trend; from San Francisco to Hong Kong, leasing businesses in major cities worldwide are feeling the pinch. Let’s take a closer look at this.
Source: CNN Business
For example, as of Q1 2023, only 860,000 square feet of office spaces were leased in San Francisco, while pre-pandemic, in 2018, this number was nearly 3 million.
In early 2023, San Francisco-based tech giant Dropbox reported a huge loss of over $175 million due to unused office space they wanted to sublease. Other big names in the city, like Airbnb, Twitter, and Uber Technologies, have also faced cutbacks. Airbnb let go of about 25% of its workforce in 2020, while Elon Musk slashed Twitter’s workforce by 80% in less than a year.
But it’s not just a Silicon Valley issue. Only about half of New York City office workers have returned to their desks. Many buildings struggle with lost tenants and the need for overhaul. Another 290,000 square feet of office space were left empty in downtown Atlanta at the beginning of 2023.
What lessons can we learn from this?
So, let’s think about what this means for all of us and what lessons we can learn from this story.
- For leasing firms. The drop in demand for commercial real estate is loud and clear. One of the possible ways to solve this problem is to rent out all these premises for events, trading areas, or warehouses. Yet, it’s not a fix-all solution – the market has its limits. Another idea is turning office spaces into residential premises, but that involves significant time and money, which is a tough call for companies on the edge of bankruptcy. Sometimes, selling these properties before they lose more value and investing elsewhere might be the smarter move.
- For banks. This situation promises trouble for banks because they are actively crediting this industry. Here are a few facts. 55% of US office loans are on banks’ balance sheets. For instance, Signature Bank had the tenth-largest commercial real estate loan portfolio in the US at the beginning of the year. And regional banks, making up 23% of the total, are feeling the pressure. If borrowers default, these banks face the risk of going under, too.
- For investors. Caution is key. The WeWork story teaches us to look beyond a company’s success. High returns are tempting, but every investment has its risks, like the unforeseen hit of a pandemic. So, where to go from here? There’s no crystal ball. We shouldn’t panic just yet, but the road to stability will be bumpy, requiring tough decisions, compromises, and smart strategies. That’s why the best universal investment is in your knowledge.
What’s next for WeWork?
In early November, the company announced that 92% of its creditors had agreed to convert their secured debt obligations into equity. This move is part of a plan to slash about $3 billion in debt. David Tolley, the current CEO, sees this as a step towards a brighter future for WeWork.
Can you imagine that? A company once valued at $47 billion now stands at just $50 million. WeWork’s story stirred people’s minds so much that Hulu even released a documentary about it. And just like that, WeWork became a striking example of how high-flying success can turn into one of the most expensive failures in real estate history.