Five lessons from the WeWork fiasco

WeWork’s travails, while unfortunate, can help to serve as a cautionary warning to tech investors who venture into the real estate industry

Updated: Sep 27, 2019 02:45:23 PM UTC
Image: Shutterstock

WeWork, the global coworking behemoth, has been in the news for all the wrong reasons with its IPO debacle. While the issue of corporate governance has taken centre stage in most of the analyses, this is not uncommon in Silicon Valley, where powerful founders hold disproportionate voting rights. Instead, here are the five most important lessons that we can learn from WeWork’s botched IPO.

1.    Real estate is too big an industry to fit the traditional VC model. At around $230 trillion, global real estate is far too big for the tech industry’s standard practice of gaining a first mover advantage and cornering a huge share of the market to create an unassailable market leader. Private equity and venture capital funds, and even the largest sovereign wealth funds, don’t have the capital to corner a significant share of this industry. For instance, Blackstone, the largest commercial property owner in the world, controls less than 0.5 percent of the global commercial property sector.

2.    Business basics matter in this industry. Since the economic mantra of Silicon Valley darlings like Uber, "gain market share and profits will eventually come", does not work in this industry due to its size, there is no great efficiency to be gained with scale. In the absence of network effects and economies of scale, sustainably successful real estate companies must figure out unit cost economics right from the start and run a profitable operation. Coworking only works with high EBITDA margins, as I and D—interest and depreciation—are big expenses in this business. The huge upfront cost of interior build-outs incur considerable capital costs in the form of interest, while interiors, unlike buildings, depreciate rapidly. In its quest for growth, WeWork lost the single-minded focus on reliable profitability that is essential in this business.

3.    Reckless growth comes at a cost, and could have long-term consequences. Profiting from commercial buildings, especially in the current market boom, should be very simple. Costs, with drivers like operating expenses, must be kept low; and revenues, with drivers like occupancy rate and rent, kept high. The winning strategy is to select buildings in the best locations, negotiate affordable rents for them on long-term leases, and keep running costs low by running a tight ship. Eschewing this simple wisdom and prioritising growth over all else, WeWork did the opposite by trying to lock up buildings at higher-than-market rents in order to expand as quickly as possible. And since its leases are long-term in nature, these high costs are baked into the business model for years to come.

4.    Business ethics and management maturity are critical for investors. Trust and transparency are critical for investors who are forking out billions of dollars, and WeWork's IPO first got into trouble because it was perceived to lack these qualities. Investor trust was eroded with instances of self-dealing and an unusual mechanism to select the next CEO, as well as in the character of key people with instances of drug use.

5.    The positive outlook for coworking is still intact. It is telling that nothing in the WeWork story has taken the shine off the intrinsic allure of real estate’s fastest growing sector, coworking. Tenants want to focus on their core business and not on peripheral activities such as facility management, managing catering, network management, etc. Especially for companies with less than 1,000 people in a single location, coworking offers a superior alternative to building and managing teams of people not working on core business functions.

WeWork’s travails, while unfortunate, can help to serve as a cautionary warning to tech investors who venture into the real estate industry. While the massive size of this industry is enticing, its nature is such that business basics matter and it is important for players to use sound business judgment while deploying capital.

The write is, Founder and CEO of SmartOwner.

The thoughts and opinions shared here are of the author.

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  • K S R Upadhya

    Smart Owner CEO has no business to comment about others. He has to first learn to respect his investors, respond to their queries, and more importantly be transparent. I am one of the several people who invested in Smart Owner products and deeply regret my decision to deal with Smart Owner.

    on Sep 28, 2019
  • Dr C P Ramchandani

    The basic foundation for any successful business has rightly been brought out. Finally it is the maturity of the founders to read the market correctly and the business ethics that drive the complex situation.

    on Sep 28, 2019