Adam Neumann’s charisma was almost enough to take WeWork, the shared-office-space company he co-founded, public. But a delayed IPO process marred by investor concerns about his behavior, the company’s governance, and valuation, pushed Neumann to step down as CEO this past week.
The move will partially mollify the company’s critics, but it will do little to change the risk inherent in WeWork’s business model. WeWork’s real estate portfolio is filled with leases that are far longer than what’s typical in the industry. Under its leases, WeWork owes a whopping $47.2 billion, according to the company’s IPO paperwork.
“The average length of the initial term of our U.S. leases is approximately 15 years,” WeWork noted in its IPO filing.
By contrast, from 2006 to 2017, the average term for leases signed by U.S. publicly traded real estate investment trusts was 6.8 years, according to Morgan Stanley.
WeWork’s long leases look particularly problematic when you consider that its client base is seeking shorter, more flexible commitments. The typical WeWork member agreement is on average less than two years, the company’s filing says.
“In many cases, our members may terminate their membership agreements with us at any time upon as little notice as one calendar month,” the company’s IPO filing says.
WeWork declined to comment on the gap between the company’s leases and its customer commitments. The company said in its S-1 filing that its annual revenue run rate was $3.3 billion.
For WeWork, taking on long-term risk is part of the value proposition they offer to both tenants and landlords, the latter seeking certainty and the former seeking flexibility.
WeWork’s most direct competitor, IWG (ticker: IWG.LN), which operates the Regus brand of coworking spaces, manages the same risk in several ways.
First, it’s more geographically diverse than WeWork, with office locations in over 1,000 cities globally. That leaves them less exposed to the regional or national economic swings than WeWork, which has locations in 111 cities. Second, IWG simply has a lower level of lease of total lease obligations than WeWork at £6.6 billion, or about $8.4 billion, according to the company’s 2018 annual report. And third, IWG signs shorter leases: 62% of its lease obligations are due within the next five years.
IWG has good reason to be relatively prudent: after the dot-com bubble burst, its U.S. business filed for bankruptcy.
WeWork’s landlords are, of course, aware of its risk. And they’ve been increasingly asking for WeWork to guarantee larger portions of the long-term leases that the company signs. Columbia Property Trust (CXP) and SL Green (SLG) both discussed guarantees they sought and received from WeWork on conference calls last year, The Wall Street Journal reported.
To make its revenue more predictable, WeWork has expanded its enterprise business, which now accounts for 40% of its membership base. Those customers come with relatively longer contracts and penalties if they are broken. WeWork also says in its filing that its revenue will rise in coming years as newly opened locations mature, which could reduce the gap between its assets and liabilities.
Neumann may be out as CEO, but the need to get potential investors’ comfortable with WeWork’s risk hasn’t changed. The task will likely be high on the priority list of the company’s new co-CEOs Artie Minson and Sebastian Gunningham.
On Thursday night, the Financial Times reported that WeWork has stopped signing new leases with landlords in an effort to reduce costs.
The company denies that report.
On Friday the company told Barron’s: “WeWork continues to sign new lease agreements with our landlord partners. We expect the pace of entering new lease agreements to slow over the next several quarters as we pursue more strategic growth and focus on accelerating our path to profitability.”