Eight Reasons WeWork's Downfall is Great for Real Estate Startups
Source: Michael Kovac/Getty; Precision editing by yours truly
Notes: This post assumes a working knowledge of what's been going on with WeWork. If you're not familiar with the story, check out these excellent pieces from Byrne Hobart, Dror Poleg, Ben Thompson, Matt Levine, and Eliot Brown.
We will define a "real estate startup" as one that has physical locations as a core component of its business model.
Whenever I tell people I'm starting a company with a physical space component, I get some variation of, "Wow, isn’t that going to be tough post-WeWork...?"
Yes. Launching a real estate startup after WeWork, the industry’s poster child, blew up is going to be tough. Capital is more expensive and less readily available. Leases are harder to obtain. People are bearish on the space and will tell you to just go build software.
But that’s all ok. In fact, the difficulties are desirable because they forge stronger companies. You just need to go into it with eyes wide open, armed with lessons learned on SoftBank’s dime.
If you're thinking about launching a real estate startup, here are eight reasons that WeWork's downfall could actually be great for you, provided you’re a sharp student of recent history and have the chutzpah to power through.
1. The underlying trends haven't changed.
WeWork helped create and supercharged a massive paradigm shift in the way ... we work. The shift has taken on a life of its own. People have become accustomed to spinning up office space like they spin up servers in the cloud, and they’re not going back to the way things were.
Two trends in particular are here to stay: flexible office and remote work.
According to JLL, flexible workspace is growing from 2% of the market today to 30% in 2030 (office real estate is a ~$22 trillion market globally). WeWork's slowdown means more opportunities for startups who partner with landlords to provide customers with the flexibility and convenience they need.
Less obvious to play from the real estate side, but potentially more impactfully, an estimated 70% of the workforce will work remote at least 5 days per month by 2025. If I were a betting man, aided by the knowledge that 21% of remote workers named loneliness as their biggest struggle, I would bet that there will be a massive opportunity in providing remote workers with IRL communities that replace the workplace friendships they lose when they work from home.
The demand for new types of places to work, live, and gather isn’t slowing down. In fact, it’s growing. And because of WeWork’s self-inflicted wounds, there opportunities for new startups to capture that demand abound.
2. WeWork fumbled a dominant position through unforced errors.
There's no telling if, under different management, a company with the same metrics as WeWork would have been able to IPO at the $50billion+ valuation that WeWork was in the process of finalizing before the wheels came off. What is abundantly clear is that WeWork, under the management it had, made a series of unforced errors that played a massive role in tanking its IPO. Here is a non-exhaustive list:
WeWork released a comically florid, confusing, and overproduced S-1, which mentioned the word "Adam" 169 times, beating out "community" (150 times) and "technology" (110 times).
WeWork's corporate governance was abominable:
Adam took loans from WeWork, which he used to buy buildings that he leased back to WeWork
Adam sold the "We" trademark to the company for $6mm
Adam had supervoting shares that made it impossible for anyone to wrest control of the company from him, other than himself
If Adam became incapacitated or died, his wife was one of three people appointed to choose his successor
This org chart:
WeWork had a history of silly investments, including millions into Laird Hamilton's superfood company and Wavegarden, which, as the name alludes to, is a wave pool company
I could continue, but it's starting to feel like piling on
Despite all of the mistakes, WeWork is still valued at $8 billion. Remove even half of those unforced errors, and we might be telling a very different story today. WeWork would have been crowed the winner. Adam would have been given the capitalist equivalent of a divine mandate to expand into any business that touched physical space. New entrants would come up against a bigger, better-capitalized competitor wherever they turned.
Because of all the unforced errors, real estate startups have more room to grow.
3. Companies building focused, differentiated products can thrive.
When SoftBank first invested in WeWork, they did so under the belief that commercial real estate was a "winner-take-all" market - that the largest company would use its scale to drive down costs to a point at which no one else could compete. If you're competing on scale and costs, growing as rapidly as possible and building a fairly uniform product are winning moves.
In his 1980 classic Competitive Strategy, Michael Porter wrote that there are three generic strategies a business can pursue to achieve competitive advantage - lower cost, differentiation, or focus. WeWork's stumbles have shown that the low cost strategy is a difficult strategy for real estate startups to successfully pursue. Landlords have a lower cost basis and a lower cost of capital than any startup will, and control the assets on which real estate startups need to build; the lower cost strategy is best left to them.
WeWork has provided clarity to the next wave of real estate startups. They should pursue focus differentiation strategies, targeting an underserved niche and providing a unique product for which they can charge a higher price. Convene, The Wing, and many of the IRL Member Communities that I wrote about here offer a specific group of customers a valuable product that landlords can't or won't provide themselves, including event production, hospitality, community, brand, and technology. As a result, they are less exposed to price wars and more attractive as a partner or tenant to landlords who want their assets to stand out without having to build new capabilities themselves.
This clarity allows new real estate startups to make the necessary trade-offs between growth and uniqueness from Day 1. Armed with this knowledge, they can raise capital from appropriate investors who are aligned with the business model from the beginning. While growth will be slower in the short-term, the benefits of customer loyalty compound over time and present opportunities for future growth from a position of strength.
4. The market has told you what it's looking for.
Blaming WeWork alone for the decisions it made misses the full story. WeWork's job was to maximize value for its shareholders, and until very recently, private market shareholders clamored for growth at all costs. Now that we have seen WeWork (and Uber and Lyft and and and) collide with the public markets, we know what the public market wants.
It wants businesses that grow quickly but not irresponsibly, with positive-to-high contribution margins, operating leverage, free cash flow, and accumulating advantages.
Armed with that knowledge, real estate startups can focus from Day 1 on building businesses that have a reasonable path to profitability. They can build products and distribution channels that command prices that generate profits, and steer clear of short-term tactics to boost customer acquisition or top line revenue at the expense of the health of the business.
There is a fine line here between building a strong business and investing in innovation. Startups will of course lose money in its early days, but they will do so with the knowledge that they'll have to provide believable answers on how those early investments will lead to profits on a reasonable time horizon.
5. The Bullshit Multiple has been priced, at 0x.
Related to the last point, real estate startups now know that the Bullshit Multiple is 0x. What's the Bullshit Multiple? It's the multiple previously applied to businesses that added hand-wavey mentions of "technology" and "AI" to their decks in hopes of receiving a technology multiple instead of a real estate multiple.
Until very recently, the private market math looked like this:
Arbitrage real estate? 2x revenue multiple.
Harness the power of AI to maximize the efficiency of square feet while enhancing the member experience and revolutionizing real estate? 15x revenue multiple.
Post-WeWork, we now know that the public market values this type of bullshit at exactly $0 until companies can prove that technology moves the needles on real financial metrics. This is a good thing: new companies are freed from having to invest in optics to the detriment of their business.
If a killer data science team helps you source enough underpriced spaces to pay for itself many times over, hire that data science team. If you have one location and want to wow investors with what AI might help you do, skip it and spend the money on things that will deliver value to your customers.
6. You can find the right space at a reasonable price again.
When I was at Breather, we would often tour and put offers in on the same spaces that WeWork was touring and putting offers in on. They often came in higher than we did. We knew what they had offered, and we knew what they would be able to charge clients, and when we went back to the office and plugged the numbers into our model... they didn't work.
At the prices they were willing to pay, there was no way that they would make money. But they did the deals anyway, driving up prices to an inflated and non-sensical rate, and letting creative accounting take care of the rest.
Since 2010, asking rents on office space in New York City have increased by 61%. The fastest growers are the neighborhoods where WeWork has been most active. Five of the eighteen submarkets tracked by Colliers exhibited greater than 100% growth in rents over that time; all five are in Midtown South, where WeWork and tech companies are the most active tenants.
That means that for real estate startups looking for space in locations that are convenient for other startups' employees, rents have doubled in less than ten years, largely fueled by WeWork and its competitors.
WeWork's growth imperative forced it to overpay in order to acquire the spaces it needed to grow top line revenue, driving up costs in its target submarkets.
So WeWork's decision to halt all new lease agreements is great news for real estate startups looking to acquire space near their early adopters. With lower demand from WeWork's absence, prices will come back down to reasonable levels, driving down real estate startups' largest cost.
7. There's a flood of smart, experienced talent coming into the ecosystem.
WeWork suffered from mismanagement at the top, but it was full of thousands of incredibly smart, talented, and hard-working people who pulled off one of the most difficult and impressive feats in startup history, moving atoms near the speed of bits.
In the twelve months prior to Q3 2019, the company added 16.3 million square feet around the globe and controlling over 2% of New York City's office inventory. They developed the sales and marketing capabilities to fill most of those square feet, the design, construction, and data science capabilities to maximize their efficiency, and the operational capabilities to manage all of them every day.
Now, many of the people responsible for all those square feet are on the market after WeWork laid off 2,400 employees in November. WeWork alums have built lists of their former colleagues in an attempt to help each other get jobs, and those lists are full of seriously impressive people.
If you are a technical or brand-focused founder who needs to hire real estate talent to turn your idea into a business, there has never been a better time to be recruiting.
8. Being non-consensus and right is the best way to make money.
In the first episode of VC Mike Maples Jr.'s podcast, Starting Greatness, Maples and Wealthfront founder Andy Rachleff discuss the importance of being both non-consensus and right.
The argument goes that in order to make money, startups need to be right and non-consensus. If a startup is non-consensus, "no one preys upon them, because no one believes their idea is important."
If you're confident that your insight is right, the fact that you're building a product with a physical space component, WeWork's downfall has just given you a big gift: it's made your idea non-consensus.
No one in their right mind would build a real estate startup right now, and that's why now is exactly the right time to build one.
Thanks to Dan Doyon for the very helpful comments and insights.
