The summer of 2019 seems like a lifetime ago; back then global pandemics and major land wars were the preserve of video games, while financial conditions were still defined by quantitative easing (QE) and interest rates were close to zero. Extremely loose financial conditions were the foundation of the Softbank Vision Fund (SVF) created in 2017, the largest technology investor ever, with more than US$100 billion in capital. The exponential quantum of capital available to disruptive new business models drove a significant distortion in the private start-up scene. Founders were encouraged to dream bigger as the SVF was ten times larger than other leading venture capital funds, with funding cheques a similar multiple.

More than ample funding led to ‘think big’

Capital-intensive business models were ideally suited to soak up this significant capital infusion. No other company dreamed bigger than WeWork, looking to disrupt the US$1 tn+ real estate market. Pitching itself as a tech company, WeWork rented out office space, claiming to digitalise real estate through a global platform, selling memberships and other services.

Softbank ultimately invested over US$10 bn in WeWork, including a US$2 bn funding round in January 2019 that valued the company at US$47 bn, which was followed by a hotly-anticipated initial public offering (IPO) that same year, with some estimates valuing the business as high as US$100 billion. However, equity markets were less convinced, with the company ultimately listed on public markets via a special purpose acquisition company (SPAC) in October 2021 at a much more sedate US$9 billion valuation. But just two years later, WeWork was forced to file for bankruptcy.

A tech start-up in real estate?

We previously met with WeWork’s co-founder and now former CEO, Adam Neumann, in the summer of 2019 as part of the company’s preparation for its impending IPO. It turned out to be one of the more entertaining two hours of our careers. The meeting was focused on how disruptive WeWork was, its huge growth potential, and their attempts to convince us that it was really a technology company, so therefore deserved a valuation to match other disruptive tech start-ups, rather than the lower multiples typical of the listed real estate sector. This provided us with an opportunity to leverage our specialist expertise and extensive experience within the technology and property sectors and bring that knowledge together to practically assess WeWork’s aspirations and claims.

“For me, a downturn is not scary. It’s an opportunity.”

                                                  Adam Neumann, 2019

The tech view (Richard):

We apply our own criteria when determining the definition of a technology company, rather than accept a company’s self-definition. We use a consistent framework of looking for proprietary technology that is fundamental to a company’s franchise and its right to make money. While WeWork demonstrated numerous technology tools to us, we viewed that none of them were truly proprietary. The business model/ right to make money was based on leasing long-term office space, and renting it out at higher rates in the short term. Having navigated multiple technology hype cycles, we recognised a highly charismatic founder with a big idea, but one that was ultimately reliant on significant external funding, rather than a virtuous flywheel of today’s profits funding future innovation and growth.

Through multiple economic and rates cycles including the Global Financial Crisis (GFC) and dot.com crash, we have seen how quickly external funding can dry up. On the unpredictability of markets, the economist John Maynard Keynes said, “Markets can remain irrational longer than you can remain solvent.” Handing out billions of dollars a month in funding was unsustainable and has proved so. Technology is a truly dynamic sector; today’s disruptors can be the disrupted of tomorrow. Hybrid working is the new co-working, which resulted in WeWork’s eventual final demise. Extraordinarily high valuations based on future years’ profit and cash flow projections are fraught with risk and should be discounted accordingly.

The real estate view (Guy):

The real estate sector tends to be one of gradual evolution and predictable incremental growth. Our time spent with a high-energy Adam Neumann was clearly very different, as he sought to disrupt one of the most fragmented businesses globally. The proposition was relatively simple, take long-term leases from office landlords and then break that space down into smaller units let on short-term contracts for individuals and businesses. Those tenants would pay a premium for the greater flexibility and to be part of the global ‘We’ community with perks like free coffee, beer, DJs and stripped back contemporary space. The challenge, as ever, comes from a mismatch of assets/income and liabilities, which was exacerbated by the acceleration in the work-from-home trend post-pandemic. WeWork lost most of its revenue as customers stayed at home, but was obliged to pay rent for their leases. The free money era and breakneck growth and investment ultimately never gave the company a chance to generate profits, with Neumann describing profitability and free cash flow at the time as a “managed outcome” – but one that was ultimately never achieved.

Despite the shortfalls of the WeWork business model, the vision was actually one that resonates with us. The office sector is evolving fast, with leases getting shorter and landlords needing to become operators rather than just rent collectors. This is something that many of the office landlords in which we invest have adapted to, with their own ‘flex’ proposition and brands, but without the same asset-liability mismatch as they own the buildings. Demand for environmental credentials and the impact of working from home are also driving change, creating challenges but also opportunities for the real estate sector. This means a highly selective approach to investment in the office space today is required. As I wrote back in 2018, “Regardless of where WeWork is in five years’ time, the office sector will look very different.”

Active management needed to navigate change and assess fundamentals

With the demise of WeWork, we think it is worth reflecting on the lessons learnt and the benefits investment experience can bring. Given how long QE and the zero-interest rate regime were in place following the GFC, we have been in a world of ‘free money’ and ample liquidity until the past couple of years. Higher rates now mean there is a higher cost of capital, companies are having to place greater emphasis on efficient capital allocation decisions.

Being able to dynamically assess a new business, stress test business models and forecasts, and appropriately value investments against a variety of market and macroeconomic backdrops are the responsibilities for any investor. Deciding when to invest is important, but equally important is knowing when not to.

IMPORTANT INFORMATION

REITs or Real Estate Investment Trusts invest in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like shares.

Real estate securities, including Real Estate Investment Trusts (REITs) may be subject to additional risks, including interest rate, management, tax, economic, environmental and concentration risks.

Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market.