Analysis: Legacy landlord concerns partially validate WeWork SPaaS model

Landlords are not a threat to WeWork.jpg

Bondholders, reporters, analysts are all looking at We Co. with a crooked eye. Now Neumann wants to slash the valuation by more than half. The company isn’t making any money and probably won’t for a long time. So what’s to love about The We Co.? Ask its enterprise clients.

The office space-as-a-service model re-engineered how corporations lease offices. Legacy landlords are now catching on to the potential threat and money left on the table from operationalizing space, and are rethinking their relationship with the likes of WeWork - as reported by the WSJ. Some are refusing to work with them. Others are launching their own brands to counter the trend. They may be too late to compete in a meaningful way.

Flex office model (quickly) explained

Commercial office leasing went virtually unchanged since the first skyscrapers went up. Commercial landlords - companies like Brookfield Asset Management, British Land, and Blackstone Group - collect rent checks on 10-15 year office space lease agreements and leave the rest of the work with their tenants i.e. furnishings, office & community management, tech-enabled security, meeting space apps, and other elements.

Landlord concerns validate WeWork’s business model - to a degree.
— Luke Bujarski

Flex operators disrupted this age-old approach by adding on a layer of services that corporate clients have grown fond of. WeWork, Regus, Knotel, Industrious, Convene enter into master lease agreements with the landlord, and then build out the space to make it move-in ready for the tenant. Companies pay a premium for full-service offices in exchange for shorter lease terms and help with operations e.g. procurement and office maintenance. Roughly double the rate - according to estimates reported by the Wall Street Journal.

Friction with landlords

Owners saw benefit in handing over multiple floors or an entire building to one client (WeWork for example) instead of managing multiple smaller tenants. Filling half-empty floors with freelancers and startups made sense.

But the flex model has since evolved from the coworking days. Now, WeWork (and others) are prioritizing bigger corporate clients, because they pay more and sign longer lease terms. JLL data show that flex space could account for 30 percent of the office market by 2030. Much of that growth is from the large enterprises - not startups and small companies.

This evolution also puts WeWork in direct competition with its landlord partners. It shifts the value chain around.

Why landlords may be too late

Scale, Expertise, Relationships. Companies want flexibility but also access to new markets and talent. High-skilled labor is harder to find in a good economy. Flex operators help enterprise access talent distributed in cities that they may not have invested in previously. 50 percent of U.S. STEM (Science, Technology, Engineering, and Math) jobs are spread across 20 of the largest U.S. metro areas (See figure below).

Talent Distribution | Industry Cluster Research | LUFT

WeWork continues to selectively sign leases in key locations with this aim in mind i.e. to engineer a space-as-a-service platform that allows companies to benefit from the network effects of a flex partner with distributed and global reach. Flex offices are for home-based employees, but also for business travelers and the mobile workforce in need of meeting spaces, access to events, etc.

Landlords are more focused on chasing returns on individual properties in hot markets. Boston Properties, for example, has 50.9 million in-service square feet of office space, according to its latest earnings report. WeWork has just over 40 million. But BP offices are concentrated in the big cities i.e. Boston, L.A., San Francisco, New York, and D.C. No secondary markets e.g. Austin, Denver, Salt Lake City.

Corporate clients are also more likely to commit to one flex-space operator for global operations. Ease of vendor management but also things like employee security and, perhaps more importantly, favorable and negotiable terms on space as the company grows into new markets. In other words, once they are integrated into the WeWork network, they will likely stay there.

Operationalizing space is also a completely different business than pure leasing. WeWork has the formula down. They have builder and vendor relationships in all of the primary and secondary hubs, and specialize in building out office environments that work for clients.

Traditional landlords are also mostly hands-off once the lease is signed. Factor in added operational costs and the business model starts to look very different.

WeWork is not an existential threat to legacy landlords, either. They still own the property; maintaining healthy relationships with the landlords is absolutely critical, particularly as the company looks to grow into new geographies.

The push into the corporate leasing space is a friction point, but one that will likely be settled at the negotiating table, rather than full-blown red ocean battles for market share between the flex operators and landlords.

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