The WSJ featured a piece last Friday on the debacle that has been WeWork.
WeWork is a real estate company that owns no real estate.
The core of WeWork’s business model is subletting.
WeWork leases large spaces in buildings, transforms them in a specific style, and then sublets the space to individuals and businesses at a higher price.
Who might be interested in leasing space from WeWork? Freelancers, startups, and other businesses who desire short-term lease agreements and flexibility.
WeWork’s tenants, or members as they are sometimes called, sign leases that last an average of 15 months. WeWork’s leases with building owners run for about 15 years on average.
The Problems with WeWork’s Business Model
See any potential problems here?
For starters, there is a mismatch between WeWork’s lease term and tenant lease terms, but that’s not even the biggest issue.
WeWork’s core customer is the marginal capacity in the office market. When a downturn comes, which tenants are most likely to default on their lease obligations? The freelancer and startup, or the established business?
Sam Zell on WeWork
Sam Zell, the billionaire real estate investor, explained some of the problems in WeWork’s model in a 2017 CNBC interview.
With all of WeWork’s potential problems, how did the firm achieve a private market value of $47 billion with hopes of a $90 billion IPO?
Who is to Blame for the WeWork Debacle?
Follow the money. You can start at the Marriner Eccles building in D.C., home to the Federal Reserve. The Fed’s decade long campaign to hold interest rates at zero and flush the financial system with liquidity via quantitative easing has encouraged banks, pension funds, and even some mom and pop investors to take risks and make investments that likely wouldn’t have had a chance of getting funded in a normal interest rate environment.
Wall Street Banks’ Role in WeWork
Public Enemy number two, as is often the case, is Wall Street. The big banks lent billions to WeWork, knowing full-well the firm was running an unproven business model.
For their own money, the banks insisted on big fees and strict protections, but Wall Street had a more significant aim in lending to WeWork—a more sinister aim. Sinister says us, of course, but you can be the judge.
The WSJ shed light on how some of the big banks may have been thinking about WeWork.
Wells Fargo bankers acknowledged internally that WeWork’s business model was unproven but agreed to lend $100 million if the company set aside cash as collateral, according to people familiar with the matter and a memo reviewed by the Journal.
WeWork would be a profitable client in Silicon Valley, where Wells Fargo doesn’t have a strong presence, they argued in the memo about whether to approve the loan. It also could land the bank a role in WeWork’s IPO and future stock sales, which the bankers estimated could bring in $12 million in fees, the memo said.
On the surface, Wells’ actions don’t sound like anything any business in any other industry wouldn’t do to earn more lucrative business from a valued customer.
That is, until you recognize who the sucker is in this scheme to make the IPO possible.
That sucker is Wall Street’s customers (as opposed to clients). Mom and pop investors, pension funds, and other institutional investors would have been the patsies in J.P. Morgan’s and Goldman’s payday from the WeWork IPO.
As you may know, the WeWork IPO failed (thankfully) and a loan tied to the offering was also pulled.
WeWork was bailed out by SoftBank in October, at a valuation of about $8 billion—less than 1/10th of what Goldman was pitching as a potential IPO valuation a few months prior.
Wall Street’s Business Model Still Riddled with Conflicts
What is the actionable advice for you? For all of the reforms and regulations that have been passed, Wall Street’s business model remains riddled with conflicts of interest.
Wall Street banks make money by selling you product.
Independent registered investment advisors (RIA) make money by advising and counseling clients of what is in the clients’ best interests and always put the clients’ interests ahead of their own.
Who do you want to be your most trusted financial advisor?