Is co-working having its ‘Emperor’s new clothes’ moment?

SoftBank’s interest in WeWork has waned, prompting questions about what the value is in co-working businesses.

The flexible office model faces its first meaningful stress test as an institutional investment now SoftBank has dialed down its backing of the sector’s headline brand WeWork.

This week, the Tokyo-based investor softened its initially bold bet on WeWork, committing just $2 billion over the next 15 months. It had previously indicated eight times as much backing.

WeWork says the new investment will leave it with an enterprise value of $47 billion, including debt. That is still higher than the market caps of any listed property company – a fact not lost on WeWork’s CFO Artie Minson who told the Financial Times his colleagues would have “high-fived” each other if they realised this predicament last July.

Nevertheless, this huge miss in expectations, coupled with the fact the commitment comes from the Softbank balance sheet, not the Vision Fund, questions the true value of both WeWork and, reasonably, its co-working peers.

In November, media outlets reported the co-working giant could have a valuation of approximately $42 billion. Despite SoftBank’s higher valuation, it is no longer looking to take a majority stake in the company, a source familiar with the matter told Real Estate Capital‘s sister publication PERE.

WeWork is responding by rebranding itself as We Company. It aims to operate in the service of “how we work, how we live and how we grow.” That move could be read in many ways – by expanding its offering it dilutes its basis being one of them.

Regardless, Softbank’s cold feet will register on office landlord radars worldwide. It will prompt them to reconsider a kind of tenant that relies on short-term, flexible and potentially volatile income.

If landlords are to accept the trend of occupiers wanting this type of accommodation, then they should revisit their optimal type of engagement. What is the right risk-reward comparison to be made between leasing to a co-working brand versus offering shared space options in-house?

Already, some real estate firms have started their own offerings. In October, Los-Angeles-based CBRE launched subsidiary Hana to provide its own flexible office and event space. Similarly, New York-based Tishman Speyer broke into co-working with Studio in September.

Others have opted to embrace WeWork and its contemporaries as tenants. The London-based Nuveen Real Estate, for instance, partnered with Danish pension fund PFA and WeWork to invest in London’s Devonshire Square where WeWork will also be a key tenant. In Asia, Hong Kong-based private equity real estate firm Pamfleet leased 80,000 square feet in the podium of western Kowloon’s Harbourfront Landmark to shared-space provider Campfire Collaborative Spaces. In making Campfire its solo tenant in the complex, that firm demonstrated some institutional capital at least, is willing to place whole-building bets on shared space tenants.

The industry also needs to decide how much co-working exposure is appropriate. The consensus seems to be around no more than 20-30 percent of a building. To mitigate risk further, some landlords ask co-working tenants for large security deposits and significant letters of credit, a source familiar with the matter told PERE.

Like most new ideas, co-working needs to be road-tested. It needs a downturn to truly be understood, as PERE heard at a UBS-hosted roundtable late last year where the Swiss bank was cautious about its own engagement with providers.

Of course, one could argue the sector’s downturn could come even before it has had a chance to shine. SoftBank appears to be turning its back before WeWork even has had a chance to be profitable. According to the FT, losses have quadrupled to $1.2 billion against earnings of $1.5 billion in the first nine months of 2018.

The sector has seen downturns on the listed side before. WeWork’s older and publicly-listed cousin, IWG – formerly Regus – thrived during the 90s, successfully listing in 2000. It filed for bankruptcy in 2003, suffering from the burst of the dotcom bubble, but has subsequently restructured and proven itself to be profitable over subsequent years.

Private real estate’s investment in the shared space arena will need to go through its own complete cycle for us to see if SoftBank’s hedged bet was part of a cooling down of co-working’s fever. Then institutional money should have a more complete understanding of one of the most hyped property trends.