WeWork is the next sub-prime real estate debacle

September 24th, 2019

Shopify started with a freemium business model. They offered their e-commerce storefront software for free, taking a small percentage of transactions on sold products. They soon realized that the model created a perverse incentive. The types of companies that were creating Shopify accounts were ones who, deep down, knew they would never make a dollar.

Barbara was a Buick fanatic. She loved them so much, she made some bumper stickers that said "My other car is a Buick LeSabre." Surely there are other LeSabre fans out there, she thought. She spun up a free Shopify account and listed her wares. Nobody bought a single bumper sticker. Oh well, no problem, it didn't cost Barbara anything to give it a try.

Meanwhile, Shopify was left in the lurch paying for precious server resources that were hosting photos of Buick stickers nobody wanted.

Under the freemium pricing model, Shopify was also directly disincentivizing companies that were selling things. Even Shopify's small cut, 1%, cleaved the already-thin margins of drop-shippers. It was still worth the effort for a small company to spin up Wordpress sites to hold on to that extra 1%.

Shopify eventually remedied this by switching to a flat monthly rate. It set a ceiling for high-volume sellers, but a floor, too. It ensured that every seller was taking their business seriously, having them put some skin in the game. The ultimate outcome was more sustainable growth and revenue for Shopify.

Let's look at WeWork through the same lens. WeWork is attractive to companies that, deep down, know they aren't going to grow. What does WeWork have that other commercial real estate doesn't? Short-term leases. The kinds of companies that can only sign a month-to-month or one-year lease are companies that are not at all confident in their future. These businesses minimize long-term exposure by paying (much) more in the short-term, up to 50%, just so they aren't liable for four more years of rent when they go bankrupt.

A founder could deliver the most incredible pitch in the world, but if they end it with "and if it doesn't work out, I can just go back to my day job in the corporate world," you know it's already doomed. That's a WeWork lease in a nutshell.

That's not a great membership to build a commercial real estate empire on. When was the last time we saw an industry built on the backs of unqualified borrowers? Oh right. The sub-prime mortgage crisis.

The companies that are confident that they will grow have no problem signing 5-year leases. It's the prudent thing to do long-term, and it's dramatically cheaper. The ultimate outcome is more sustainable growth and revenue for commercial real estate.

P.S. RE: the coming wave of the remote workforce, that just means more home offices, not more WeWork leases. Commercial real estate will feel it, though.