In a time when investing in real estate is as hard as it’s been in a long time, it’s easy to forget how powerful real estate can be for building wealth. No better example can be given than comparing WeWork’s legendary collapse in 2019 with McDonald’s incredible rise to become a mainstay of American corporate giants (although it’s probably wise to avoid eating there more than once in a great while to avoid a WeWork-like collapse in your general health).
The WeWork Disaster
WeWork was a good, albeit simple idea: Create a high-end, co-working space for startups and entrepreneurs. While a solid concept, it’s hard to see how this was much better than Regus, a long-established (albeit less modern and chic) co-working space company.
Yet somehow, WeWork was able to finagle its way into being valued at $47 billion in 2019. After one of the most disastrous IPOs in corporate history, the company lost 99% of its value in four years and is now worth a mere $503 million. Somehow, though, it is still limping along with a new CEO and modest goals.
But back to the collapse. A lot of things happened to make WeWork a word that commonly appears in sentences with the likes of business failures like Pets.com and Theranos.
For one, the company grew way too fast. WeWork was founded in 2010, and by 2019, it had grown to 590,000 members in 111 cities. In 2017, it was barely over 150,000. The number of locations went from 275 in 2017 to 850 in 2019!
In 2013, WeWork added 231,682 sq. ft. of space. In 2018, it added 4,441,954. And in 2019, it added 7,704,684 sq. ft.
This kind of exponential growth is a rather unwise strategy.
Regardless of the wisdom (or lack thereof) behind the decision to base its business plan on how a cancerous cell functions, WeWork was only able to grow so fast after Masayoshi Son’s Softbank invested a whopping $4.4 billion in the fledgling startup. According to then-WeWork CEO Adam Neumann, “When Masa chose to invest in me for the first time, he only met me for 28 minutes.”
(On a side note, if you happen to have $4.4 billion sitting around, take at least half an hour to vet any potential investment).
Masayoshi Son would live to regret this decision.
Had he done a bit more research, he would have learned that Adam Neumann and his wife Rebekah ran the company almost like a cult. Indeed, the stories were so strange that a book on WeWork was titled The Cult of We.
From throwing wild, mandatory, alcohol-drenched, and drug-laden employee retreats to having a live tiger roam one of their mansions, WeWork was not your typical company, to say the least. It was really more of a for-profit cult.
As an offshoot, the company created apartments called WeLive (rented almost exclusively by WeWork employees) and WeGrow schools (whose students were almost exclusively WeWork employees).
The staff lived, worked, and breathed WeWork. Slowly but surely, many of them would only hang out with other WeWork staff. In the documentary WeWork: Or the Making and Breaking of a $47 Billion Unicorn, one former employee notes that if you ever had friends from outside WeLive visit, “they came over once and never returned.”
Given this cult-like vibe, it shouldn’t be surprising that Rebekah Neumann was into all sorts of spiritual mumbo jumbo that she tried to pass on to the staff.
Adam Neumann’s eccentric style and mad rush for growth cost a fortune and was bleeding cash. WeWork had a net operating loss of $933 million in 2017, which skyrocketed to $3.78 billion in 2019 when WeWork desperately needed money. When SoftBank turned them down, they decided to launch one of the most catastrophic (and hilarious) IPOs in corporate history.
The IPO all but admitted the company had no corporate governance structure whatsoever and made the most rosy and unrealistic predictions imaginable. But more ridiculously, the IPO acknowledged the company had made multiple loans at the somewhat generous rate of 1% to CEO Adam Neumann and, best of all, that Neumann would also be charging $5.9 million to WeWork to use the “We” trademark.
In spite of this obscene self-dealing, the IPO was also full of language that might as well have come from some college sophomore’s bad attempt at poetry:
“If you take the ‘me’ and you flip it, and you get the ‘we,’ you understand that we’re about to change the way people work, and the way people live, but more importantly, change the world.”
As one business columnist sarcastically retorted: “For God’s sake, you’re renting f—ing desks.”
The IPO fell flat, and WeWork’s stock collapsed by over 99%.
There are a lot of lessons for entrepreneurs in WeWork’s collapse: don’t grow too fast, build systems, drop the cultist nonsense, don’t let employee retreats become degenerate brothels, stay above board, and avoid self-dealing.
But there is another lesson that is rarely discussed: It’s much better to own than to rent.
WeWork was so obsessed with expanding that it went with the cheaper option of renting on virtually all of its properties. Furthermore, the average lease they signed was 15 years. This created an enormous recession risk because WeWork’s rent payments were fixed. But during recessions, they would lose many of their tenants, causing their income to plummet.
Plummeting income means access to credit would dry up. And since they didn’t own the real estate, they couldn’t tap into any equity because they didn’t have any.
In hindsight, it’s absolutely incredible that WeWork was valued at $47 billion, whereas Regus, which operates under the IWG name, is only at $1.6 billion. (I should note that many of Regus’ entities went bankrupt in 2020, primarily due to Covid, although the company has since recovered).
WeWork had 850 locations and was hemorrhaging money, whereas Regus had over 3,000 and was (at the time) making money. Furthermore, Regus owns many of its buildings, whereas WeWork rented (sometimes from Adam Neumann himself, in another conflict of interest the IPO brought to light).
Somehow, Wall Street viewed WeWork as a technology company, not a real estate company, which allowed its meager earnings to be inflated into Facebook-like potential by many analysts. But in the end, it went up in smoke.
In the meantime, Regus continued along and, despite the struggles of the pandemic era, is back on its feet (in large part thanks to its real estate equity) and is expected to break even in 2023.
McDonald’s is a Real Estate Company, Not a Burger Company
An even better example than Regus when it comes to the power of real estate is McDonald’s. While WeWork was a real estate company (that exclusively rented) confused for a technology company. McDonald’s was a real estate company whose founders originally confused it for a burger company.
In 1954, Ray Kroc convinced Richard and Maurice McDonald to franchise their successful San Bernardino McDonald’s restaurant. Ray Kroc began finding franchisees to start up new locations but was constantly hamstrung with cash flow issues. As Inc.com notes:
“In 1956, Ray Kroc was a couple years into a business agreement with the McDonald brothers. He had opened his first franchise in Illinois. He had added a few more. But he struggled to bring in enough revenue to make a reasonable profit, much less generate funds for further expansion. Nor could he attract franchisees with sufficient capital to purchase their own land and build their own stores.
He faced the classic entrepreneurial dilemma: Rapid growth was needed to grow revenue per fixed costs and overcome tiny operating margins. But he had no money to fuel that growth.”
This problem was resolved when Harry Sonneborn approached Ray Kroc to explain that his entire approach to McDonald’s was wrong. A scene from The Founder depicts a (simplified) version of what happened.
Harry Sonneborn starts off by saying:
“To summarize, you have a minuscule revenue stream, no cash reserves, and an albatross of a contract that requires you to go through a slow approval process to enact changes if they’re approved, which they never are.”
He then asks Ray Kroc how their process worked up until that point. Kroc responds:
“Franchisee finds a piece of land he likes. Gets a lease, usually 20 years. Takes out a construction loan, throws up a building, and off he goes.”
Then Kroc asks, “Is there a problem?” To which Sonneborn replies, “A big one.” And then, the most important line of the movie,
“You don’t seem to realize what business you’re in. You’re not in the burger business. You’re in the real estate business.”
“You don’t build an empire off a 1.4% cut of a 15-cent hamburger. You build it by owning the land upon which that burger is cooked. What you ought to be doing is buying up plots of land, then turning around and leasing said plots to franchisees, who, as a condition of their deal, should be permitted to lease from you and you alone.
This will provide you with two things. One, a steady, upfront revenue stream. Money flows in before the first stake is in the ground. Two, greater capital for expansion. Which in turn fuels further land acquisition, which in turn fuels further expansion, and so on and so on. Land. That’s where the money is.”
After this fictionalized account of a real conversation happened, Ray Kroc eventually brought Harry Sonneborn on board in 1959 to serve as McDonald’s first CEO. In 1957, they set up Franchise Realty Corp. to help finance new franchisees, which almost immediately solved Kroc’s cash flow issues and allowed McDonald’s to expand rapidly.
(As an aside, this is one of the major factors that ended up leading to Kroc’s break with the McDonald’s brothers and subsequently buying them out in a wildly one-sided deal.)
As of the second quarter of 2023, McDonald’s owns a whopping more than 40,000 properties in over 100 countries, which represents $28.4 billion in real estate. They pay a 4% to 5% franchise fee. In addition, 85% of McDonald’s restaurants are franchise-run locations.
As real estate investors also know, depreciation is a huge advantage to owning real estate. McDonald’s reported over $1.7 billion in depreciation in 2022. Although, as QZ again notes, “it’s unclear what portion of that was depreciation of real estate rented to franchisees.”
As of this writing, McDonald’s has a market cap of $186.7 billion, which makes it the 50th-largest company in the world and the largest restaurant chain.
Or, perhaps more aptly put, McDonald’s has become the largest real estate company in the world.
The Simple Lesson for Real Estate Investors
There are a lot of things that went into both McDonald’s success and WeWork’s spectacular failure. But the long-term power of owning real estate is a major one that should not be overlooked.
In a time when real estate investing is extraordinarily challenging, it’s important to remember that despite the current market, in the long run, the benefits of owning real estate make it the place to be.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.