WeWork's CEO says the way it rents out office space makes companies' financials look better. Some experts aren't sure how legitimate the pitch is.
- In a recent Business Insider interview, WeWork's co-president and founder Adam Neumann said that an accounting change will make WeWork a more desirable place for potential customers to move to.
- But accountants and commercial real estate executives aren't sure that Neumann's pitch will actually stand up to these guidelines. Instead, they said companies are more likely to switch to WeWork for culture, flexibility, and cost savings, not the accounting advantage.
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Part of WeWork's recent pitch to prospective tenants is that it's more than just a great office - also great for their finances.
The company, which has nearly 500 offices worldwide, has been moving beyond its start as a coworking space provider. Managing space for big companies like IBM now accounts for 40% of its business - and its copresident and founder told Business Insider this spring that WeWork is "just getting started" with these kinds of tenants.
Some of the appeal comes from WeWork's image as a millennial-friendly office manager, with space that's more fun, flexible, and cheaper than cubicle farms.
WeWork executives have also been touting a more esoteric benefit.
Cofounder Adam Neumann told Business Insider earlier this spring that because WeWork records its office space agreements as memberships, rather than as leases, companies can tuck their WeWork spend into income statements.
See more: WeWork's CEO says his $47 billion company is recession-proof. Industry watchers aren't convinced.
"I'm not a new balance sheet. As of 2020, all leases need to be on a balance sheet. I'm a membership agreement and I'm off your balance sheet. That's very attractive," Neumann said. In a separate interview with Business Insider earlier this spring, copresident and chief financial officer Artie Minson also mentioned the benefit.
Their remarks come as WeWork prepares for an IPO later this year.
New accounting rules
Under revamped US accounting standards that took effect in January for public companies and come next year for private companies, leases that were previously buried in the footnotes of financial statements now need to be recorded as a balance sheet liability.
There's no economic difference between the new and old accounting standards, but liabilities make a company look more indebted, which can raise concerns among investors, creditors, and analysts. Previously, only the real estate that a company owned needed to be on a balance sheet, while leases for rentals were recorded as expenses on an income statement.
That could be a significant change to companies' balance sheets, depending on their current and future leasing costs, which WeWork executives said could be a boon for the office operator. WeWork's argument is that if companies end their leases and take space with WeWork, they could move the real estate costs off balance sheet.
But accounting standards groups have anticipated companies looking for ways to circumvent the new rules, accountants said. Restrictions on what does and doesn't count as a lease may not mean WeWork sees a huge uptick in customers despite Neumann's pitch, said commercial real estate executives, who haven't seen much change in leasing behavior because of the new rules.
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And leases over a year - or even memberships that are likely to be renewed after a year - don't count under this new rule. In WeWork's financial presentations, which Business Insider has reviewed, the company doesn't disclose the average length of its agreements or the typical range, so it's unclear how many of WeWork's 466,000 members would be affected by the new accounting standards.
The membership-balance sheet argument isn't the company's only accounting quirk. Last year, WeWork created a unique metric called community-adjusted EBITDA, defining it as "equal to membership and services revenue, less adjusted rent, tenancy costs, and adjusted building and operating expenses." Onlookers have been skeptical, with some even drawing parallels to the frenzied days of the dot-com bubble, Business Insider reported last month.
A spokesman for WeWork declined to comment.
What is a lease?
WeWork's arrangement in calling its agreements something other than leases isn't new, according to real estate executives with decades of experience in the flexible office space.
"Accounting standards were not what they are today, but the type of agreement this has always been is a service agreement, like a cellphone or licensing agreement. It was never written as a lease or sublease," said Melanie Gladwell, the Americas head of flexible working solutions for real estate services firm Cushman & Wakefield.
What is new is how how auditors could ultimately treat the membership agreement under the revised standards, accountants said.
The new accounting standards set up a number of ways to determine if a contract is a true lease. Depending on how an auditor thinks about a WeWork membership under these categories, that may determine whether WeWork's - and other flexible office providers' - agreements are counted as leases.
Accountants told Business Insider that considerations include:
- Length: any lease over a year is counted as a balance sheet liability, not an expense.
- Specific space and flexibility: some flexible space providers may switch up a tenant's office as they rework office plans. In that case, tenants' agreements would not be considered leases, since their space can be moved around. But auditors will likely consider the companies that have one or more siloed floors managed by a provider as a separate category, one that qualifies as a true lease.
- Likelihood of renewal: if a company has a five-year lease with a three-year renewal option, the previous accounting standards would count a five-year lease term. But under the new standards, if there's a high likelihood - PwC says 75% or more chance - that the five-year lease will be renewed, it counts as an eight-year lease. Tenants with leases under a year, which would otherwise skirt the new lease accounting rules, may need to reconsider their accounting if they're likely to stay in the space. If they'd probably renew after the year, their arrangement may be considered long-term.
Those considerations would typically exclude co-working arrangements from being considered a lease, but perhaps not a flexible office company's agreements with bigger tenants, said Jeff Beatty, the senior managing director of CBRE's financial consulting group.
"Just because a document doesn't say 'lease' doesn't mean it's not a lease. Just because an agile provider says it's a licensing or membership agreement doesn't mean it's not a lease," he said.
"If you have a company that wants to use some coworking or agile space for 100 employees, it's hard to imagine they won't have a specific space, i.e. floor 10, so you have a specified space, and you're typically not going to do that for a one-year term," Beatty said. "At a broad level when you start talking about enterprise agreements, I think they're more likely than not to be potentially a lease and therefore recorded on your balance sheet."
Cushman & Wakefield's Gladwell, however, said the flexible office providers structure their memberships as service agreements ranging from three months to three years. Because the operator has the lease from the building's landlord, even under the new accounting rules, she said the memberships they sell are still considered service agreements, not leases, for their customers.
Whether or not the company says the membership is a lease, customers would do well to scrutinize the new rules, accountants cautioned. Scott Lehman, a partner at accounting firm Crowe, said that whenever standards change, some companies try to create new categories to circumvent the rules.
"If you think about a public company like IBM, at the end of the day, they're responsible for their accounting," he said. "It's not [a landlord's] responsibility to tell tenants how to apply accounting principles."
'They'll deal with the accounting'
Industry observers are mixed on if the accounting change is driving more interest to WeWork and its peers.
The CEO of one of the biggest managed office companies said he has seen an increase in customers seeking out flexible service providers because of the accounting changes - but not for the specific reason Neumann articulated. The membership structure itself isn't what helps companies bypass the new standards; rather, it's because leases are under a year, the executive said.
See also: A top WeWork executive explains why the company doesn't have the same issues as Airbnb and Uber
Steve Kahn, an audit partner at Anchin, Block & Anchin, said the accounting rules have come up just in passing conversations.
"People are making business decisions based on the economics, if a deal makes sense or not. They'll deal with the accounting," he said.
CBRE's Beatty said public companies' experience in the first quarter is a good barometer. Wall Street analysts already anticipated the accounting change, factoring the balance sheets with added liabilities into their models so there were no surprises.
"To say it's driving people toward coworking agreements - we haven't seen that happen," Beatty said.
Cushman & Wakefield's Gladwell said the accounting standard change is driving some demand to flexible workplace providers, "but it's not the primary reason."
"I've been working with the Fortune 100s of the world, and what I see driving the shift to the flexible workplace model is technology advancement and companies' need to win the war for talent in providing these environments that also offer access to hospitality and workplace and wellness amenities," she said.
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