By E.B. Tucker, senior analyst, Casey Research
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I had never heard of the “room hustle” until I met Delonta (pronounced “Dee-lon-tay”) in June 2011. Three years later, it’s a phrase I was happy to forget.
I had just posted a sign in front of my largest rental house – “7-bed 4-bath available NOW!”
Delonta called me within minutes. He told me he was on the way with a cash deposit.
Delonta had a plan. He wanted to start a business. It was well thought out. He’d rent the house, pay all the bills, and rent the additional rooms to friends. He said he had enough people interested and could move in right away.
I told him it was a residential house, not a boarding house. I’d rent it to him personally. What he did from there was between him and the rules of the county.
Delonta’s plan worked. Every month, on time, he brought me a big envelope of cash.
At first, it was tough. He continued to work the day shift at a car battery recycling company east of town. He hated it. He had bigger plans.
Room Hustling 101
Month by month, I could see his confidence building. After two years, he asked me to come to him to pick up the rent. It was unusual, but he wanted me to see his new office.
To my surprise, his business was booming. Delonta now had half a dozen houses rented. Each one had a regular lease with the owner. Renting out the rooms individually roughly doubled what he paid landlords like me. The spread was his to keep.
He told me the room hustle was his path from “Rags, to Rooms, to Riches.” He wanted to share it with people. He made a website and a DVD about his system. He also posted a YouTube video about it.
His inspirational website no longer works. Luckily, I saved a screenshot memorializing his effort:
But things turned south for Delonta in 2014.
That’s when a friend emailed me a link to a local news story. He said, “Isn’t this one of your properties?”
Uh oh.
Delonta had fallen behind on servicing his growing empire. He started living large. Meanwhile, sinks backed up, bulbs went out, and some people stopped paying. Evidently, this went on for a while.
One day, he allegedly tossed two tenants from my house by moving their furniture to the yard. They moved back into the living room, hanging a sheet from the ceiling to form makeshift rooms. Delonta apparently flipped out and cut off the power to teach everyone a lesson.
With a news crew on site and an active tenant mutiny, Delonta abandoned ship. My lawyer had to prepare a special eviction to remove seven tenants. We didn’t even have their names to give the judge.
It all worked out in the end. But I learned the room hustle is a tough business.
A Much Larger Room Hustle
At almost the exact time Delonta first tried to rent my seven-bedroom property, there was another man starting up his own room hustle.
Adam Neumann had the same idea. He’d rent office space and sublease it to individuals.
Today, the company WeWork owes landlords billions in rental commitments it may never fulfill. It could go down in history as the blow that sunk the entire commercial real estate market.
Between 2010-2019, Neumann’s WeWork leased 425 offices in 36 countries, according to a May 2019 Bloomberg Businessweek article. It’s fair to say the company was Neumann’s, because he maintained majority voting control over its shares. He also played the role of larger-than-life front man.
I recognized the room hustle the second I read that article. Neumann took a page from Delonta’s playbook. He kept the focus off of the financial numbers. Instead, he talked constantly about big, dreamy ideas.
During an interview with Bloomberg, Neumann said that everyone has a superpower, and that his was the power of change. He then stopped the interview to announce he’d “broken his fast,” meaning he would now eat breakfast. An assistant brought him a bowl of “amazingly interesting” oatmeal from an artisanal grower.
This is the kind of behavior that only works at the top of a market cycle.
In this case, it screamed bubble.
WeWork is a private company. That means there’s no stock to track. However, the company did issue $702 million worth of bonds at the height of debt market excesses in April 2018. Neumann himself picked 702, telling bankers it was his lucky number.
Today, those bonds sell for $0.40 on the dollar. At that price, they yield 33%. They may fall further.
Thirty-three percent isn’t enough to compensate bondholders for WeWork risk. The company doesn’t own much. The room hustle is an asset-light business. That means it doesn’t have many physical assets. It leases something, which is a liability, and aims to re-lease it to other people at a higher price.
Every Bubble Needs Someone to Blow It Up
The key to WeWork’s sky-high valuation was a Japanese billionaire named Masayoshi Son.
Son has a history of blowing bubbles. Twenty years ago, his investment company poured money into tech stocks right at the top of the market. Son told Bloomberg’s David Rubinstein that for three days at the very top of the tech bubble, his fortune grew by $10 billion per day. For a short time, his net worth was higher than Bill Gates’.
That didn’t last. Son got in too late and didn’t get out. His firm’s share price fell 99%.
But Son clawed back. He made an early investment in Chinese ecommerce company Alibaba. Back on his feet, he picked up where he left off, speculating at the top of the previous tech bubble.
He plowed money into private venture capital deals. WeWork was one of them. Neumann conveyed the impression of a tech giant. But remember, the room hustle isn’t innovative. There’s nothing tech-savvy about it.
WeWork torched cash. And Neumann continued to distract by doing outrageous things – according to Business Insider, he even tried to trademark the word “we,” and charged his own company $5.9 million to use it.
Obviously, there’s a limit to how far this type of circus can go.
$47 billion was the limit.
Losing Over $21 Million per Day
In the fourth quarter of 2019, WeWork lost $1.9 billion. Its attempted IPO failed.
Dangerously short on other people’s money, Neumann agreed to step down. Masayoshi Son, effectively on the hook for the business, agreed to pay Neumann a $185 million consulting fee, buy nearly $1 billion worth of his stock, and extend a loan worth $500 million.
As of the end of last year, Son plowed a total of roughly $18.5 billion into WeWork under Neumann’s control. He made his peak investment at a $47 billion valuation. Late last year, he revalued it at $7-8 billion. That might not be low enough.
WeWork was in a tailspin before the virus scare. With its valuation plunging, SoftBank, a Japanese firm, began laying off many of the thousands of Neumann loyalists operating the business. It shuttered some of Neumann’s side projects like WeGrow, an elementary school, and WeLive, a communal housing concept.
Son walked away from the final piece of the Neumann exit deal, failing to buy $970 million of his stock. That was in the middle of a two-month period when WeWork’s offices sat mostly vacant.
WeWork is a zero. That means its equity value is something close to $0, or at least a lot less than $47 billion.
WeWork is one of the largest leaseholders in the world today. It’s on the hook for something on the order of $47 billion in lease payments. It’s the largest leaseholder in Manhattan. If it can’t fill up those offices with independent working people who need space, all it has is $47 billion of liabilities and $0 of assets.
Delonta had it right. The room hustle is the fast track from rags to riches. The problem is, it’s a business built on nothing.
As for me, I’ll be watching how the WeWork story plays out. It will likely rock the commercial real estate market, sending valuations much lower. My thinking here is that as WeWork re-negotiates lower rents or moves out entirely, building owners won’t find comparable tenants. They might not find any tenants if the world stays in shutdown mode.
If that happens, there will be defaults. Building owners have mortgages. There’s a trickle-up effect here.
It may create the buying opportunity of a lifetime, like the one we saw in residential housing a decade ago. If so, I’ll be ready.
Regards,
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E.B. Tucker
Senior Analyst, Casey Research