How venture capital is changing real estate

Even venture capital funds are not immune from competition with new trends in funding – and new players - changing the dynamics of proptech and its capital, the INMAN Connect conference in Las Vegas heard.

Speaking at Capital Connect, Patricia Nakache, general partner in Trinity Ventures – one of the first VCs to invest in real estate technology – and Dave Eisenberg, CEO of Zigg Capital identified key issues across their industry that are having an impact on the size, scale and speed fueling real estate innovation. This has taken control of the changes out of the hands of the traditional real estate industry.

Here’s an overview:

Real estate needs to understand venture capital

“The fundamental principal behind venture capital is that we are investing to buy equity in a business – usually 20% ownership – so we’re part owners,” said Patricia. “There’s no interest or due date on the capital we put in. We get liquidity through a sale or an IPO and we are looking for outsized returns.”

VCs look usually to 10 x their investment so the focus is not on profitability – as in a traditional business owner – but in growth. This leads to funds investing in multiple businesses to spread their risk.

“There is a big mismatch between how the industry has been valued – a multiple of the net profit of the business - compared to the technology companies which are valued on how big they will be,” said Dave. “Not many acquisitions are operating with a level of financial maturity that make it comprehensible to a traditional company.”

With 90 to 95% of investments failing, it’s an investment strategy that is not for the faint-hearted.

“We have infant mortality. Not all our investments are going to achieve return on capital,” said Patricia.

But this approach has led to new “unit economics” of analysing the value of a business for investment potential by its customer acquisition together with its ability to deliver a positive gross margin.

“You’re never sure how many will work but there is a lot of appetite for risk capital,” said Dave. “But the stock market and bonds are not returning good yields so more money is going into it.”

Real estate is now a technology industry

“What’s happened broadly is that every industry is becoming if not entirely then partially a technology industry because software is eating the world,” said Dave.

“Agriculture companies, education, financial – everyone needs technology to deliver long term value to their shareholders. If you look at the fintech ecosystem, this has played out. Now real estate is starting to do this with well capitalised, fast-moving good operators forcing older parts of the real estate industry to do the same.”

One of the drivers is the fact that technology companies themselves – now operating for 20 or more years – have become factories of technology talent, many of whom are looking for new challenges in new industries.

“The quality of talent inside mega tech companies is amazingly good,” said Dave. “And there are entrepreneurs who are these bundles of energy looking to be deployed somewhere and looking for categories to play in.”

Real estate and health care are the two places where mega technology players are not currently active, Dave said. Health is a difficult industry to learn and has high consequences should things go wrong. Real estate is slightly more forgiving.

“Real estate is part of the wealth of most Americans and it’s easier for technologists to learn to real estate than it is for real estate people to learn technology.”

Deal sizes are getting bigger

Venture capital investment last year was $135b according to Patricia, compared to the prior four years where it had been in the $70b to $80b range.

But in 2018, the number of deals that were done with this larger pile of investment money was flat and this has significant implications for the real estate industry.

“Round sizes are just getting bigger with $25m or above rounds becoming even bigger,” explained Patricia.

“It means the growth of these companies is being massively accelerated by an infusion of capital at a scale and stage that hasn’t been seen before. Big cheques are coming in earlier and earlier and there is more opportunity to stay private longer.”

Private balance sheets are important as it allows innovators to continue innovating without being responsible to the stock market every quarter, allowing new businesses to become more stable and established.

The chances therefore of the traditional industry being able to ignore innovation on the basis that it’s a flash in the pan that will die before it takes off because of unrealistic market pressure are diminished.

Real estate is investing in itself

In addition to traditional venture capital firms now establishing funds to specialise in proptech, both Patricia and Dave commented on the emergence of sector specific funds.

These funds are combining their knowledge of the industry with their existing client bases to accelerate the growth of the proptechs they invest in. Their involvement means industry identified problems are starting to receive funding for solutions.

“There’s a bunch of funds in the proptech ecosystem have said part of the value I can drive is that I can place you with my limited funds,” said Dave. “If you can buy into a business for two to three times earnings and roll it into a business that is earning ten times earnings that’s a phenomenal value.”

“The battle for the future of brokerages is where a lot of the action is happening,” said Patricia. “We’ve evolved from one size fits all, to much more tailored solutions that meet different customer segment needs from iBuyer through to full service.”

A lot of investment activity is occurring around new brokerage or franchise models, property management, housing affordability, tenant experiences, short term rentals and smart buildings.

“None of this innovation is going away – it’s just going to escalate as more capital comes into the space,” said Dave.

How can traditional real estate agents engage?

“Just be a customer of the technology company,” said Dave. “For every tech company that’s trying to disrupt you, there’s another tech company trying to help you beat the disruptor.”

Industry suspicion and tech fatigue are greater enemies of traditional real estate agents than the innovators, he said.

“Most innovators are trying to sell to the industry rather than compete. But if you don’t engage, they will just move to be a competitor of the industry.”

“I would be more scared of the ones that are trying to compete head on, than those trying to work with us. Look at these innovators as providing ways to help you plan the future of your business.”

NOTE: I've recently been sent this great resource which is a report on The State of the Venture Capital Industry from Alex Graham with a pile of statitstics and figures on how VC is faring. It's worth checking out