April 19, 2021
This week’s Future of Fintech is on the future of proptech, including what it takes to get VCs interested in proptech businesses, changing regulations, and more.
Guests for this week include:
This interview has been lightly edited for length and clarity.
Proptech classes to pay attention to
If Series A venture capital is more accessible to proptechs
How to raise funds for proptech startups
ADENA (Divvy): When COVID hit, everyone had PTSD from 2009’s global financial crisis and thought, "The economy is volatile, home prices are going to drop." That didn't happen. Supply decreased because rates were lowered. Most people refinanced their homes, weren't selling their properties, and didn't want to move out. Demand then increased because everyone who thought about buying a house within the next two years said, "I want to buy a house with a backyard because I can't live in my studio apartment without an office.”
Houses became more challenging to get, not easier. Mortgage underwriting tightened quite a bit. People looked for alternative ways to finance and purchase a home.
BREW (PeerStreet): The amount of changes in the market from the last 12 months alone is bananas. We went through three decades of crazy swings in a short amount of time.
JON (Starcity): I have a different perspective here, being someone who's building urban housing, at scale, in the middle of a pandemic. If you had a small inkling that you wanted to eventually move to the suburbs, the pandemic accelerated that. If you were not happy with your job, you probably decided to make bread in Montana. The pandemic accelerated these desires that people had, whether to move to the suburbs or work remotely in rural America.
Some of my friends who are in proptech have done extraordinarily well. Those who are in the short-term rental space, or coworking, or co-living, experienced a lot of pain.
Now things are significantly different, at least from the early data. People are moving back to cities and demand is picking back up. It's also going to be a boon for the industry because people are consuming physical real estate in different ways. There are going to be huge opportunities for new startups. If you look at the direction of fintech, proptech is just 5 or 10 years behind that.
ADENA (Divvy): Single-family home units have taken off. Both iBuyer and Divvy's rent-to-own have done well as there's this rush to have more space. The house went from being a place where you slept at night to being your office, childcare center, and everything else. There was this mass rush from multifamily to single-family. Rents in multifamily fell, occupancy decreased, and single-family rents and occupancy increased.
JON (Starcity): Construction technology is an area that I'm fascinated with, whether it comes to drywall robots, modular construction, or prefabricated units. That could be a huge societal shift. The application to single-family rentals is huge. It's really difficult to do this for vertical sites. One of our engineers came from SpaceX and was like, "It's more difficult to create affordable high-rise modular housing than it is to create a rocket." A lot of companies are trying. We all have seen that graph of construction productivity being one of the only scaled manufacturing businesses that have lost productivity over the last century.
I also would love to see what the comeback of retail and office space is going to look like. There are many vacant storefronts in major cities. Are we going to go back to coffee shops and retail shops on every corner? Or are there other uses?
BREW (PeerStreet): 15 years ago, people didn't think that SaaS companies could be that big. Now there are multiple unicorns in SaaS. The same thing is happening in proptech. The property tech stack is being deconstructed into standalone services that make it easier to start new businesses. If I started PeerStreet today, I could plug in Mercury as a banking provider. I could plug in fraud, valuation, and data providers that didn't exist four or five years ago.
That is going to make it a lot easier to innovate on proptech. There's no more important market than real estate and property. It's the only asset class in the world that touches every man, woman, child.
BREW (PeerStreet): PeerStreet wants to create the Amazon of real estate finance: how do you connect buyers and sellers that invest in properties? How do you collect payments? How do you provide data, do financial operations, and manage treasury? The cost of distributing such a product is zero. Then you can turn all these cost centers into revenue centers, and distribute them out.
ADENA (Divvy): There could be those in the future, but not today. If you talk to any proptech founder, they feel like they're building a hundred companies. You're either plugging into 15 small providers to help you complete a real estate transaction or you end up building most of it internally. The experience isn't seamless when you're working with a bunch of small fintech players to provide these services.
JON (Starcity): Opendoor started first with Silicon Valley Bank, but eventually built out very large credit facilities with asset managers and private equity funds. It took a level of understanding and adoption from multiple capital providers to allow businesses to scale. CoStar, LoopNet, Zillow, and Redfin — startups of Web 1.0 — were simple web businesses. Then when Web 2.0 started, it was purely a marketplace. This next iteration showed that to scale physical, capital-intensive businesses there needed to be partnerships with private equity, capital markets, and venture capital.
JON (Starcity): Now that some really good exits have occurred, e.g. Opendoor, it's a lot more clear how to structure a proptech company. That's good for a Series A investor to now be able to say, "I know what the market looks like from here to exit and what we need to do to make that work." Whereas five years ago, that was not the case. ADENA (Divvy): You’d go into pitch meetings and no one would want to start a conversation about proptech because it's confusing, operationally intense, or because real assets are hard and challenging. But companies will figure this out and people are smart.
It's easy to look back and say, once they've gone public, "Oh, I wish I had done that." But it's the people who were there first. The two investors that have been supporting companies since the beginning have been Alex Rampell and Keith Rabois.
BREW (PeerStreet): The stories that still need to be told are, do you have an advantage in your acquisition? When I look at early-stage investments, five out of six investments that come across my plate are cool, but there's almost no way these businesses will scale. If it works, it's going to be huge because they completely rethought the whole process. The amount of aperture for investors to invest in potentially disruptive businesses has gone up. It's easier to raise. The harder part is the operationally intensive stuff. That's a harder thing to start in the early stage.
ADENA (Divvy): There are so many advantages to scaling. Starting a proptech company is one of the hardest things in the world: the amount of capital you need, the amount of technology you need to build out an end-to-end platform, and managing assets.
Turns out, things happen to houses. They can burn down. Once you get it functioning at scale, you attract a cheaper cost-of-capital. You can then lower your pricing and offer your product to more customers. It adds to success.
There's much more that you need to do when starting an asset-heavy business than a SaaS business. But once you get up to a certain size, you naturally have defensive modes against the new entrants coming in. That scale becomes a competitive advantage.
ADENA (Divvy): We have a business that is focused on cash flow. We get rental income. That is what I bet on. As long as that cash flow is enough to offset the cost of a home’s decline, we're in a good position.
If you look at the largest single-family rental companies, they were all started in 2012. Why? Because assets were cheap and home prices fell. But rent holds well.
What you don't want to do is buy a bunch of homes at the peak and not have any capital to buy homes when prices go down. We run an analysis of how much of a home-price-decline we could take on our current portfolio and still break even, given the amount of cash flow we get over the life of the asset.
That always ended up being somewhere around a 15 to 20% home price decline to still break even. Make sure you have the capital available to double down during that time. Buy low.
That's the nature of both the equity and real estate market. When home prices are low, rents tend to hold because there's a flight to rental. The yield that you end up getting, the return from the rent payments over how much you purchased the home for, ends up being a lot better during a recession.
JON (Starcity): First stop at high-net-worth individuals and family offices to establish credibility and a track record. From there, go to small private equity funds. From there, move to the main, opportunistic funds. That's Blackstone down to Warburg Pincus and TPG. From there, work your way down the cost of the capital value chain.
Starting first with high-net-worth and family offices is good because it'll allow you more leeway. Most of those folks are looking for wealth preservation and a story to tell their friends on the golf course.
ADENA (Divvy): Going to folks who have never invested in proptech is a strategy for spending a long time trying to get to the finish line and never actually being able to get there. Don't beat around the bush. When I get on the phone with people, I'm very upfront. Treat it the same way you would treat equity raises, which is to focus on people who are known to show up to the table and stand by their term sheets.
ADENA (Divvy): The cost of capital is not determined by how much equity capital you raise. It's determined by who you're getting the money from. Some people have lower return hurdles and you need to tap into those people. Those people only give you money when you've proven yourself and have a track record. There hasn't been an ADS deal, like a securitization, but that would ultimately be where the cheapest cost of capital would be in proptech.
BREW (PeerStreet): We did our first facility with a hedge credit fund. It was a 10% interest rate. And it was a $10 million facility. We were paying the full amount, whether we were using it or not, from day one. But now, as you get to scale and you get a track record, you can access different types of investors, with different return requirements.
The cost of capital has gone down significantly from there. We wouldn't have done that if we didn’t have three years of track record or an understanding of what the performance is. It's one of those things you have to build. The problem is, with proptech and investment-type businesses, you can't scale without quality. Because if you blow up your track record, you're going to be destroyed and won’t be able to access capital.
JON (Starcity): I thought I was going to design beautiful, co-living buildings with these communities of people hanging out together and enjoying conversations about art, politics, science, and music. That happens but I don't touch it. I haven't touched it for five years. Literally, all I ever do is raise money.
ADENA (Divvy): I love talking about interest rates and spreads and advances. Talk about a good time. This is it.
Want to hear more? Tune in to the podcast episode where we cover lots more.
The Mercury Team