Real Estate Venture Capital: The New Operating Model?

Direct investment in technology is reshaping the property industry and redefining the role of real estate developers

In part 1 and part 2 of this series, we examined how the traditional private equity fund model is undermined by technology and how fund managers are responding to this challenge.

In this part, we will look at the growing impact of venture capital investment on the real estate industry, how it impacts the structure of the industry, and what it tells us about being a real estate company in the 21st Century.

Real Big, Real Vulnerable

The world’s residential and commercial real estate is worth worth around $200 trillion. Real estate is, by far, the world largest asset class. But when it comes to real estate development, the industry is extremely fragmented, does not develop “products” per se, spends close to nothing on R&D, and its customer focus usually boils down to “one size fits most”.

A typical commercial real estate project is built on land owned by one party, in partnership with a another, with equity capital from a third, debt from a fourth, architectural design from a fifth, actual construction work by a sixth, and is then leased or sold by a seventh, and operated by an eight. In between, dozen of other parties contribute to the development process. This makes real estate the most “imperfect asset class”, with high transaction fees and severe information asymmetries. It also means real estate developers are at a disadvantage responding to changes driven by technology.

The impact of innovation on the automotive industry offers an interesting comparison: Traditional car companies need to catch-up to a completely new product (electric and autonomous) and adjust to completely new business models (mobility as-a-service). The good news is that traditional car companies are technology companies to begin with, albeit hardware, not software-focused. They produce products with specific consumers in mind, in a relatively concentrated market. Hence, it is possible to imagine Toyota will still be with us in 50 years.

But, facing a disruption that redefines how physical space is valued, developed, and used, what chance do traditional real estate developers and operators have?

Real Money, Real Fast

So far, the prototypes for the real estate company of the future are being developed on the outskirts of the industry: Startups such as WeWork and Common are combining hardware and software to address the needs of specific customers; and private equity firms such as Blackstone are consolidating large portfolios and deepening their development and operational capabilities to create efficiencies that smaller real estate companies won’t be able to compete with.

The world’s largest real estate developers are rising to this challenge by making direct investments into technology companies, by developing new capabilities and in-house software platforms, and by setting up or backing venture capital funds that are focused specifically on the industry’s needs.

  • Examples of direct investment include the Durst Organization, one of the NYC largest operators of office space, invested in Convene, an operator of flexible meeting and office space; K11, one of Asia’s most innovative shopping mall developers, invested in ObEN, an Artificial Intelligence startup seeking to create new experiences for consumers; LeFrak, another NYC-based real estate giant invested in coliving startup Common, in an effort to reinvent rental housing for young urbanites; and the Rudin family invested in companies such Enertiv, Latch, Honest Buildings, and Hightower, with technologies that affect how buildings are operated, accessed, and leased.
  • Development of proprietary tools includes Tishman Speyer’s introduction of Zo, a software platform that provides a new experience and service offering to people working within the companies buildings; Stonehenge’s homemade consumer app and portal that allows residents to access services, interact with the local community, and submit maintenance requests; and Westfield’s development of OneMarket, a layer of services and capabilities that empowers retailers to digitize their sales and fulfillment process. Note that Westfield’s owners are now in the process of selling their retail portfolio but are planning to keep the digital layer.
  • New venture capital funds include CapitaLand’s C31 Ventures, which so far invested in retail-related startups that impact the company’s shopping mall business; Silverstein’s Silvertech Ventures; and Milstein’s Circle Ventures and involvement with Grand Central Tech; and real estate-focused funds such as Tamarisc, Corigin, and Camber Creek that were set up by individuals or families with significant investments in real estate. Apart from acquiring new capabilities, Silverstein and Milstein, for example, also use VC investments to incubate smaller tenants who can later expand and take larger office spaces in their buildings.

In addition, real estate companies or family offices have backed third-party venture funds such Fifth Wall, MetaProp, and Pi Labs. Backers includes giants like Hines, Equity Office, Lennar, Macerich. Meanwhile, traditional venture funds such as A16Z, Khosla, and Softbank’s Opportunity Fund are also increasingly active in the space, with investments in companies such as Opendoor, Cadre, Point, Compass, and WeWork. Entrepreneurs and investors are expecting these type of investments to increase in coming years.

Full service real estate companies are also investing in technology to maintain their edge. Last year, CBRE acquired Floored, and invested in startups such as Matterport, LiquidSpace, and Comfy. Jones Lang LaSalle, for its part, invested in Zipgrid and joined forces with Seedcamp and Starwood Capital to launch Concrete, a venture capital fund focused on innovations that impact the real estate industry.

Real Soon…

Some of these initiatives will prove to be bad investments. But those that succeed will define what it means to be a real estate company in the 21st Century. What is clear is that “building and filling boxes” is no longer a viable model and that successful real estate companies will have to combine the development of quality assets with a firm grasp of technology and some proprietary tools and a solid understanding of their end-users’ specific needs.

Venture funds are not just facilitating the flow of new technology and capabilities into the industry. In some cases, money invested by these funds is used to finance real estate inventory — as equity for new developments or as a downpayment on long-term leases. This seems perplexing as venture money is “expensive”, expecting higher returns than money traditionally allocated to real estate. But new business models and the promise of becoming a key player in a multi-trillion dollar industry are pushing investors to keep an open mind.

In Part 4 of this series, to be published next month, we will look at how traditional institutional investors —the pension and insurance funds that serve as Limited Partners in many real estate funds — are aligning themselves to make the most of the structural changes in the industry and the changing risk profile of real estate as an asset class.

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Dror Poleg works with private equity funds, institutional investors, and real estate companies to capitalize on long-term economic and technological trends.