Fifth Wall’s Brendan Wallace On What’s Next After Closing $866M Proptech Fund

A serial entrepreneur and investor, Wallace began his career at Goldman Sachs in the real estate, hospitality and gaming group, before joining Blackstone’s real estate private equity practice. He co-founded the L.A.-based Fifth Wall in 2016.

The interview has been edited for length and clarity.

PropTech Insider: Overall, what has closing this latest fund meant to you about where proptech is today?

Brendan Wallace: Our Fund III was kind of a marker punctuating this pretty dramatic effect of the growth that we’ve seen in the whole proptech ecosystem. What’s interesting is the extent to which over the course of five years the landscape has changed. The contours and nuance, the scope of what proptech means now is vast. As probably the first institutional fund in the space, I just find that incredibly exciting, and I think there’s so much more we can achieve in what we today call proptech.

Fund III is the biggest ever in proptech, far surpassing your previous funds. What made Fifth Wall go so big at this point, given the macroeconomic situation and other headwinds?

I’d say two things. One is the scale of capital inflows into proptech. When we started in 2016, I think about $4 billion went into what we today call proptech. Last year, over $30 billion went into the space, eight or nine times growth. So, on the one hand, more capital is flowing in, and as it flows in you’re seeing more heterogeneity in the sizes of businesses within proptech, alongside that you’re also seeing a maturity in the ecosystem. When we started, there wasn’t an opportunity to start a growth-stage investor in proptech; there just weren’t enough businesses in that universe to deploy capital into. Now what we’ve seen is that there’s a lot of businesses in proptech, some that are very mature in the private space, some that are even public and now have public equity currency, and some that are just getting started. 

In our model, where we work with strategic limited partners, what we’ve seen is a growing appetite for proptech in general, but I would say a growing tolerance for risks. Meaning there’s an interest from big strategic corporate LPs that invest in our funds to partner with companies at an earlier stage today than when we started. The implication is that Fifth Wall needs to be able to support the entire proptech ecosystem — not just mature companies, not just early-stage companies, but the whole continuum of proptech innovation.

Fifth Wall is expanding its focus to early-stage proptech startups with this fund. Is that driven by your LPs or other factors?

It’s not solely driven by any single factor. I think it’s a constellation of factors. The reason we find early stage very interesting today is that there’s now enough maturity in the proptech ecosystem for there to be intermediate-size acquisitions of early-stage proptech businesses by larger incumbents in the space. These can be public companies or private companies. That’s one driving force. 

The second is that there is an institutionalization of proptech as a category amongst non-proptech specialist VCs. Meaning proptech was seen as a niche category five years ago. Today, it’s absolutely not. You could argue that proptech is one of the most compelling generators of enterprise value in all of tech. As a result, a lot of generalist VCs are very interested in supporting these businesses at the early stage, but also in the intermediate and kind of pre-IPO stages.

Then, alongside that is what you mentioned, which is the tolerance levels of our corporate LPs to adopt technologies. The way proptech has changed is that having a strategy to invest in proptech in 2017 was innovative and the strategic LPs that came into Fifth Wall’s first fund were truly at the vanguard of proptech innovation. Today, in 2022, if you’re a real estate organization investing in proptech, it’s table stakes. It’s not just investing in it, it’s that you need to invest in all of it — early and late, because there’s a lot of really compelling innovations that are happening at the early stage. If you only invest at a late stage, you’re neglecting that. We needed our funds to accommodate an investment strategy that was the whole spectrum of proptech innovation from early all the way to pre-IPO.

Fifth Wall launched Fund III in the face of declining real estate and proptech startup values caused by myriad economic factors. Did you close the fund thinking you could ride out the downturn?

I would actually phrase it differently. I don’t think we would view it as riding anything out.

Obviously, we’re cognizant of the fact that the capital environment for early-stage, fast-growing tech businesses has re-rated on account of a lot of public companies, particularly software and software businesses, becoming devalued. That is a dynamic that is afoot and we could probably talk at length about all the inputs to that, probably the most important of which is rates.

There’s added compound effects that impact residential-focused businesses that probably are asymmetrically impacted by rising rates. Nonetheless, you still have an industry in real estate that is one of the lowest spenders on IT of any major U.S. industry; is the single largest industry in the U.S.; is still the largest capital market, even with the reduction of debt markets in the U.S.; and is impressionistically and empirically one of the least-technologized industries. I’m highlighting this to say that a lot has changed. But all of the main growth drivers that should make anyone excited about proptech are kind of still there.

Real estate is definitionally a high-margin business. A lot of capex goes into building a building, but, on a margin perspective, it’s a very high gross margin business. The result is if any real estate owner is coming to the conclusion that because of the capital markets cycle we find ourselves in right now the thing that should be cut is tech, I don’t think that will be a long-term owner of real estate. Tech is arguably one of the last things that real estate is looking to cut right now, because it’s one of the few differentiating factors in light of all the existential questions the real estate industry is grappling with today.

How did Fifth Wall’s investment structure work to match the evolution of proptech and real estate adoption?

I would say there are three approaches to how large real estate organizations would pursue proptech innovation. Strategy one was, “I don’t do this. I do real estate, there’s nothing to do [with technology].” That strategy is clearly on the wrong side of history and is largely absent from the industry today. There’s some exceptions, but most real estate firms of note have a strategy to identify new proptech businesses. 

Strategy two was a kind of do-it-yourself approach to venture investing. So a lot of real estate organizations built in-house venture capital arms, or their family office would pursue proptech investments. The problem with that was that it didn’t scale very well. The extent of the capital that an investor needs to deploy into the project ecosystems was more than most real estate organizations could possibly put up.

The third is the advent of these third-party funds, of which Fifth Wall is the largest, where you have real estate organizations investing as part of a consortium and a larger pool of capital that is acting as a way for the industry to harness technologies and innovation collectively, not just individually as a firm. I believe that is the future of proptech investing — a consortium-based model.

From its beginnings, Fifth Wall had vertical partnerships across the real estate value chain, a key differentiator from other proptech VC firms. Has that design lived up to your expectations?

It’s working better than I anticipated. One of the reasons is that when you think about the pain points that real estate organizations confront, and the opportunities where technology can change positively, some real estate businesses don’t tend to be idiosyncratic by company, they tend to be idiosyncratic by asset class. Meaning that the business of owning an office building in London versus Chicago versus Tokyo — there are differences and some regional idiosyncrasies, but by and large it’s the same pain points.

The result is that when we were evaluating a proptech business, we had what I would almost describe as intellectual economies of scale. We’re talking to so many different office owners operating in so many different geographies and so many different stages of their own kind of tech journey that we’re able to identify patterns and best practices to deploy across all of them — because in all instances they’re looking to make their buildings more energy efficient, increase their engagement with tenants, and deliver a more personalized office experience. Knowing how the whole industry is demanding technology to pursue those pain points is an advantage we have because we sit at the intersection and we can mediate all of this demand from the real estate industry, by bringing in proptech companies we’re seeing in the tech ecosystem. 

So I would say the network effect, so to speak, of Fifth Wall’s consortium model has been a positive surprise. I was actually nervous at the outset as to how well the model would scale, but we’ve seen that as more strategic LPs have come into the consortium, our ability to add value to all of the LPs improves because of the density of that network.

Has the adoption of technology happened as quickly and thoroughly in real estate as you expected when you began?

The real estate industry is a challenging industry when it comes to adopting technology for the very reason that it’s a high gross margin business. The industry failed to adopt technology for decades and did just fine. And that created the opportunity for proptech. Clearly, Fifth Wall believes that there’s an imperative for real estate companies to innovate and adopt proptech, but because you are dealing with an industry that has been historically so slow to adopt, there’s always friction in adopting. 

Overcoming that friction is one of the benefits of having a consortium because we’ve done integrations with our technology companies and one office owner, making it a lot easier to spot patterns and best practices to accelerate adoption in others. But, by and large, the real estate industry is still slow to adopt technology. That is why there’s still a big opportunity in proptech.

What area of proptech are your LPs and the overall real estate industry emphasizing now?

It’s a great question, and the reason I’m struggling to answer it is because the answer is kind of everything. For example, construction tech is a prime example of what I would define as a newly attractive category for Fifth Wall investment. Part of that was because construction tech was probably three or four years behind proptech in terms of its innovation cycle.

We’re seeing this kind of Cambrian explosion of new technology solutions to improve how we build everything: homes, buildings, factories, etc. So that’s a new category for us, alongside anything and everything to reduce the energy consumption per square foot of real estate assets, which is very much in demand and interconnected to what has been historically described as smart building technology. A lot of the demand for what we called smart building tech at the asset level was based on what tenants want. This delivers a better tenant experience, but a derivative impact of that is that when you better understand how people are using your asset you can become less energy consumptive at the asset level in aggregate through automation and machine learning. So what’s happening is that smart building technology is now becoming interconnected to climate tech in really interesting ways that I think are going to be an exciting category for space.

Having just raised a $866 million fund, what are Fifth Wall’s plans for next year?

From our perspective, it’s a great time to be investing because nothing about the fundamental demand for technology in the real estate industry has changed. Capital markets, however, have changed dramatically. The cash needs of proptech companies continue and in some cases become greater because the IPO window is closed. The cheapest form of financing is revenue and is top of mind for proptech entrepreneurs. So it doesn’t really change our business other than it does change capital markets.

Does the devaluation of many proptech companies in 2022 tempt Fifth Wall to invest in distressed startups in 2023?

The answer is no, and the reason is that venture capital and tech investing is just so fundamentally different from real estate investing. The value of being in the second-best tech solution, versus the first, can be profound. Whereas the value in being in the second-best building in New York City versus the best building in New York City is probably the same. 

There’s more of a winner-take-all dynamic and more of a zero-sum dynamic to tech investing. Actually, you might see more of a flight to quality, with valuation adjustments that have happened in proptech less pronounced in more successful businesses, while less successful businesses may not be financeable at all and may actually no longer exist.

What’s the first thing you are planning to do now that you’ve closed Fund III?

Make an excellent next first investment.

Want to give a clue as to what that will be? What sector of proptech?

We’d like to do something really exciting in the construction tech space.

Philip Russo can be reached at prusso@commercialobserver.com.