The Churn in Proptech Could Last Awhile

Firms going out of business, investors pulling back, big names gobbling littler ones — get used to it for 2024 and maybe beyond

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The last quarter of 2023 saw some prominent proptech startups crash and burn. Now, industry experts are speculating whether the pace of such failures will accelerate, or if proptech phoenixes will start to rise from the ashes.

From November 2023 through mid-January of this year, proptech startups such as Here, a fractional short-term vacation rental marketplace; Veev, a tech-enabled prefabricated homebuilder; and Zeus Living, a flexible home rental company for business and personal travel, were all reported to have closed down.

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In addition, earlier this month, Frontdesk, a short-term rental provider, reportedly laid off its staff and was on the verge of shuttering. Meanwhile, Latch, an access control startup that ran into financial statement reporting issues after going public as a special purpose acquisition company with Tishman Speyer in June 2021, changed its leadership and rebranded as Door.com.

As high interest rates continue to make investment in all industries problematic, proptech entrepreneurs and investors are trying to make sense of their marketplace in 2024.

“In a maturing industry like proptech there’s always a natural attrition,” said Joshua Butler, who as a director at Milwaukee-based investment bank Baird focuses on proptech. “As the industry matures and becomes less fragmented, you’re going to see more consolidation of duplicate non-differentiated solutions. Those former high-value startups that aren’t really battle tested from their business models perspective, they’re going to be the ones that get acquired at a lower valuation than their historical 2021 unicorn valuations.

“But I think there’s still a significant amount of opportunity, optimism and growth there for those companies that have resilient and differentiated solutions. They’re absolutely going to capture that additional growth-market share and, frankly, upside valuations.”

On the lending side, Butler, who mostly works advising proptech companies after their early stages, believes we won’t see clarity in funding until the Federal Reserve makes its expected first interest rate cut.

“The market is trying to price it in but also be cautious,” Butler said. “Speaking with the investment community and company founders, I think we’re headed in the right direction. The capital is still sitting on the sidelines. There are transactions happening and we have seen a couple this year, not necessarily on a large scale, but there are some that have gotten done. But not at the scale that we’re expecting to see in historical terms. That’s still to come.”

Whatever the funding headwinds, though, Baird remains committed to its advisory work on behalf of proptech companies, said Butler.

“It’s a natural attrition for companies to go through this churn,” he said. “If they don’t have solutions, if there’s not a path to profitability, the burn rate is just not under control. I don’t like to use the term winners and losers, but the winners will continue to prove out and get that support, grow, receive capital, and ultimately find a way for an exit. The other side is going to find it more challenging.”

Speaking of challenges, Greg Smithies, partner and co-head of climate tech investing at proptech venture capital firm Fifth Wall, is blunt in his assessment of proptech company fortunes in 2024.

“Yes, more companies are going out of business,” said Smithies. “But I don’t think it’s a proptech-specific phenomenon. This is more a venture capital phenomenon right now. We’ll probably see an impending tidal wave, if anything, of even more [closings] and it really just comes down to money no longer being free. Most of the money in venture capital comes from these institutional LPs, the big sovereigns, and pensions and endowments. And they’re very cold sort of numbers-driven folks, meaning when they’re thinking of allocating to different asset classes, be it fixed income or private equity or venture capital, they’re just running a big portfolio optimization calculation behind the scenes.”

When interest rates were low, such institutional investors could bet on higher return risks like venture capital for proptech startups. However, when rates went up, the investors’ portfolio optimization algorithms indicated that “you don’t need these higher returning asset classes because we can get a decent return on non-risky assets,” said Smithies. “So you see just a massive pullback of money out of the riskier asset classes like venture capital.”

Even more ominous, venture capitalists who raised money in 2021 or 2020 are still sitting on those funds, meaning there is anywhere from two to three times too much money in venture capital overall, he added. 

“That’s going to take about a decade to work through the system as people’s next funds that they raise are smaller, or they don’t raise the next fund,” Smithies said. “People like OpenView Venture Partners, who just shut down at the end of last year.

“So the smattering of closures that we’re seeing right now is the beginning of the storm. It’s not the end of the storm or even the middle of the storm. It’s actually going to be roughly a 10-year cycle to go from however many hundreds of billions of dollars in venture capital down to a new normal of some other number.”

In this investment climate, proptech startups must sharpen their business focus for investors like Fifth Wall to fund them, Smithies said.

“You need to have hit whatever your business milestones are, like delivering hard ROI to your customers,” he said. “And you need to be line-of-sight to cash-flow break even. If you aren’t doing those two things, chances are you will still actually be able to raise money, you’ll be fine.

“But here’s the caveat: It’s probably going to be at a down round or some kind of new structure, a flat round with higher liquidation preference. You need management and other investors to put their egos away, and be willing to take a down round or a difficult flat round. There obviously are going to be a percentage of companies who check all three of those boxes and they will get financed.”

As usual in any market churn, some see opportunities in select failing proptech companies.

“We see a lot that are kind of at the bitter end in terms of their capitalization,” said Glenn Murray, founder and CEO of Imkore, a Fort Lauderdale-based commercial real estate and financial services technology advisory company. “So their valuations are falling because they’re underwater. We’ve looked at acquiring two companies this year, one in Europe and one here in the U.S. They’re losing millions of dollars a year. I still don’t understand how they run a business that way per se, but the operating model doesn’t make sense from a financial standpoint.

“But we see it as an opportunity. So we’re definitely going to pick up a couple of firms, and we’re looking at other opportunities that are conducive to the product set that we have. Even companies that are plummeting, there are still good technologies out there. So it’s not all wasted.”

There are specific reasons beyond funding challenges for the failures of companies like Veev and Katerra, the latter of which folded in October 2021, said Jason Mullen, CEO at ILC Studios, a vertically integrated lighting design and materials contech supplier headquartered in Denver.

“Veev is a good example of these unicorns failing because they’re treating the symptom and not the disease in our opinion,” said Mullen. “Veev had a really good idea, as have most of the companies that I’ve seen. A really ingenious approach to what I see as a symptomatic issue — the upstream problem of the continuity between design and construction.

“Until those two things are not marginalized, I do not believe that we’re going to be able to fix it with software, 3-D printing, or industrial construction. I think that we’ll make small, incremental improvements, but not the whole.”

Investments in the proptech and climate tech sectors are facing one more obstacle, said Fifth Wall’s Smithies.

“These have tended historically to be specialist places to invest,” he said. “You need domain expertise. On the climate side, you need to understand physics. It’s a very insular, complicated industry that not a lot of people understand. So, traditionally, when these areas started up, there were specialist VC funds who were investing, because of that free money phenomenon up until 2021-2022. We had a lot of generalist funds who were investing in these spaces, honestly, because they just had too much money and there weren’t enough holes for them to shove the money.”

The investment emphasis has shifted.

“Now we have almost immediately seen all of those generalist funds shutting down anything that isn’t straight down the fairway for them,” Smithies said. “So we’ve seen massive exits of people out of climate and proptech on the generalist fund side. People like Tiger Global and all of those people who were in a lot of things in 2021-2022. It’s been kind of like crickets from them over the last two years. They are steering very clear of these more specialist areas.”

Philip Russo can be reached at prusso@commercialobserver.com