When people talk about the rise of interest rates, one industry is always included in the conversation: real estate.

 

The combination of rising interest rates, climate change, construction labor shortages, housing shortages, a paradigm shift in office use, and so many other factors has set the stage for what is likely to be a pivotal year in the real estate sector…and an interesting time for tech companies targeting it.

 

At Primary we’ve been investing in companies targeting the built world dating back to 2015 and have been thinking a lot about things that sit at the intersection of proptech, construction, fintech, and climate. With a deep focus on those spaces, we reached out to a number of close investor, founder, and operator friends to get their takes on what is to come in 2023. (Considering our willingness to wish Happy New Year late into January, we thought it would be appropriate to share out 2023 predictions at the deadline.)

 

Spoiler alert: OpCo/PropCo models are exciting, the housing shortage will open opportunities many investors are long on, the office is back, automation is inevitable, sub-verticals will finally get better SaaS solutions, and new technology will help drive a more equitable and sustainable built world.

 

“With rising interest rates anticipated to drive the U.S. into a mild recession, demand is likely to decrease across many real estate asset classes—specifically those which generate revenue on a short-term and/or transient basis and lack the protection of long-term leases. While the master-lease arbitrage model that most proptech operators historically employed to grow supply has been flawed since the start, a pronounced demand dip would represent the “nail in the coffin” for companies with significant outstanding lease liabilities. Looking ahead, brands and operators in proptech will need to remain truly asset light, with an elevated focus on delivering value to PropCo investors via a 3rd party management structure. Given high relative barriers to raising PropCo capital vs. venture capital at the earliest stages, fewer such companies will be funded compared to recent years. The companies that achieve funding, however – and are able to scale with an OpCo/PropCo model – will thrive, such that the return profile of venture investments in this sector will be outsized vs. 2015-2020 vintage deals.”

 

“2023 is the year we’ll see the institutional propco continue to accelerate to take advantage of the alpha created by new/innovative business models in RE. RE investors seeking yield in sectors such as Single Family Rental, Hospitality, and Multifamily will turn to proptech solutions and specialized propco funds as a way to manage, operate, and acquire these assets at scale. This acceleration will be an enabler of new startup value creation as historically that risk/opportunity has either burdened the unit economics of the startups themselves or been subject to illiquid/inefficient capital markets. If the last cycle of proptech value growth was enabled by low-priced venture capital or family office equity capital, this cycle will be driven by institutional funds seeking attractive risk-adjusted returns.”

 

“Over the last decade, venture-backed proptech companies utilizing the OpCo/PropCo model benefited from unwavering valuation increases across both OpCo/PropCo assets. It effectively didn’t matter if a real estate owner ran at 80-90% LTV when real estate prices were consistently rising and there was always more venture capital equity to keep businesses going.

Times have changed: asset prices have declined, debt is much more expensive, and cash flow matters. Investors across the capital stack have retrenched and companies that employ an OpCo/PropCo model will need to get creative. They will either 1) take more balance sheet risk, which is challenging because the cost of their equity is typically higher than real estate returns 2) shift their models towards pure software or servicing or 3) build around pre-existing capital sources, such as assumable mortgages or home equity, that are largely untapped and ripe for disruption.”

 

“Real Estate doesn’t aways mix well with “blitzscaling.” But that’s ok, blitzscaling is predicated on winner take all markets and real estate markets are so big, one doesn’t need to own a market. Many verticals will have multiple, multiple billion dollar businesses built. They just are built on a different time horizon which necessitates different types of capital.”

 

“Over the last few years, the prevalence of PropCo/OpCo structures have become more frequent and the deal sizes have gotten larger. This is because founders are realizing that the broader base of real estate that they have access to, the more they can apply their technology & software to. By setting up a PropCo structure and capitalizing it w/ traditional real estate capital, founders are giving their business (OpCo) a capital efficient way to accelerate their traction. Whereas historically the demand for PropCo structures have been soaked up by HNW, Real Estate Family Offices & Esoteric Hedge Funds, we’re now starting to see institutional investors really roll up their sleeves and allocate capital to these PropCo structures.”

 

“We believe that investment in vacation rental properties in premium markets across LatAm will continue to show strength throughout 2023, as investors in the sector move away from non-premium markets.

On the bookings side, we see an uptick in reservations for 2023 and into the peak months of 2024, in spite of an increase in rates and global uncertainty. The proximity of Mexico and relative cost advantages of vacationing here continue to attract tourists in spite of global economic uncertainty.”

“On the back of the Inflation Reduction Act (IRA) being signed into law in August of this year, moving the country away from fossil fuels, home electrification will take center stage in 2023.”

 

“Alternative energy storage and grid rebalancing in commercial buildings is going to become increasingly important. Landlords want to reduce their carbon emissions and spend less money heating and cooling their buildings. We are seeing some really interesting companies popping up in this category.”

 

“I think my biggest one is we will see deflation at the back end of the year. Something my parents never even saw.”

 

“Improving affordability and access have typically been key considerations for anyone building in the proptech space. Over the past year, the high inflation and rising interest rates we’ve seen have made this more important than ever.

Consumers need access to tools that can give them the best possible sense of what they can afford and what their costs will look like, both near-term and in the future. These tools work best when they help consumers explore and understand a wide range of options, to ensure they have a clear sense of what they’re getting. A marketplace approach can really deliver this experience to consumers and we can expect to see that model really shine in 2023.”

 

“We are short approximately 4 million homes in the U.S., and lack of housing affordability has reached full-blown crisis territory. Unfortunately, rising interest rates coupled with potential job loss / income contraction will slow the pace of new housing starts—making this issue even more dire.

I’d expect to see a renewed focus on adaptive reuse of existing structures—specifically out of favor commercial and hospitality properties—to meet the growing demand for affordable and workforce housing. It is very difficult to build this type of housing net-new given the cost of construction in the U.S., yet we have a tremendous amount of existing built environment that can be repurposed. We’ll see new services and products that attempt to standardize the process of adaptive reuse—from prefab kitchens and bathrooms to the use of heat pumps and infrared heating technologies that will make the electrification of these assets more cost and schedule effective.

Finally, we may see new platforms that connect employers directly to the housing that their employees need. Housing as an employment “perk”—particularly in the hospitality sector—may become a necessary standard.”

 

“Despite the Fed’s best efforts, the unemployment rate remains at record lows, and the construction trades are feeling this acutely. New models leveraging software solutions need to be developed in order to effectively train the next crop of skilled laborers. Despite a construction slowdown in single family, multi family, office and retail, we anticipate continued tightness in the construction labor market due to increased infrastructure and factory spending.”

 

“On the heels of Meta confirming it will release a new Quest VR Headset and Apple’s long rumored headset entering mass production, both in 2023, we’ll see AR/VR app development accelerate via increasing consumer hardware adoption. It’ll closely mirror the iPhone catalyzing mobile app development for iOS with Apple’s entry into VR supercharging VR software development.”

“With the growing demand for sustainable and efficient construction methods, prefabrication has become a popular trend in the proptech industry. In 2023, we predict that the use of localized mobile micro factories will take this trend to the next level (we’re biased). These factories, which can be easily transported to different construction sites, will allow for even greater customization and faster construction times, playing into some of the thematics around a massive lack of skilled labor around the country. As a result, we expect to see an increase in the use of alternative construction in both residential and commercial real estate development, with adoption finally accelerating by gorilla incumbents who need to survive in this awkward and challenging real estate market.”

 

“The real estate sector includes a large number of substantial sub-verticals that remain vastly underserved by legacy software solutions that in many cases have been cobbled together over the past fifteen years. Legacy solutions still support billion-dollar industries like HOA management, self-storage management, or construction management. As tech-native decision-makers rise to senior management roles, we anticipate increased demand for and willingness to adopt bespoke solutions that truly address pain points, improve work flows, and enhance margins. Embedded finance will continue to expand the addressable market for software solutions and their platform distribution partners, further encouraging innovation. In 2023 and the coming years, we anticipate legacy solutions to cede market share at a quicker rate across built environment sub-verticals. This thesis is reflected in Third Prime’s recent investment in Cubby Storage.”

“From conversations I’ve had over the past six months, my experience indicates that CEOs have settled into two camps: Those who are passionately committed to building a fully-remote organization and those who are gnashing their teeth to find a reason to ask their employees to return to the office at least four days per week. I have not met a single CEO who has expressed enthusiasm for a hybrid approach, and the latter category outnumbers the former by a decent margin even within the tech industry. Political leanings aside, many technology CEOs were quietly rooting for Musk when he abruptly ended Twitter’s remote work policy last month.

While it’s likely true that great managers can get the most out of their employees remotely, it’s a fantasy to assume that any organization of sufficient scale is stacked with nothing but great managers, and executives know this. So what’s been holding them back? Record-low unemployment and wage growth has given white-collar employees the power to push back, short-circuiting many executives’ best efforts to force a return to the office. But if the Fed continues on its current trajectory and layoffs intensify in the coming months—see point (1) above—the power balance will likely swing back.

Note that I’m bearish on hybrid organizations, not fully-remote ones that were forged over video calls and Discord. Those companies exist, and their founders are very vocal on Twitter. But I don’t think most companies—particularly large ones—have the willingness or ability to get there.”

 

“Proptech startups selling into real estate owners and operators will need to find ways to expand their profit capture given the general unwillingness of these customers to spend on software. To counter this dynamic, companies are starting to stack business models—e.g. charging a small SaaS fee that is easily digested by owners/operators and adding on transactional revenues via marketplaces (e.g. for vendor procurement or property manager selection) where they may be able to charge high take rates.

 

Other types of proptech businesses that have historically built their companies around assisting consumers with the home buying and selling journey, and often using balance sheet capital to physically purchase homes (i.e. OpCo/PropCo models), will start distributing more software products to their captive customer base, driving tech-like multiples rather than settling for REIT-like multiples.”

 

“The Lessen + SMS Assist deal foreshadows what will be a flurry of activity, as competitors realize it’s easier to work together and benefit from scale, incumbents find opportunities to acquire startups at more attractive valuations and founders experience increasing hurdles to raising capital at attractive terms.”

“Will continue to be a challenging environment for those Proptech startups that have not found true PMF with great unit economics—this will lead to accelerated consolidation (we already started to see some of this over the past 12-18 months)”

“It seems quite possible that we’ll see a PE takeout of a proptech company that went public via a SPAC. We’ve taken phone calls with a handful of PE funds scouring the ecosystem. There are several compelling add-ons now trading at multi-year lows in our category.”

 

“All tech is not created equal. During the post-pandemic boom in proptech and the housing market, some companies were able to get by using outdated technology or repackaging clunky legacy platforms. The tide has changed as high inflation and rising rates have meant a more competitive space and a market that demands efficiency. Expect to see more focus on core tech offerings this year, with good product that powers more efficient processes helping to differentiate the companies that have true staying power.”

“There’s been a number of companies over the last few years that have been working on making investors’ lives easier (sourcing, acquisitions, underwriting). In other words, how can an investment firm do more with less people (AUM to overhead or look at 3,000 deals quicker than anyone else and get to the best 3 efficiently). I see companies in this space having real traction finally as investors struggle to navigate an awkward and challenging market. More so, I see folks building these tools in house (i.e., Two Sigma, Stablewood, etc.).”

 

“Generative AI will start to find its way into the world of Proptech, although likely initially focused in areas that are perhaps not viewed as ‘sexy’ such as digitization of transaction documents that contain valuable data and information.”

 

“The rise of remotely sensed data from satellites and drones is growing at unprecedented scale with the cost reduction of satellites and launch costs as well as beyond visual line of sight (BVLOS) advances in tech and regulation for drones. In 2022, a record 180 successful rocket launches to orbit occurred with SpaceX completing 61 trips to orbit and the company wants to hit 100 launches, which is nearly two launches every week. What does this mean for proptech? A lot more unique data sets about our built environment related to building thermal efficiency, roofing, disaster recovery, utility management, etc. will be available.”

 

“Real estate practitioners are presented with many challenges in a rising rate environment. What we are hearing from friends in real estate is that this is a back-to-basics year. They are focused on reducing costs thoughtfully where possible (sometimes new software solutions can be productive here) and attracting and retaining tenants. What is not top of mind is investing in speculative technology businesses. We expect the real estate industry to both pull back on commitments to venture funds and to invest less into tech companies directly.”

– Dave Eisenberg, Founding Partner at Zigg Capital

 

 

“Despite widespread adoption of PMS systems across commercial properties, so many processes remain human capital intensive at an asset or regional level. We are investing in tooling that eases the integration of new capabilities, enabling property managers, owners and operators to adopt new applications more easily and in the process, create a smoother pathway for founders to tackle longstanding challenges.” 

– Gavin Myers, Founder and GP at Prudence