Insight from the Leaders of PropTech Investing
A discussion with Fifth Wall Partner Vik Chawla
Most people have a favorite company that they look up to and follow religiously. For me that company is Fifth Wall. If you have been reading my blog, you know that my passion for PropTech runs deep. Fifth Wall not only has a keen eye for what the future of the industry will look like, but they also put their money (and their investors’ money) where their mouth is to help brilliant entrepreneurs change the world. For better or worse, changing the world requires significant amounts of capital and that capital comes with insane amounts of risk (according to Embroker: 90% of startups fail). But it is that risk taking that has delivered the innovation for us to have a cleaner planet, a better quality of life, and modern day conveniences. I have followed Fifth Wall for years, and I had so many questions for them: “What does the future of the industry look like”? “Is iBuying really a sustainable model”? “ What is Fifth Wall’s involvement once they cut a check”? “Is the industry overheated”?
How many times have you heard the statement: “You should never meet your heroes”? Since I didn't know anyone personally at Fifth Wall I was honestly concerned that meeting the team would eventually disappoint me, whether it was from huge egos, poor attitudes, or dismissive personalities. Let’s face it, when you have the level of success that they have had, it wouldn’t be surprising for the team to have enormous egos. Last month, after reaching out via a cold email, I had the privilege of chatting with Fifth Wall’s Chief of Staff Michael New. Not only was I blown away by his view of the world, but he was incredibly kind and very generous with his time. When I explained to him what my objective was for an article that I was looking to write, he immediately said that he had the perfect person for the interview - Fifth Wall’s partner Vik Chawla. When I first spoke with Vik, any concerns that I had about meeting the people that I looked up to so much immediately vanished. I found Vik to be warm, unbelievably intelligent, and eager to answer any questions that I asked. Below is the interview that I conducted with Vik.
For many years, companies have tried and failed to disrupt the traditional residential brokerage business; mainly focusing on reduced commissions. From an iBuyer perspective, this time feels different based on just how much capital is being deployed. What is your view on the future of the residential brokerage business and what role does iBuying play?
“When I think about the development of the consumer home transaction, and I analyze the lack of digitization that is really playing in that space, the only conclusion I can draw is that a more consumer friendly, less friction transaction is the only one that will survive in our digital era. Because of this, I believe that the iBuying business is here to stay. When you think about what an iBuying business is, on an end-to-end basis, it’s about giving the consumer a delightful experience when they're going through what otherwise is a very challenging life transaction. Often the sale of a home accompanies a major life event: death, divorce, changing jobs, starting a family. So selling a home only adds to this stress for people. And when you think of these non frequent transaction markets, not markets like San Francisco Bay where things transact in less than 30 days, but some of the markets more where transaction timelines are on a 120 day horizon, what you realize is how burdensome such a transaction is for consumers. What iBuyers are doing is they're saying, ‘look, we will facilitate this transaction as a marketplace, purchase a home from a person who's interested in selling, retrofit the property, and then sell it to the ultimate buyer’. So for that reason, and for understanding how iBuyers have put the consumers first by giving them this really great transaction process, I think the only logical conclusion is that this model will be here to stay. In an increasingly digital world, rarely do people want to turn back the clock to days where they were encumbered by that technology. You don't typically hear people say, ‘Oh, I have a car, now we should go back to riding a horse’. So we do believe that these digital transaction changes are permanent. And when you believe that digital transaction changes will continue to dominate the consumer home landscape, the inevitable conclusion is the success of iBuyers”.
There is no doubt that the iBuying process is more convenient than a traditional home sale, but isn’t there significant risk in this model? What happens when an iBuyer acquires a significant amount of real estate, and the market experiences a downturn? Is this model really sustainable?
“That’s a really good question. Let's talk about a few parts of that. So the first risk, as you so aptly pointed out, is inventory risk. You're holding a bunch of homes and things get really bad. There's a few ways that that's mitigated by iBuyers that we're familiar with. So the first way is, they're obviously holding on their books properties that they anticipate selling in less than 60 days. So the plan is calibrated to be at about 60 days. The inventory risk is only expected to be a two month hold. What that allows for them to do is go into the property, knowing what kind of property attributes and pricing regime they need to transact on the timeline.
The second is the structure of the business. The properties are typically held in bankruptcy remote special purpose vehicles, where there's debt capital against the properties. They are not cross collateralized with the main business, meaning a lender can't come after the operating company if there's impairment on the home. It's kind of the analog of if you have a debt line yourself personally that's non recourse. If you owe that person money, and you can't pay it, they can’t come after your retirement account or your checking accounts. So the way that businesses are set up structurally limits the damage to the operating company.
And then the third risk is a protracted housing market downturn. There's going to be some impairments because you're still holding properties, even if you anticipated getting them off your books. And even though they're not cross collateralized, you are still taking some loss. But my view is that the loss would pale in comparison to what more traditional real estate owners would experience. Technology platforms are leveraging data analytics. They're going to see this problem and be able to adjust the dials far ahead of more analog businesses. So the pain would be amongst the lightest felt relative to other industry participants. For these three reasons, we think that we understand the risks of the business and we are comfortable with them.
There is actually a fourth risk, which I think is worthy of discussing. And that is, what is the steady state valuation of these kinds of businesses? Do these businesses trade at multiples that are more indicative of advertising platforms like the Facebooks of the world? Do they trade at software multiples? Do they trade at more specialty finance multiples? I think the real paradigm question is going to be what multiple do these businesses trade under. From a more generalized standpoint on the iBuyer business, some of the risks actually have more to do with the valuation paradigm, then whether it is a convenient, desirable counterparty. There's plenty of businesses and ventures that have had great rises, and then the market revalues them in a different form, and then there are some adjustments thereafter. So those are the risks as we see”.
Besides investing in iBuyers including Opendoor, Flyhomes, and Knock, Fifth Wall has made investments in digital lending companies (Blend) and digital title agencies (Doma). Part of what makes modernizing the home buying process so challenging are the ancillary services like mortgage and title. These investments appear to demonstrate that you believe that the entire process can be simplified with technology. What is your view on the future of the industry as a whole and will we see an end-to-end solution for buying/selling online with a few clicks? What timeline are we looking at?
“Many of the professionals at my firm tease me about the nomenclature that I developed which is called One-Click-Vik. It's a view that over time, there'll be this one click experience that people will be able to enjoy when purchasing a home. So Glenn will come on a platform, find a home that he and his family like, look at it on the platform, maybe tour and open the lock from their cell phones; they won't need somebody touring them. They'll find the home, they fall in love with the home, and they decide to buy it. The mortgage will line up tied to their bank account, title escrow will all be a part of that process, and you'll close. I do believe that we will see that well before 2025. In some respects, you can already have a similar experience on some iBuyer platforms where you can bolt on your mortgage, title, and escrow all through the purchase process. And I do think other firms and platforms are going to begin to similarly adjoin these other products into their core business model. If you think about more pure play real estate brokerages, like the Compass and the Redfins of the world, they need to know that there's not only a convenience factor, but also a lot of economics in giving people an end-to-end transaction experience. And I think for that reason, others will look to offer this as well. Now, I think one of the questions behind your question was, with these bets in both the AI buying businesses and mortgage software and title, how does this competitive landscape play out? I think while it's winners take most, I don't think it's winners take all. There will be room for both software businesses and more full stack end to end businesses to succeed.”
Is that because certain home transactions don't fit into the mold of what a traditional iBuyer acquisition looks like? For example, iBuyers prefer markets like Phoenix where many homes are of similar size and price?
“There are a few reasons. For one, the market is extremely large. When you live in San Francisco, you think that every company is a tech company, but it turns out the world is a lot larger. And the real estate market itself is one of the largest markets. That typically allows for room for multiple businesses. Then, you also have the dynamic where homes over a certain price point aren’t as eligible for iBuyer platforms. These transactions may be more appropriate for traditional brokerages”.
Analyzing Investment Opportunities
I’m sure that a significant amount of your time goes into analyzing whether or not to invest in a company. If you do decide to participate, what happens after the check is cut? Are you hands off or do you get heavily involved with the decisions of the company? What other benefits does Fifth Wall provide to portfolio companies besides for capital?
“In the early days of our business our goal was to articulate an investment philosophy that would survive the test of time through differentiation. So unlike more traditional venture capitalists that just focused on deals, then moving on to the next deal, we were first conceptualizing how to build a firm that has a sustainable competitive moat over the next 20 years. And the view that we took was if we're able to be in a position to really have a business that has strategic partners in our LP base, and create this flywheel effect, we would be able to be the single most unique form of capital for entrepreneurs looking to build PropTech businesses. And so in our business, our first fund raised a large amount of our capital from the largest owners and managers of real estate. Our first fund was focused on the US. So firms like Equity Residential, Lennar, Prologis, CBRE, Hines, Host Hotels, Lowes, Macerich Properties, and Rudin Management Company invested in the fund. In Fund II, we took that model internationally, and now we’ve built out an even larger presence with 70+ global strategic partners. So we look to consummate strategic business development relationships with the companies in which we invest at the time that we deploy capital as well. And we think that's one of the unique flavors of our business.
While I am sure that every investment decision is unique, what are the key factors that you look for when deciding whether or not to participate in an investment? Is there a specific factor that either really excites you, or conversely convinces you to pass on an investment?
“I think that company building is still a people business. If you're in a business where you have an amazing team that are very passionate about the problem, they are capable people, and they work well together, that's one of the biggest excitement factors as a venture capitalist. We love to partner with amazing founders and teams. Of course, like other investors, we need to understand what the market looks like. What's the competitive landscape? How stratified is the market in terms of customer concentration? What are the unit economics of the business? And so like other investors, we're looking at market and unit economics and competitive landscape and product quality. But if I pick one factor that really is sort of a needle mover, it's the quality of the team. If we love the team, and every other thing has checked out, it's worked out great. If we haven't loved the team, and everything else has checked out, it is true that it hasn’t gone as great. So if I have to pick one linchpin factor, I think the quality of the team is the most important part.”
The State of the PropTech Industry
This is the most exciting time in the history of PropTech. There is so much capital flowing into this space right now. Is the market overheated, or can this pace be sustained?
“Part of the increase in investment in PropTech is that you have to take it in the context of the underinvestment historically that real estate firms have made in tech initiatives. While of course this space has been on a tear since Fifth Wall started its business, the amount of dollars invested in the preceding two decades in tech for real estate pales in comparison to that of other industries. So a lot of those dollars I see as catch up dollars. The industry was so under invested in technology structure and infrastructure, that there are some dollars that just went into catching up. If you think about the size of the space, if you look at the outcomes that we've seen today relative to the market size of real estate, it still pales in comparison to the outcomes you've seen in other spaces like in advertising platforms, software businesses, and cybersecurity. We think there are a lot more outcomes to come given how large the market is. This is just the early innings of the growth of PropTech”.
Unpacking This Conversation
There is a lot to unpack in this conversation. The truth is that I have been skeptical of the iBuyer business for some time now, mainly regarding the risk that the operators are taking on, and in turn the sustainability of the model. Although I have always been excited about the conveniences that iBuying delivers over a traditional sale, Vik made some extremely compelling points about the risk of a downturn being way more impactful to a traditional broker than to an iBuyer. The traditional process of buying/selling a home is incredibly complex and frustrating. If iBuying can prove to be sustainable, this model has a good chance of delivering the market disruption that has been promised for years.
As Vik spoke about raising funds from strategic partners including the largest real estate companies in the world, I couldn’t help but draw parallels to my recent interview with Breton Birkhofer from DivcoWest. Raising money from strategic partners where you have a built-in customer base is an ingenious strategy for investing. By partnering with the biggest real estate companies in the US, and over 70 international real estate leaders, Fifth Wall has mastered this game.
I asked Vik if he had anything else that he wanted to add that we hadn’t already covered. His answer echoed one of the reasons why I am so passionate about PropTech.
“One final part that is worth discussing is how we look at the very important role PropTech investors and venture capitalists play in the broader world. At Fifth Wall, we take this responsibility very seriously. We are big believers in: You can't just do well without doing good. And so we hold that true to our investment thesis as well. We very much believe the future of real assets is changing as well, buildings and cities are going to have to take into account things like climate change and climate technology for the future of construction, and how we think about the development of real assets. What excites me about the next decade is all of these ancillary opportunities, like reimagining how cities and buildings are built in more sustainable ways. Leveraging technology, if done correctly, can help leave the planet better off for future generations. This is just one of the earliest spaces that we're excited about, and Fifth Wall is committed to not only doing well, but also doing good”.