Market performance in 2023 was a reminder of how correlated real estate is to monetary and fiscal policy. Although interest rates have recently plateaued, rates rose at their fastest pace in more than five decades and increased the cost of capital, constrained transaction volumes, and impaired PropTech growth and efficiency.[1] This created a challenging operating environment for startups that aggressively hired for growth driven by artificially high 2020 and 2021 performance. As a result, burn rates quickly grew out of control and cash runways deteriorated, which forced PropTechs to right-size distorted cost structures to match market conditions and new expectations. To help PropTechs avoid making the same mistakes in the future, it could require a meaningful mindset shift.
In 2021 startup land, cheap equity and irrational exuberance led to record amounts of transactions and interest in software. In order to keep up with demand, many startups adopted a growth-at-all-costs approach that the VC community rewarded. Growth plays an important part in a startup’s valuation equation, but things have changed: profitability matters, as does managing burn and sales efficiency. There’s a delicate balance between those that cannot be ignored. A general rule of thumb is that growth tends to be more in favor at the top of cycles or during loose monetary policy when capital is cheap, but profitability tends to be more in favor at the bottom of cycles or during tight monetary policy when capital is expensive. There’s an ebb and flow between the two, but they too frequently work in isolation. It doesn’t have to be that way, and, more often than not, the best outcomes are when they work in tandem.
It may be obvious, but we recommend founders plan accordingly and protect their businesses from slower periods of growth. Cash is king. One way to do this is to set more modest growth plans that can still drive meaningful returns for shareholders, but won’t require as much burn and/or hiring ahead of growth that may or may not come. Do not depend on needing another investor further down the track to keep you alive (“Default alive”, as they say). Keeping a healthier tension between growth and profitability and a “tighter band”, so to speak, could mitigate downside exposure to larger swings in the market and help prevent meaningful erosion in operational efficiencies in case things fall off a cliff like they did in 2022 and 2023. Mature, successful companies will always be valued on their future cash flows, so a focus on efficiency earlier on in a company’s lifecycle could pay dividends down the line. If you aren’t using the cash to build or scale something with demonstrated positive unit economics, you probably want to think twice about raising in this environment.
Another way to protect businesses is to diversify revenue streams away from transactions tied to the infrequent buying and selling of real estate assets. If there are opportunities to expand into tangential markets with similar use cases with more frequency (e.g. construction, insurance, property management, etc.) that won’t require much distraction, those should be explored. The idea is that if one sector or business model is impaired by market conditions than the other sectors and models could pick up the slack. This helps to break from the correlations described above and ultimately de-risk the company via reduced revenue volatility. Startups are constrained by time and capital so it’s important to focus early on, but a good time to strategize, test, and implement diversification is at the beginning of a startup’s life. Every company is unique and there are judgement calls, but most companies should be considering this earlier than they currently are. We’ve observed MVPs and running small, cheap, iterative tests can be helpful in moving the needle here.
Although real estate may be more sensitive to macro-economic forces, the silver lining is that built world industries are so large that there’s still potential for early-stage startups to take market share and grow, even during a contracting market. These are the largest asset classes in the world that have been around forever, and aren’t going away tomorrow. Unfortunately, the same can’t be said for other markets that aren’t as ‘insulated’ as PropTech. From a risk adjusted perspective, the next Facebook probably won’t be founded in the space, but it likely won’t have the same number of flameouts either.
It would also be unfair to not call out the fact that everything is harder for everyone now across all industries, segments, and business models. PropTech had its fair share of challenges but can sometimes be unfairly judged. The built world is so diverse and includes so many different industries, segments, and business models, that it’s important to look at them individually because some pockets are outperforming relative to others. We remain steadfast in our support of technology’s potential impact on the world and are excited to help the next generation of PropTechs be more successful by learning from the last.
Disclaimer:
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by Nine Four Ventures. All views expressed herein are the opinions of Nine Four Ventures employees and are not the views of our affiliates or investors.
