Next Gen Real Estate: Activating the PropCo/OpCo Flywheel

Authors: Daniel Fetner, Ryan Freedman & Adam Donahue

This post is part of an ongoing series by Alpaca exploring the next generation of Real Estate and the opportunity we see ahead. New to the series? Read the previous posts Introducing Alpaca’s Next Gen Real Estate “PropCo” Series and Yesterday’s Real Estate vs. Tomorrow’s.

Thus far in this ongoing Alpaca blog series, we’ve spent time discussing the benefits of bifurcating OpCo (the venture-backed technology portion of a company) and PropCo (the Real Estate portion). We’ve looked at how doing so unlocks tremendous value for both founders and real asset allocators. We could end the narrative right here, and ask you if you prefer to invest in Venture or Real Estate? Or we could dig in a little further and see if it’s possible to marry these two asset classes, thus creating a newfound technology powered dynamic, in which these entities work in unison and intersect to create:

• Greater efficiency
• Increased alpha
• More downside protection

PropCo Driving OpCo Value

These two sectors have collided on numerous occasions. The most recent example has come in the form of traditional venture-led OpCo investments, i.e. PropTech 1.0, or “The Built World,” as it is commonly referred to. In this scenario, Real Estate technology products (generally in the form of software or hardware) have been adopted and rolled out across some of the largest global Real Estate portfolios. This mass adoption and deployment has not only created value for buildings owners and tenants, but also the technology companies themselves. As more Real Estate absorbs the product or service, the more valuable the company providing that product inherently becomes.

A prime example of this is Alpaca portfolio company Latch, which is a smart-lock and operating system for building security. As brand-name Real Estate firms such as Related, Greystar, Tishman Speyer, and Avalon Bay adopted the product for their portfolios, it helped further drive the value of OpCo.

At this point, we’ve lost count as to how many instances we’ve seen this narrative unfold. What we are certain of: we continue to be encouraged by the Real Estate industry’s ability to seek out and absorb new and innovative technology solutions for their portfolios.

The Big Question

The above PropCo/OpCo dynamic is incredibly compelling. We believe there is an enormous growing market for technology products to find homes in Real Estate portfolios. But if you’re the startup founder, you will eventually sit back and wonder:

“Wouldn’t it be nice if you were able to own those assets in which your company was creating so much value and efficiency for?”

Or if you’re a real asset allocator (reaping the benefit of technology deployed on your assets):

“Would you be interested in owning a piece of the company that your portfolio is helping to scale?”

We believe the answer to those questions is a resounding,“Yes.” The “Why” has everything to do with the “How” these two standalone entities work together in tandem.

OpCo Efficiency Drives PropCo Value, a.k.a. “The Flywheel”

For illustration purposes, let’s look at this through the lens of a real asset allocator who wants exposure to the underlying Real Estate that a technology company owns, but also wants exposure to the company in the event they scale and become valuable. Here’s how it may play out:

• The investor decides to invest in the “PropCo” portion of the company to achieve their stated goal of Real Estate exposure.
• The investor may also may have the opportunity to negotiate warrants in the OpCo, which creates further alignment between parties, and upside for the investor.
• After the investor’s capital is deployed, more investors feel compelled to invest, thus compressing cap rates over time and generating above-market returns for the PropCo.
• At the same time, the OpCo technology application broadens as capital inflows and portfolio size increases.
• Now that technology is broadly applied, the PropCo continues to become more and more efficient and valuable. At the same time, the OpCo sees greater product usage + engagement.
• This results in OpCo generating more revenue — and likely a higher valuation.
• Now back to our investor (who has found themselves trapped in a Flywheel of value creation).
• They have now just profited from the Real Estate portfolio expanding and becoming more efficient, but they also have the potential for asymmetrical upside through warrant exposure in OpCo.

We realize that was a bit of a journey (we like those around here), but it can be summed up by asking two simple questions:

If the Real Estate that I own is made more efficient by layering in technology, are my assets worth more or less with that technology powering them?

If I own an expanding Real Estate portfolio and have exposure to the technology company powering it, do I stand to benefit when the Real Estate portfolio scales?

Self-Fulfilling Prophecy

One can clearly see how the interconnectedness between OpCo and PropCo, will create unparalleled investment opportunities for LPs, as well as present more accretive structuring and financing optionality for founders.

Historically, we used to ask ourselves:

“For every dollar invested into a specific Real Estate transaction, how much Real Estate value are we creating?”

We now find ourselves going to an investment committee on a PropCo deal and asking a slightly more nuanced, yet much more exciting question:

“For every dollar that we invest into the Real Estate, how much value are we creating for the Real Estate AND the corresponding OpCo?”

We have examined how these once-standalone entities work in unison to create value. Next up in the series, we will double-click into each Alpha Generation Source to better understand what’s driving the end return on each PropCo investment. Stay tuned for that later this month.

In the meantime, please reach out!

If you’re an entrepreneur considering a PropCo-OpCo structure or an institution exploring the PropCo space, please reach out as we’d love to speak with you! Daniel@alpaca.vc + Ryan@alpaca.vc

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