The Great “PropCo” Opportunity
By Daniel Fetner & Ryan Freedman
TLDR: We are on the verge of a major inflection point in PropTech land.
Specifically, there is an imminent wave of institutional capital flowing into “PropCo” structures — historically the demand for PropCo capital has been mostly limited to Family Offices, Real Estate firms, and a few esoteric Hedge Funds. However, as the use cases for PropCo structures become more prevalent (see case studies below), and historical PropCo investments become more liquid (i.e. recent Point Securitization), we are seeing more and more true institutions enter the fray.
Alpaca’s LP base includes some of the largest allocators globally. Many of our LPs are strategic in nature and their rationale for investing includes a desire to see unique deal flow in the form of PropCo structures, which they can allocate “traditional real estate capital” to, alongside our VC investment in the company’s OpCo.
For Alpaca, these relationships position us squarely in the middle of our two most important stakeholders (Founders & LPs) and allows us to add value to both parties simultaneously.
There is a lot to unpack here, so let’s start with the basics and then dive in…
Primer + Definitions:
While the real estate industry continues to expand its adoption of technology, startups addressing the industry’s challenges come in many shapes and sizes and have varying capital needs. Some companies may be straightforward software platforms solving transactional or managerial problems, whereas others may resemble tech-enabled professional service providers, which occasionally require a large investment in hard assets — more closely resembling traditional real estate investing. As such, a one-size-fits-all investment approach is rarely appropriate.
To separate these capital needs and business streams, PropTech startups commonly use a PropCo/OpCo structure to raise funds in parallel:
OpCo (Operating Company): The venture-backed technology company whose business model is commonly asset-lite, such as collecting a fee or taking a percentage of GMV.
PropCo (Property Company): An entity collateralized by real estate that is both complementary and critical to the success of the OpCo.
For investors, this spectrum of business models presents an opportunity to deploy a diversity of capital across an entire value chain.
Macro Opportunity for Strategic Real Estate LPs:
If you are a Real Estate Firm, Hedge Fund or a Pension/Endowment Real Asset team, here is why you should be paying attention to the wave of capital being invested into PropCo vehicles.
#1 Current Dislocation:
Given the (relative) newness of PropCo structures, there has been a somewhat limited amount of capital allocators who have really dug into these opportunities. We think there are a few reasons for this:
Unproven OpCo Models: while part of the success for PropCo structures is tied to the ability of the OpCo to execute, remember that the ultimate collateral for PropCo investors are real assets. Assuming the investment is structured with enough cushion, many of these opportunities offer downside protection paired with above-market yields and IRR (relative to the risk taken).
Small Investment Sizing: given that we’re still early in the PropCo evolution, many opportunities have been on the smaller size in terms of potential investment (i.e. $5–20M), which makes it hard for institutional allocators to justify doing the homework. The allocators that we engage with often need to see line of sight to deploy ~$25–100M+ to make it worth their time.
Lack of Return Data: with all new emerging asset classes and categories comes a lack of historical return data. We are just now seeing ~5-year track records from companies who pioneered the PropCo structure in 2015–2016. These companies are paving the way in their respective categories for new entrants to replicate existing structures/templates and not have to reinvent the wheel.
For all these reasons, we believe that there is a dislocation in the market for PropCo investors seeking high risk-adjusted returns.
#2 OpCo Upside Participation:
In addition to the returns offered by PropCo, investors also capture the subsequent appreciation in the company’s OpCo (our LPs do this via investing in our funds). The image below illustrates this synergistic flywheel, depicting how the “PropCo validation” ultimately accrues value to the company’s OpCo. Alpaca’s equity investment in the OpCo captures this subsequent appreciation.
Lastly, especially for companies at the early stage who haven’t fully proven out their model, there may also be an opportunity to negotiate warrants or some other levered upside mechanism. PropCo investors often have more leverage than they realize if they are one of the first to validate the OpCo’s model by capitalizing the PropCo.
#3 Unique Deal Flow + Insight into Emerging Niche Categories:
Because technology trends tend to move faster than real estate trends, technology investors often see the emergence of a new trend or asset class before traditional real estate investors do. Traditional real estate investors will also have a difficult time sourcing PropCo investment opportunities without the right Venture/Startup network.
For example, technology investors were the first to identify the rise of ghost kitchens:
Given the rise of delivery apps (Postmates, Doordash, UberEats, etc.), “kitchen-as-a-service” has turned into a real asset class. UberEats alone has 5,000+ ghost kitchens globally and investors spent $5.5B on ghost kitchens in 2020. Instead of buying an expensive restaurant site with heavy foot traffic, these properties use vacant or dilapidated industrial buildings in cheaper locales. CloudKitchens, for example, has built a $400M+ OpCo/PropCo partnership with Saudia Arabia’s Public Investment Fund (PIF), LeFrak Enterprises & Goldman Sachs to acquire the properties outright.
One of our LPs jokes that, “Alpaca is our guide for rarified air.” Having a guide to 1) help assess these emerging landscapes & 2) access opportunities via their network is critical to identifying and executing on PropCo opportunities.
Case Study for PropCo Opportunities in Single Family Residential:
Fueled by both macro and micro trends, the opportunity for innovation to disrupt the Single-Family Residential asset class has come to the forefront of technology and investment. The main factors fueling this trend are:
- COVID has spurred Americans to look for new homes at unprecedented rates
- Institutional investors see an opportunity to find yield in single-family homes
- Low-interest rates and cheap mortgages fuel the buying frenzy from all sides
Home Equity Financial Products: ~50% of consumers do not qualify for a traditional HELOC; this has led many startups (e.g. Point, Hometap, Unison, Noah, HomeFunds, etc.) to build innovative financial products, which enable consumers to extract their home equity. The financial products are often not considered debt, and in exchange for the cash, investors get a share of the home’s future upside.
Consumer Value Prop: homeowners get upfront cash with no monthly payments. Consumers can use the proceeds to reduce debt, increase FICO scores, pay off high-interest loans, perform home improvements, and ultimately position themselves to access new liquidity options.
PropCo Investor Value Prop: gain exposure to single-family residential homes, typically with downside protection and without the Single-Family Rental headline risk (i.e. regulators are criticizing institutions for reducing housing supply, making it hard for consumers to own homes).
Example: $1M home value, and homeowner receives $100K cash from PropCo. PropCo investor receives 12% ownership in home (10% for $100K + 2% downside protection).
One of the prominent companies in this space, Point, recently conducted the first successful securitization ($140M).
Other PropCo Examples & Use-Cases:
Below are a handful of other examples for PropCo investment. We have identified 10+ use cases that we are actively identifying opportunities and matching our PropCo-oriented LPs.
Rural Hospitality:
Companies like Getaway are acquiring land a few hours outside of CBD and are building tiny cabins for millennials and others to escape the urban environment and unplug. The occupancy rates have been extremely high and COVID has only accelerated this trend. However, it is inefficient for these companies to use venture capital to buy/develop real estate. As a result, they raise PropCo capital from traditional RE investors, who receive a high yield and collateralize the property.
Hypothetical Example: Early-stage glamping startup seeking a debt facility to finance the infrastructure buildout of four new cabin sites. The debt facility, which would function like a traditional construction loan for the lender, would therefore not only drive new revenue but also dramatically increase the enterprise value of the startup.
Tech-Enabled Senior Housing Facilities: (See Alpaca Senior Living Tech Field Study HERE)
Existing senior living communities rarely focus on social health determinants and are often prohibitively expensive; they have failed to cater to the aging demographic, hence why so many seniors have opted to stay at home for as long as they can remain independent. At the same time, there is maturing technology focused on increased occupancy, stay length, and reduced staff turnover, all leading toward reduced variable costs associated with senior care. We believe there is high demand for tech-enabled, purpose-built properties in large urban centers targeting older adults.
Hypothetical Example: SeniorTech startup partners with developer to create purpose-built developments (or units/floors within a project) by delivering a turnkey service package, including: design specs, a targeted marketing and lease up plan, in-person service delivery, and a proprietary digital platform. The Development partner receives a proprietary operating system for their senior housing asset, which should reduce operational costs and drive higher rents.
Short-Term Rentals:
After initially seeing strong growth, short-term rentals and co-living felt the pinch of the Covid-19 pandemic. However, the sector is now starting to bounce back thanks to continuing trends favoring convenience, comfort, and proximity to work. STR assets tend to exceed the performance of hospitality generally, with 50% operating cost reduction over traditional hotels.
Hypothetical Example: A home-sharing startup partnering with a real estate owner and LP for full-service property management through a revenue-share agreement. This arrangement creates a win-win scenario. The LP benefits from increased stabilized property value thanks to the boost to NOI and yield-on-cost generated by the home-sharing service, while the incremental revenue from property management and rev share increases the enterprise value of the startup — and likewise the value of LP’s ownership in the OpCo.
Virtual Real Estate: (let’s get crazy! See Alpaca Virtual Real Estate Field Study HERE)
With growing buzz around web3 and metaverse technology, the role of virtual platforms and land ownership on those platforms is increasingly coming into focus. Decentralized ledger technology and NFTs allow for true ownership and monetization of tokenized virtual land. As a result, these investments can closely resemble physical real estate investment in terms of acquisition, development, asset management, and disposition. While the majority of use cases are currently on entirely virtual platforms, such as Sandbox or Somnium Space, mixed-reality parcels corresponding with physical locations are also growing in popularity.
Hypothetical Example: A startup provides a virtual platform that maps the digital twin of physical properties. PropCo investor partners with the physical real estate owner to “develop” the virtual version of their asset — such as digital gaming, shopping, or event experiences — through a team of virtual architects and designers. The virtual real estate experiences drive value not only to the corresponding physical building, but also to the underlying OpCo’s platform. A hypothetical investor would therefore have three complementary vehicles: serving as LP to a sponsor for physical real estate, directly investing in the startup OpCo, and serving as LP to the same (or different) sponsor for the corresponding virtual real estate.
Please Reach Out!
If you’re an entrepreneur considering a PropCo-OpCo structure or an institution exploring the PropCo space, please reach out to us we’d love to speak with you! Daniel@alpaca.vc + Ryan@alpaca.vc
