Real Estate Tech and Market Making

Some real estate tech businesses such as Airbnb function like marketplaces — asset light models with reduced operational complexity. While Airbnb does incur costs with things like payments processing and insurance, they play a minimized role in the property experience, which is ultimately left to the seller (host).

Other companies take a different approach. Zeus (business travel), WeWork (office space), and Sonder (distributed hotel) lease space from landlords and property owners in order to market and distribute them through dynamic digital channels. End users and buyers interact with a single brand or entity, rather than a platform of supply-side agents. These types of businesses are betting that users care about a unified and consistent end experience in the physical space, only possible through management and leasing of the individual spaces. They create margins because they lease space from landlords with long term lock-in and lower rates to then ‘lease’ the properties on a more flexible basis with higher rates and shorter durations to paying customers.

Property owners prefer to lock in tenants for multi-year contracts to provide more certainty around NOI (Net Operating Income), the key metric in real estate valuations. It’s more in line with the way they’ve done business for years. Startups contend that they have data and acquisition advantage, as well as the ability to lower transaction costs so its economically feasible to chop up the long-term lease into smaller segments.

One way I’ve thought about framing these types of real estate tech businesses is as market makers. In the stock market, market makers provide liquidity for investors through the purchase and sale of assets held in inventory. They reduce transaction costs and accept operational complexity, but get compensated through making money on the price spread. The ‘managed’ real estate tech companies mentioned before function in a similar fashion. Companies in this mold sometimes come under fire for the risk they incur through their drastic operational expenses. It does not fit the typical venture profile. However, viewing businesses like Zeus and WeWork through the lens of market making opens up a few questions:

• What does it tell us about growth strategy? How many transactions do they need to be a part of for the model to work at scale? What does breakeven/breakout look like?
• What does ‘market making’ look like for other property types (industrial, logistics warehouses, data centers, specialty venues, etc.)?
• How will operating leases moving to the balance sheet under new GAAP rules impact these businesses?

I would say the venture market has had mixed responses to these types of businesses as they’ve worked out their kinks over the years, which is fair and deserved. But words and language matter, and a reclassification of their potential could help investors see the growth opportunities and market participants appreciate the value.

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