How Family Offices & Real Estate Firms Can Source Great Proptech Opportunities

Note: This article first appeared the Fall 2020 edition of Family Office Real Estate Magazine.

Publisher’s Insight: For years now, I have been a big supporter of property technology or “proptech.” It is an area that will change and disrupt the industry, mainly because the industry is so fragmented and because it is one of the sectors that typically lag other sectors due to the nature of the business. This article is insightful and helpful in identifying some of these opportunities, primarily because this is the future of real estate.

Many family offices that invest in real estate property startups (“proptech”) are real estate operators with reasons for investing from strategic insights to benefit their assets. For the family office that is heavily invested in real estate, the case for investing in proptech startups or Venture Capital funds is doubly strong.

But it is much easier said than done. This scenario is quite typical:

1. A family office with real estate roots decides to find great startups to invest in or partner with.
2. Someone, usually from the younger generation of the family, with a fair amount of real estate knowledge, but virtually no startup experience is tapped to lead the charge.
3. Once the word gets out of the interest in investing in proptech companies, they are bombarded with startup and fund pitches, not to mention a host of investment advisors.
4. Many of these investments are not even proptech, but enough are that he or she spends tons of time wading through pitch decks.
5. A few of these startups look pretty good, so the family office decides to invest and/or set up pilot projects with the operating company.
6. These fail miserably.
7. The family office decides that engaging with startups is a waste of time.

There is, however, a better way to go about this.

HOW TO IDENTIFY GREAT STARTUPS TO PARTNER WITH AND/OR INVEST IN

As the Cheshire Cat told Alice, “If you don’t know where you are going, any road can take you there.”

If the goal is to partner with a proptech startup to get a leg up competitively or even if the operating company vets the startup’s solution, you need to be looking at startups at the right level of maturity. This means looking for startups raising Seed ($1M-$2M) or, to be safer, Series A ($4M- $8M+) rounds.** Earlier stage startups are still cocktail napkins and science projects; the later stage isn’t cutting edge. The founders are also less experienced, and the product is still a bit raw, so while it’s tempting to want to get in earlier (and you can write smaller checks and still be a player), you probably want to start with the slightly more mature guys. This filter, by itself, will weed out many startups and save tons of time.

* * Important note: you would not be investing this amount in the startups. The lead investor will generally fund half or more of the total investment round. A family office participating in the round would likely invest 10-25% of the whole round. An investment of this size would equal roughly $100K-$500K+, depending on the round’s size.

MAKE SURE YOU PICK THE RIGHT PARTNER

In-depth domain knowledge isn’t enough. You wouldn’t let someone with no development experience pick real estate assets to invest in, so why would you let someone with no startup investment experience pick startups? You need to pair up the industry experience with the VC skills. Fortunately, it’s possible to find people with 5+ years of venture experience and at least some proptech investment experience. It is those investors who will ultimately want to raise their venture funds. If approached with this kind of opportunity, they will look to invest in 10-20 startups over the next year or two with the expectation that, if all goes well, you would jointly look to bring in outside money to turn this into a formal VC fund. To give you a sense of what this translates into financially, assume that you are focusing on (relatively) more mature startups raising Series A rounds (average $5M) where you are committing to 10% of the round (average $500K check size), so for 10-20 investments, this comes to a $5M-$10M commitment.

As an alternative, some family offices invest in a proptech VC fund to get early access to a range of portfolio companies. Depending on the size of the fund. It will generally want a $1M-$5M investment (technically, a “commitment”) to be called over 4-6 years. With a smaller investment, an investor would not necessarily have access to as many proptech startups. The exception would be if an investment were made into multiple funds.) A downside would be you would most likely not receive the same insights into the rapidly evolving real estate world you would otherwise get from investing directly.

Often you need someone with more than just a proptech VC experience. Many investors with real estate operating companies use the business line to help assess how well a startup’s product or service fits the market; in some cases, their entire purpose of investing in proptech startups is to find innovation for their own real estate business. If piloting with the parent company is vital to your strategy, then having your business units work with the startup for some time (viz., a “pilot” or trial project) is critical. It would help if you had someone who can work internal politics. You can’t pilot with startups if you don’t know who in the line is genuinely interested in innovation instead of just paying lip service to it: you need someone who can work internal politics. This is not part of the typical VC experience, so you have to look at the candidates’ backgrounds for other indications. Prior experience at large companies (including consulting), business development work, a stint at an accelerator, etc. are all some clues that a candidate might have the right political antenna.

THE TRUTH ABOUT INVESTMENT ADVISORS

Having third parties bring you deals in exchange for a commission is entirely normal in the real estate world. This could translate into a kiss of death in the venture world; the best startups are never represented by an investment advisor.

VCs are the most networked people on the face of the earth. VC professionals present at panels or judge pitch events all the time. They meet dozens of entrepreneurs every week and know – and have often co-invested with – virtually every other VC in the same space. If a founder can’t network into a warm introduction to a VC, how will he find customers? Plus, the very fact that the founder thinks he can wave his hand and have someone else take on something this crucial to his business for him is a huge red flag. Those startups are invariably hairy, old, over-shopped deals that every halfway serious investor has already turned down.

DON’T GO TOO DEEP INTO TOO MANY STARTUPS

When you get a startup’s pitch deck, the temptation is to read it all, think about the business as a whole, and come to a holistic, well-reasoned thesis. That kind of deep-dive takes much time, and there are many startups to review. The startup needs to earn that much of your time. Your first pass review should be much quicker, just a few minutes, to filter out startups that can’t make the cut. It takes time, domain expertise, and much deal flow to build the kind of pattern recognition that lets you immediately filter out the proptech startups that are too early or too fatally flawed to be worth the extra time.

SETTING UP SUCCESSFUL PILOTS

There’s a saying in business: You get what you measure.

Do you measure the number of startup pilots a division undertakes? Is this a factor in whether a manager gets promoted? If you do track pilots, how do you track them?

One of the more subtle mistakes companies makes a focus on success. In most cases, a failed project is a black mark that can cost a manager their bonus and promotions. If a project isn’t performing, the manager will often throw more resources at it until they can claim some victory, delaying resolution, and wasting time and money.

Instead, the focus needs to be on learning quickly. Pilots should explicitly be for 3-6 months, and the questions should telegraph that even negative results are a win, as long as they get there quickly, and the results are actionable. To make this a bit more concrete, here are a few examples:

THE RIGHT QUESTIONS TO ASK:

• “It’s been three months; what have we learned so far? What actions should we take?”
• “Have we learned enough, or do we need another three months?” What specifically would we learn if we extended?”
• “What would teach us more and generate more actionable results: extending this pilot or moving on to the next one?”

THE ANSWERS YOU WANT TO HEAR

• “We’ve tried syndicating XYZ deal on a real estate blockchain exchange but didn’t get any qualified investors.” (Close this pilot and try something new.)
• “We proved that we could charge an $$$ per month premium for smart apartments, but the product itself was buggy.” (Is it fixable, or should we ditch this startup and pilot with a competitor?)
• “Our tenants love the amenity portal, and the software seamlessly coordinates access for the dog walkers, fitness pros, cleaners, etc. with the front desk. Plus, the founders are a pleasure to work with.” (Stop the pilot and roll out more broadly.)

SUMMARY

For the family office with significant real estate assets, investing in proptech startups is not just a financial opportunity; it is also a strategic opportunity in many cases. But it is much easier said than done, and how you do it and whom you pick to do it for you to make a huge difference.