First American News LLC: Raleigh, NC: Property startups emerged as one of the hottest tickets for venture investors during a record-breaking 2021. The recent stock-market selloff is testing the limits of that boom. Real-estate companies collected $12.2 billion in venture funding last year, according to private company data tracker CB Insights, up 34% from the previous peak in 2019.
The number of funds investing in the sector is also growing. Wilshire Lane Capital, based in Los Angeles, said Tuesday it has raised $40 million for its first vehicle, joining an expanding list of real estate-focused venture-capital firms. The fund’s backers include landlord Morgan Properties, J.P. Morgan Asset Management and private-equity firm Nile Capital Group.
Venture investors say in the past real estate was slower to adopt new technologies than other major industries, such as finance. That is creating growth opportunities now for property startups—sometimes referred to as proptech companies—which the Covid-19 pandemic has accelerated.
Low interest rates and rising stock prices made startup investments more appealing, while landlords looking to fill malls and office towers have been more willing to pay for new technologies such as touchless doors, lunch-delivery apps and clean-air filters.
“2021 was a watershed year,” Wilshire’s founder Adam Demuyakor said.
Now, the recent rout in technology stocks is putting venture appetite for real estate to the test.
Share prices for some of the biggest real-estate companies that went public last year, including co-working company WeWork and property brokerage Compass Inc., have fallen significantly. That has made high valuations of private companies harder to justify.
Although money is still flowing, valuations at some recent funding rounds have dropped by as much as half, investors say.
Mr. Demuyakor said he is mostly shying away from larger, older companies, where the growth in valuations has been strongest, and instead focusing on newer startups. The company’s investments include real estate-fintech companies Esusu and Jetty, and metaverse real-estate firm Everyrealm.
Real-estate companies used to get little attention from venture investors. That changed in the late 2010s, when SoftBank Group Corp. and other fund managers began pumping billions into companies like WeWork, Compass and construction firm Katerra Inc.
Venture investment in real estate dropped in 2020 following WeWork’s botched IPO attempt and the start of the Covid-19 pandemic, but came soaring back in 2021.
As in other industries, real-estate startups have benefited from central banks opening the cash spigot during the pandemic. A boom in blank-check companies targeting real-estate firms brought in new investors, said Allison Sedrish, who heads proptech coverage at Barclays.
Startups also are getting more funding from landlords. Blackstone Inc., Brookfield Asset Management and RXR Realty have emerged as major backers of property startups.
“A lot of these traditional real-estate companies have immense cash balances, and one use of it is to invest in innovation,” said Merritt Hummer, a partner at startup investor Bain Capital Ventures.
Brendan Wallace, co-founder of Fifth Wall Ventures, a real estate-focused venture-capital firm, said about half its $3 billion in assets under management comes from real-estate firms. Last week the company said it raised a new 140 million euro ($159 million) European fund.
Mr. Wallace said he expects the boom to continue in part because the sector is newer and hasn’t attracted as much funding in past years. “I don’t think you’ve seen the same run-up that you have in other categories of venture,” he said.
Other investors say they see similarities to the dot-com bubble. “It feels the same to me,” said Craig Spencer, chief executive officer of real-estate company Arden Group, which recently launched a proptech investing venture. “Before that bubble burst, there was a euphoria and a sense of things can only go up.”
The real-estate sector also poses challenges to entrepreneurs and their financial backers. Fields like property brokerage and office management have historically had low profit margins, and efforts to juice returns by leasing space long-term and subletting it short-term can backfire.
Flexible-office operator Knotel went bankrupt last year in part because of its massive lease obligations; WeWork narrowly avoided the same fate in late 2019. WeWork said it has since managed to get more longer-term commitments from its customers, reducing risk.
Katerra went bankrupt last year after raising almost $3 billion, in part because it underestimated the complexity of the construction industry, former employees said. Sellers of software often depend on a few big landlords as customers, who may have little incentive to spend on technology when rents—and profits—are high.
Startup investors say they no longer underwrite capital-intensive real-estate companies as if they were nimble software firms. The massive size of the real-estate industry is still enticing, and a growing corporate interest in making buildings greener is creating new opportunities for startups to make money.
“None of the capital has really dried up,” Ms. Hummer said. “If anything, it feels like there’s as much capital as there ever was in the market.”