Proptech capital formation falls back to earth

Capital raised by the top 20 firms in the space ticked up modestly in 2023 after nearly doubling in 2022. Managers say slower growth was expected given macroeconomic headwinds and could be the norm moving forward.

Private capital formation around property technology strategies stumbled in 2023 after a boom year in 2022. The firms in this year’s PERE Proptech 20 cumulatively raised $11.28 billion over a rolling five-year period, an uptick of roughly $1.3 billion or 13 percent over last year’s total. The bump is paltry compared with the 80 percent growth rate between the 2021 edition of the ranking and the 2022 version.

Managers say the year-on-year stagnation reflects the exuberance leading into 2022’s list more than it indicates waning interest in real estate innovations.

“The 2021-22 phenomenon was money moving into the space at a faster than absorbable pace,” says Travis Connors, co-founder and general partner of Boston-based Building Ventures. “We see a steady increase in opportunities, but there is a mismatch in understanding of how fast these things can scale and what the capital deployment into the companies needs to be. The money always seems to flow far faster than the absorption of the innovation into the markets.”

Capital volumes were not the only element of the list to remain largely unchanged. The top four fundraisers in 2022 held their spots for 2023, and the threshold for inclusion in the list – $100 million – was also the same.

Brendan Wallace, managing partner of New York-based venture capital firm Fifth Wall, attributes this consistency to a consolidation of capital around the top performing firms in the space.

“The largest, most institutional firms have a depth of talent, a depth of experience, a brand recognition that still attracts a lot of capital, and in a more challenging environment, like the one we find ourselves in right now, usually those differences become more pronounced, not less,” Wallace says. “If you haven’t seen a lot of reshuffling of the ranking, my assumption is that a lot of that has to do with flight to quality.”

Macro headwinds

Macroeconomic conditions have changed materially since the last iteration of the ranking in ways that have diminished investors’ near-term appetite for loss-heavy venture capital strategies and could reshape the proptech sector for years to come.

The biggest shift has come from the monetary policy arena. Interest rates have risen steeply during the past year and a half, jumping up in unison around the world.
Herbin Koh, head of venture capital and growth equity at Hong Kong-based Gaw Capital, says the rapid tightening by central banks has cut through the proptech space like a double-edged sword. On one side, higher interest rates have wreaked havoc on a start-up industry cultivated on record-low borrowing costs. On the other, incumbent real estate firms – some of the most loyal supporters of proptech vehicles – have seen their profit margins squeezed, thus reducing their capacity to invest.

“Gone are the days of ‘cheap’ money, which affects how start-ups grow,” Koh says. “This, coupled with landlords needing to deal with the consequence of rising rates and tenants turning in keys, makes it harder for asset management teams to focus on proptech opportunities that are ‘good to have’ but not a ‘must-have’ in the near term.”

Scale in specialization

Wallace says his firm’s reliance on the commercial real estate sector for funding has proven advantageous in the current environment. Fifth Wall’s investors – many of the largest commercial property owners and developers in the world – are benefiting from their own form of consolidation. In turn, he says, that has generated more capital to commit to proptech strategies that offer both a financial return and access to innovative technologies with a built-in network of users.

“Valuations have reset quite a bit to levels that we were seeing five, six, seven years ago that are just a lot more attractive for investors”

Jake Fingert
Camber Creek

“There is going to be more consolidation in the real estate industry… there’s more consolidation, probably, in every industry, and so the big will get bigger. That is exactly what will happen and what has been happening in the real estate industry,” Wallace says. “As the big get bigger, their ability to justify making investments in tech increases, and so that has been a tailwind.”

In some regards, the pullback of capital in the proptech space has been advantageous to specialists. According to Connors, generalist venture capital firms that flocked to the property sector from mid-2020 to early 2022 have largely moved away from the space. He attributed this shift to both macroeconomic pressures forcing them to refocus on their core competencies, and a newfound understanding of the idiosyncrasies of commercial real ­estate.

“People fell in love with the idea that if something is logically better, then it should scale really quickly. But that is counter to the way that real estate companies and construction companies operate,” Connors says. “They tend to operate as collections of assets or collections of projects, so this enterprise scaling vector that you’ve seen in so many other markets, like fintech, that’s not quite how the real estate world is organized.”

The result of this reduced competition and more costly capital market for start-ups has led to a decrease in the valuation of proptech companies, a development that could create a buying opportunity for firms with deployable capital, says Jake Fingert, managing partner of the Washington, DC-based proptech venture capital manager Camber Creek.

“Valuations have reset quite a bit to levels that we were seeing five, six, seven years ago that are just a lot more attractive for investors,” Fingert says. “That will definitely be a good thing for the industry going forward. There will be a lot more companies where investors are positioned to make stronger returns and funds are positioned to do better.”

A new paradigm

The top managers in the proptech space remain confident in their ability to attract and deploy capital in the sector. But there is little doubt that the complexion of the space is at or near a sea change moment. Without the benefit of cheap, abundant funding, venture firms and the companies they invest in are under enhanced pressure to deliver results to investors.

Some in the space welcome this shift. Jonathan Hannam, co-founder and managing partner of Sydney-based Taronga Ventures, says the tighter fundraising environment will help industry standouts differentiate themselves.

“If there is a broader slowdown in capital, it is probably in areas where the market hype is being replaced by experienced mangers that can deliver returns and asset level outcomes,” Hannam says. “As our sector matures, what we are seeing is that investors are more focused on managers that can deliver performance – both at a fund level and also within their portfolios.”

The challenges facing the venture capital space and proptech more specifically are unlikely to abate anytime soon. Even if conditions were to stabilize sooner than expected, few anticipate the space would look exactly as it did in the heady years of 2021 and 2022. For now, leaders in the sector are bracing for an extended period of moderate capital formation.

“We’re prepared for a multi-year slowdown across real estate capital markets as well as technology capital markets,” Wallace says. “I hope to be surprised, because I hope we’re being too conservative, but we’re prepared for that.”