Five Traps for Real Estate Tech Entrepreneurs

Selling into real estate owners? Here's what not to do

For better or worse, real estate is gaining a reputation as a tough industry for tech innovation. While perhaps warranted, many of the proptech startup failures I witness can be boiled down to a handful of mistakes. And I see those mistakes getting made over and over again; it’s rare I meet an real estate tech entrepreneur who isn’t making at least one.

Today’s letter will go through each of those mistakes with examples as well as illustrations of what entrepreneurs can do instead to build their businesses while avoiding these mistakes.

Mistake #1: Repeatedly Hit a Stabilized Asset’s NOI

VCs love recurring revenue software businesses. Margins are high, revenue is predictable, and vertical software offers plenty of inspiring success stories. And since buildings last a long time and don’t change very much, real estate seems like a great fit for the recurring revenue SaaS model.

Unfortunately, the fundamentals of real estate finance don’t agree, and many entrepreneurs have failed in their attempts to sell a product that is an expense line on an individual building’s P&L, even if that product comes with the promise of future savings or increased revenue.

In the real estate world, NOI is everything; stabilized buildings are valued on a multiple of NOI. So the cost of a software product isn’t just a monthly fee, it’s the impact of that monthly fee on the building’s asset value given current valuation multiples. Suddenly, the cost of a $50 per month software product sold into a stabilized multifamily asset trading at a 5 cap is $12,000. ([$50 * 12] / 0.05

While many software products promise higher revenue or lower expenses, owners don’t always get credit for those benefits in the sale or refinancing process. For example, buyers will often apply their own revenue and cost assumptions to a potential purchase, adding back in costs based on their own operating model—but are unlikely to look line-by-line at individual software expenses, meaning that the seller gets dinged for a SaaS product’s cost but doesn’t get credit for its benefits.

Software with benefits that are very difficult to tease out of the noise—higher tenant renewal rates, for instance—are in a particularly tough situation. But the same goes for products that promise improved results in categories that aren’t currently a problem, such as tenant marketing in supply-constrained coastal markets.

What to do instead: In general, developers are far more willing to spend money during an asset’s design and construction and lease-up periods if they believe it’ll enhance the asset’s ultimate value. Vendors can be much more successful selling high-ticket one-time purchases during that time than attempting to harvest recurring revenue in perpetuity from stabilized assets. For startups, this also means cash comes sooner, reducing the need for outside capital.

And relying on one-time sales on a per-project basis doesn’t mean that each purchase needs to be sold in again; most developers have a regular flow of new projects and will be happy repeat customers of a good product.