VCs overestimated how fast proptech startups could scale, says one longtime real estate investor

We’ve all seen the headlines of companies calling employees back into the office, but a record percentage of office space remains unused. That’s bad news for the commercial real estate industry—and, by extension, for the startups that cater to it.

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As the real estate market contends with factors like soaring interest rates and high vacancies, "there is one factor that every startup has to think about," argues Jeffrey Berman, general partner at real estate tech-focused VC firm Camber Creek, and “it’s actually in two parts: One, their pricing, and two, their internal spending control.” He explains that “when you have dislocation in the real estate markets, the owners and operators of real estate very quickly look at their bottom lines and say, 'Okay, this is our bottom line today, let's look into the expense column, and what can we get rid of?'”

Many real estate and proptech (or “property technology”) startups may be finding themselves on the wrong side of that equation. He explains that startups can fall into the nice-to-have and need-to-have categories, but that even “if you're in the need-to-have, you might have a renegotiation on your hands with a real estate company that says, 'Listen, we really need your product, we know this is valuable. But here's what's happening with us, we need to figure out how to be able to continue using your product at a [lower] price.'” For startups Camber Creek is looking at today, Berman says valuations are coming down “quite a bit, because their product, software, or service may not be as mission critical as they once thought for a real estate market in flux.” (Camber Creek has a pretty small portfolio: 27 companies, including investment platform Fundrise and rent payment startup Flex.)

Other investors have been putting capital to work in companies focused on the massive asset class, with the likes of Andreessen Horowitz pouring tons of cash into Adam Neumann’s real estate venture Flow last year, while other firms, including Camber Creek, have invested in commercial real estate leasing management platform VTS. But as The Information reported this week, many proptech startups that went public via SPACs have seen their values plummet amid the tougher conditions.

Berman sees pressure for business models that have a subscription-based service for tenant amenities or residents, where building managers are deciding whether to pass rising costs along to tenants, or if they’ll stop offering those services completely.

In Berman’s view, “many businesses in our ecosystem, I would argue, are good businesses, but not venture appropriate,” he says, given that they lack the high growth prospects that VCs like to see. Yet VCs have nonetheless been excited by the space in recent years, as I wrote about last summer. Proptech “had a light shone on it,” says Berman. While he believes that spotlight is deserved considering real estate is the largest asset class, “at the same time, you have this misunderstanding I think for many entrepreneurs and even venture capitalists” that overestimated how “quickly something could scale in an industry that typically has not been quick to scale.”

Owners and operators in the real estate space have made money doing things the same way for a long time, Berman explains, and startups seeking to disrupt things should approach their offering more as “a step change in terms of the way your business is operated” instead of a tech upgrade for tech’s sake, he believes.

We’re already seeing how challenging the environment is for some real estate-focused companies, like commercial real estate investment platform Cadre. As The Information reported this week, the company told investors last year it would likely make less than $30 million in annual revenue and wasn’t profitable, while in the past six months, it has reportedly been having issues raising tens of millions of dollars (per PitchBook, Cadre is valued at $800 million from a 2017 round).

Other VCs are worried about commercial real estate broadly: In the wake of the bank collapses of First Republic and Silicon Valley Bank, Peter Hébert, cofounder and managing partner at Lux Capital, recently told me that he thinks commercial real estate will be where the “storm clouds” gather next, as regional banks are outsized lenders. “I think commercial real estate will be the eye of the storm,” he said, calling out factors like the work-from-home environment, the COVID impact with “all of these leases rolling off,” and sensitivity to soaring interest rates.

In other words, real estate startups may be looking for shelter.

OpenAI’s losses: Beloved A.I. startup OpenAI’s losses roughly doubled to around $540 million in 2022, according to The Information. The losses came as the startup developed the popular chatbot ChatGPT and hired new employees, per the report. OpenAI is certainly well-funded, though, striking a $10 billion deal with Microsoft earlier this year. Meanwhile, The Information reported that its revenue has increased after it launched a paid version of the chatbot, even as the costs of training future models will likely continue to rise, per the report—apparently prompting CEO Sam Altman to discuss possible future funding.

Have a great weekend,

Anne Sraders
Twitter: @AnneSraders
Email: anne.sraders@fortune.com
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Jackson Fordyce curated the deals section of today’s newsletter.

This story was originally featured on Fortune.com

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