Impact of Covid-19 on Real Estate Industry and PropTech (Part 3 of 3)

Interviewer:

Yeah, I think that's really interesting. And obviously, there is some similarities to the auto insurance space from that regard. Let's say your auto insurance is based upon your mileage and sort of good performance. From a driving perspective, I definitely could see the same happening having those sensors in buildings that you spend, you know, either investing a lot of money and spending a lot of time in etc. Your tenants are then being able to base premiums, deductibles, or what have you based on the results of actual measurement instead of a standardized cost.

Zain:

Correct. Yes.

Interviewer:

That's great. Interesting. Maybe you could just tell us a little bit about your investment process. You know, as you said, many VCs have a different view on real estate, or feel as if real estate is a different beast, a different animal to attack. So, that being said, when you are writing investment memos, when you are sitting down and having conversations with your partners about these different startups and investing or not, what are the things that you are looking for? What do you feel like are your...what's your sort of standard process?

Zain:

Sure. So, look, here's something that I think is very valuable for your listeners to understand, right? When you talk about investors, you need to really break it down. And I think there are two types of investors, angel investors and venture capitalists. But I did not appreciate this until I became a VC—and I started off as an angel investor, okay?

They have a very different process. As an angel investor, I want to invest in things I'm passionate about. I can take a lot of risk. It's my money. And I'm looking for 1000X return, or I'm looking for a founder that I think is the next Jeff Bezos, Elon Musk. And it's about the person, 100%, and then it's about, you know, the market size.

One of my mentors, Ben Narasin, we did a video interview on this, and the advice he gave me is great. Here's the priority. It's like people, people, people, and then it's the market size, and then it's the idea, right? That's how important it is. And that translates everywhere, basically. But the later the stage you go, the people are less relevant at this point, you know, you're investing in a future stream of income.

And then Tim Draper, another one of my mentors, who, again, I did a video interview on my YouTube channel. He was giving me advice, and I said to him, "Look, how do I transition to, you know, being an investor?" And he was like, "There's a difference between being a professional investor and an angel investor."

And now that I'm a professional investor, I have a different process. So, with my family office, I tend make more personal investments. And when I do, it has to be a company that changes the world and I have to love the founder, okay? On the VC side, I have a very, very particular process. I've got investment theses and literally have vision statements of what I think the world is going to look like.

We look for startups that can match those statements. When they come through and they apply to us, there has to be some criteria. Our criterias are, you can be based anywhere in the world as long as you're able to expand to the U.S. and you can work with our portfolio.

It doesn't make sense for me to invest in companies that can't relate to my portfolio. If you're targeting hotels, if you're targeting apartments, then I won't be able to do extra due diligence and potentially become a customer. It's unrealistic that I can be a customer to every startup. My God, I'd be flooded, right? And it just takes a long time to do a deal often, property tech, but I want to be able to do a thorough due diligence. So, being able to work with my portfolio, or do a deep dive with my portfolio is essential.

I generally like seed or post-seed stage. So, not pre-seed, but seed. I've done pre-seed, I'm open to doing pre-seed. But if I do pre-seed...like Canopy was pre-seed, we loved it, you know? We just came in, and he had a product, but, you know, hadn't really built revenue yet.

We loved it, we led the round, we joined the board, whatever. But most of the time I'm going to do seed and post-revenue, and the reason is, I've got real estate, I want to start making money from my real estate. And I would rather implement something that can immediately make my real estate more money than something that's too much in the idea stage. So, that's the reason why we do that.

And then I prefer B2B. I'm open to tech-enabled services. We're about to invest in a tech-enabled service now. But here's the fact, you can't put lipstick on a pig, okay? A tech-enabled service doesn't have the same valuation as a software company, neither does an IoT company that sells hardware, right? You're just a hardware vendor.

And so, I have to discount the lumpy revenues that come from integration and hardware fees and sales. And I worked with O.vision on this. We worked with O.vision to say, “Look, pivot away from selling your device and set a subscription fee to your device.” Rather than charging...let's make up a number because, you know, I don't want to reveal too much confidential information.

Let's just say it's 500 bucks a device, right? Rather than selling it for 500 bucks, sell it for, you know, 20 bucks a month, but that customer is going to be with you for many, many years and build a platform on top of it. So, I like platforms, but I'm not shy about tech-enabled services. I'm just not going to pay the same valuation, you know?

So, yeah, that's basically what we do.

Another interesting theme for us is alternative use of real estate. So, if you can figure out how to use real estate differently, maybe it's some unique angle with co-living, or maybe it's something around, you know, automation. And maybe it's just a unique way of running real estate.

Let me be specific, I met a company called Shelter, really liked what they're doing. They are buying land near urban areas and basically putting prefab tents. Really cool idea because now they're able to charge so much more and the future trend for the land is going to be that people are tired of working from home and they want to get out a little bit, so …

Another idea was a co-living startup that was basically buying big-box retail or warehouses and turning them into co-living environments. And putting a yoga studio, a gym, and, you know, every city will need one of these. So, I see a lot of startups like that. When I see startups like that, I think there's an opportunity to become an investor in the real estate and have them be our tenant.

So, at some point, I might set up an alternative real estate fund where we do something like this. We take an equity stake in the startup, and we also go and buy a bunch of land, a bunch of real estate, and they become our tenant. It's sort of like how WeWork started.

So, that's another interesting area. And I don't see VCs ever doing that. That's not a VC backable business, but there's definitely returns there as a real estate investor. And I'll make a lot more from it, because of the risk reward ratio than just, you know, doing multi-family where the cap rates are being compressed so much.

Interviewer:

Interesting, interesting. And I mentioned AutoCamp, earlier. I met AutoCamp, but also Hipcamp is another one of those startups that is using space alternatively. So, to your point, like, there are so many different parts of the huge real estate market that are opportunities that we just haven't hit. And so, you know, in terms of potentially, from an investor point of view, getting up to speed, being able to understand this market more, what do you think are the main things that someone needs to know, that wants to invest in this space?

Zain:

Would you clarify that again?

Interviewer:

What do you think the main things are that an investor, a VC investor, an angel investor, looking to get into or focus on PropTech, construction tech type companies, what they need to focus on fundamentally?

Zain:

I'd say, a lot of startups come to you and pitch a really nice tech vision. I taught myself some basic machine learning and Python and stuff like that, because the number of startups that come to me with an amazing AI story, it's hilarious. You know, at some point, it's like, in your deck, just as you have a market size slide, now startups have an AI slide. You've really got to check if there's a “there” there.

Is there AI? Is there tech? Because if you're not technical, it's easy to get sort of carried away and buy into the vision, and the reality is, it's not entirely truthful. In some cases, they might sell the AI vision, but AI doesn't work unless you have scale. So, that's something to sort of watch out for as an investor. And something that's kind of, I think, specific to PropTech especially.

And then the other thing you've got to be careful about are valuations, especially as you're running a venture fund. You want to make sure you generate certain returns for your LP investors. And very, very key there is to make sure that the market size is large enough, and that the valuation you're investing in is sensible enough so that you can get the return you want as a venture investor. A question I like to ask entrepreneurs is, what do you think you need to achieve, based on this valuation, to grow into the next valuation?

So, if you're raising at a $10 million pre-money valuation, and this is your current revenue... And, you know, let's say it's a $2 million round, so, it's a top post. Well, what do you think your next round needs to be? Right? It needs to be maybe 30 million, maybe 50 million, ideally, right? Maybe 20, 25.

But what metrics do you need to hit to justify that? And when you look back, you realize, wow, this guy has to literally go revenue 10X, maybe 20X to, you know, honestly justify that valuation. So, that's what I mean by really understanding what the milestones are to achieve that.

Now, look, some founders are brilliant. They can create a lot of hype and FOMO. And they can raise crazy rounds, even pre-seed, right? And, you know, those guys have a magic touch, and some of them can actually make it. But on the VC side, I'm much more focused and sensitive on valuation.

You have to appreciate, when you're talking to a venture capitalist, they spend a lot of time on portfolio construction. And that basically is complex modeling and assumptions around “how much money am I going to put into how many startups?” What is the average valuation going to be? And if I make a few moves that break the rule, my whole portfolio construction is screwed up.

So, there are times when I simply can't invest in a startup by the VC fund, because the valuation is too high, you know? And I know the entrepreneur wants to focus on lack of dilution. And I appreciate that, by the way. I played this game myself, I was an entrepreneur.

I raised 25 million in venture capital, for my Series B round, I had seven term sheets. And, you know, I managed to bid up the process so that between the lowest bid and the highest bid, the spread, I had a 3X difference in valuation. One Series B investor for, it's like 30 million that I'm raising at 100 million, right?

So, a bit more than 3X even. But the investors that came in at that range was a family office actually. And by the way, they got a crazy deal, because, you know, it was a 7.8X return after that for the Series B investor. But investors have their limits, and it's true.

Even ownership percentage is really key. You hear VCs talk about, "I need to earn 20% of your business." I didn't believe that before. I was like, "No, you don't need to own 20% of my business. What if you own 10%, but you get such a great return, it's like owning 20%?" It doesn't work that way. I've learned now, on the VC side, percentage ownership is very important. I'm giving you the inside things you'd never hear from a VC by the way. This is how it works.

Interviewer:

No. I mean, this is extremely helpful.

Zain:

This is literally how it works. And then we'll put on our LP documents and our presentation, "Here's how much percentage ownership we're striving for." So, I don't really want to break that. If I say I'm going to do something, I want to honor that and stick to it.

So, a lot of startups will say, you know, "Can you please break the rules? Can you please do something unique?" And I'm like, "I can't, I'm sorry. I've got a process here. I'm now managing other people's money, not just my own with the VC fund. And look, I have to think about fund two and fund three."

Fund one, I want to make sure it's a homerun return, so I can raise a larger fund two and a larger fund three, because that's the stage where it starts to be more meaningful and makes sense. And this is something MetaProp, and Fifth Wall, and all these guys have done such a good job at. Their portfolio constructions are solid. And, you know, that's why they've been able to grow and become such powerhouses in the space.

Interviewer:

Yeah, definitely. I know we're coming up on time here, but I want to open up the questions to you specifically, just anything that...the floor to you specifically. And there's anything that, you know, that you are deeply passionate about that you want to talk about, or, you know, that you find interesting either in the VC market, in the real estate space, what have you. Just so our listeners can, you know, see and get a peek into your brain and what's something you're thinking about these days?

Zain:

Yeah. I've written a lot about a topic that I'm passionate about that does actually relate to PropTech itself, and that's basically environmental sustainability. And COVID has forced us to appreciate that perhaps we're having an impact, perhaps our actions impact our neighbors. And guess what, maybe our actions impact the wider planet. And companies have made lots of promises regarding being carbon neutral. And shareholders and society and governments are holding them accountable now.

Now, what's happening is, in real estate, I'm hearing everyone talk about clean investing and sustainability. You know, brokers have, on their brochures, metrics around green energy and sustainability. Mortgage providers are now packaging up like green mortgage financing options. You are seeing this whole concept start to become somewhat of a fad. It's starting to gain a critical mass.

But I'm skeptical, and I hope, beyond COVID, that this stays. Climate change is having an impact on our planet, and, you know, buildings are a large source of the problem. And a focus on sustainability is key right now, even when it comes to how we reopen up safely. There's a lot of focus on health and safety.

And think about this, for example, right? Are people ever going to return back to work? What's going to happen to the office? Right now, you are working remotely. For the first time ever, you get to spend time with your significant other, or your family, or you get to be in control of your own schedule.

You don't have to hop on a commuter train, or bus, or drive on the 101 highway or wherever you are in the world, in traffic. It's going to take a lot for employers to convince you to come back to their office. So, employers are now thinking about more green spaces. They're thinking about more amenities. They're thinking about sort of a hybridized version of what it means to return back to the office.

Interviewer:

Or like a co-working space, you know?

Zain:

Right, co-working space. Or you only come in part-time, or you come in during the morning, or you come in during the planning stages of a project and not the execution stage, where you can do remote collaboration. So, COVID is forcing us to be more aware of our actions.

It's starting to penetrate in every layer, every part of PropTech and real estate now is focusing on this. And, you know, it's a big trend. But I just hope it stays, and I hope that, you know, beyond COVID, the focus on environmental sustainability is there, and that people do hold real estate owners and companies accountable.

Interviewer:

And, you know, I think you're correct from so many different perspectives, that environmental sustainability will continue to become more of a factor in the investment process, and for a number of different real estate companies, as well as individuals. So, this has been awesome. Thank you so much, Zain. We are so happy to have had you on, and we look forward to continuing our relationship with you.

Zain:

Sounds good. Thank you so much for having me.