- Some real estate companies are valued using different standards than others -- top-line revenue instead of net income or vice verse.
- This leads to sky-high valuations for some companies -- but there could be bumpy roads ahead for tech startups.
- Deals are still getting done though -- and the goal is to be a "cockroach," a self-sustaining company that doesn't need huge valuations and funding rounds to survive because it is continuously profitable.
Real estate broker Joe Rand feels envy and frustration when he reads about the financial valuations of companies like Compass and Redfin — or even ZipRealty when it sold to Realogy for $166 million in 2014.
Zip was valued at six times top-line revenue, while the valuation arithmetic for traditional brokerages — like Rand’s profitable Better Homes and Gardens brokerage — is only four to five times net income.
The difference between the two methods of valuing companies is like the gap between the cost of a Tesla and the price of a skateboard.
“Maybe I should start telling people that I am a technology company — give me $100 million and I can build a kick-ass company,” said Rand.
These sorts of “valuations really don’t make sense, considering their business models are the same as mine.”
Sky-high valuations
Six months ago, when Compass announced it had raised $50 million at a reported valuation of $800 million, many legacy brokers were stupefied. “Are you kidding me?”
Compass proudly boasts it is deploying a traditional broker model.
Eighteen months ago, Seattle-based Redfin raised $70.9 million. Its valuation has been reported to be as high as $800 million.
With old-school business models, these real estate tech darlings seem to be the greatest thing since TSA PreCheck.
And for many smaller startups, venture capital has been as easy as picking up listing brochures at open houses. Firms successfully raising funds recently include Roofstock, SoloPro RealtyShares, HomeUnion, the app-based brokerage Real and Opendoor, which raised $80 million in October in a third funding round allegedly valued at about $580 million.
But these sky-high valuations are yesterday’s headlines, as the technology sector and its valuations are hitting turbulence.
Bumpy road ahead
Once a dance in the park, raising money for tech ventures today is like setting the treadmill incline switch at 15 with 5-pound weights on each foot. If the spigot closes too much, the pace of innovation could also slow.
“On the one hand, VC funds have raised more capital this year than any other over the past five-plus years; so capital is there to be deployed,” said Constance Freedman, managing partner of Moderne Ventures, which specializes in real estate tech ventures. “On the other hand, VCs at board rooms everywhere are telling their companies to start pulling the trigger on their ‘cash flow positive plan’ as funding is expected to tighten up”
She said that the public markets favor profitability over growth and that thinking crosses over to the private funding markets, as IPO windows shrink because fewer companies qualify for what the markets are trending to favor.
VCs are wondering if they are going to need to use more capital to sustain their existing portfolio companies and are therefore tightening on deploying capital into new deals.
“I don’t think this means doomsday for startups by any means but there might be a reset in valuations and a reset in time to close future rounds,” said Freedman.
How are startups handling the dry spell?
On the hunt for another round of capital, one tech entrepreneur who wanted to remain nameless said that, “anecdotally, it does appear that fewer deals are getting done. Which means more meetings, more ‘nos.’ He said that “generally speaking, investors are urging their portfolio companies (and prospective portfolio companies) to achieve profitability faster and run leaner — but deals are still getting done.”
SoloPro founder Tommy Sowers is preparing to raise another round and remains bullish. “If I ran another online delivery service or new social media website, I’d be more concerned. There aren’t too many other markets left to revolutionize as big as real estate.”
Caterina Fake recently wrote a blog dubbed “The Age of the Cockroach,” in which she stated: “Good things happen slow, and since the comeback from the 2008 crash we’ve been living large, investment was easy to come by. But bad things happen fast. And ups and downs are inevitable. Who will survive? As always, the less glamorous, but very hardy cockroaches can live for six weeks without food. Companies that want to outlast the coming funding crisis will need to move fast, cut costs, and plan for a future without much money in it. They will have to lay off staff, move their pricy downtown office to the unsexy exurbs, pivot into revenue-generating business models, kill projects going nowhere, live with less.”
A cockroach builds its business methodically focused on revenues and profits. Controlling spending is as important as growth.
That sounds a lot like a traditional real estate broker. Maybe Joe Rand will finally get his wish and some investor will pony up $100 million, because he is such a good cockroach.
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