On this episode of REALtalk, Brendan Wallace, Co-Founder and Managing Partner at Fifth Wall, joins REALPAC CEO Michael Brooks to discuss the intersection of PropTech and innovation in the age of COVID-19 and beyond.

The episode covers:

• The evolution of PropTech
  
• What the future of PropTech looks like in a post pandemic world
  
• The WeWork crash and its impact on real estate
  
• Fifth Wall’s $100 million Retail Fund
  
• Accelerating brands beyond brick-and-mortar expansion
  
• The online to offline trend
  
• How to move towards achievement of sustainability and climate goals within real estate
  

Brendan Wallace is a Co-Founder and Managing Partner at Fifth Wall, where he guides the firm’s strategic vision.

Prior to starting Fifth Wall, Brendan co-founded Identified, a workforce optimization data and analytics company that raised $33 million of venture funding and was acquired by Workday (NYSE: WKDY) in 2014. He also co-founded Cabify, the largest ridesharing service in Latin America, and has been an active investor, leading more than 60 angel investments including Bonobos, Dollar Shave Club, Lyft, SpaceX, Clutter, and Philz Coffee.

Michael Brooks (REALPAC): Hello, everyone, thanks for listening and welcome to REALtalk, the show that brings you unique insights from leaders in Canadian and international commercial real estate. I’m Michael Brooks, CEO of REALPAC. Our guest today is Brandon Wallace of Fifth Wall, who will be talking with us about the intersection of PropTech and Innovation in the era of Covid. Brandon is a co-founder and managing partner at Fifth Wall, which is the largest venture capital firm focused on the global real estate industry and property technology for the built world. It connects the world’s largest and most influential owners, developers and operators, redefining how the world interacts with its physical environment. Prior to starting Fifth Wall, Brendan co-founded Identified with a capital “I” – a workforce optimization data and analytics company, as well as co-founded Cabify, the largest ridesharing service in Latin America. So a very entrepreneurial, technological and future thinking mindset. Welcome, Brendan.

Brendan Wallace (Fifth Wall): Thank you so much for having me.

Michael Brooks (REALPAC): All right, let’s get to the discussion. Brendan, it seems like long ago we started hearing about PropTech, and a lot of us started attending conferences with panels of startups. It’s got to go back to 2017-2018-2019. Maybe that was PropTech 1.0 in your world, but it was it was almost a must have session at every real estate conference. And we heard about many great early successes, VCs, Airbnb, Convene, Honest Buildings and many others. And I think actually that many Canadian companies were early investors in some of those. Then we had a WeWork crash and probably all of our attention’s diverted away by the pandemic. Where do you think we are now? And what’s the way forward in PropTech following the end of the pandemic? Is it back on like it never left it? Will it be somehow different? How do you see this market now?

Brendan Wallace (Fifth Wall): Yeah, I think PropTech, just as a category, has matured enormously. And I agree with much of what you said in terms of just like the history of PropTech, there was kind of something around 2015 – 2016, which was kind of like a age of enlightenment moment for the real estate industry, where owner operator, developers of real estate who previously never really had any clear or discernible point of view on technology, recognized they needed to. And I know that sounds like something that is obvious. Of course they should have. You have to contextualize this in the real the context of the real estate industry, the real estate industry as an industry which is the lowest spender of any major industry on it. The real estate industry is probably the biggest tech laggard, major industry. And it’s also an enormous industry in the US. It’s 13% of US GDP. It’s the largest asset class, the largest lending category. And basically that whole industry missed the entire Internet and all of mobile. And then around 2015 – 2016, this light bulb went off. And so the demand for tech was voracious. And you had this kind of leapfrog effect where you went from analog solutions, you know, Excel models or literally spreadsheets and kind of pen and paper to fully mobile cloud enabled data and analytics and powered software.

Brendan Wallace (Fifth Wall): And so demand was voracious and it spawned a lot of enterprise value creation over really the period from when Fifth Wall started, like 2016 until 2020, pre pandemic. With that said, I think one of the things that the real estate industry never fully embraced was that, you know, tech is not decorative, meaning it’s core to the business of owning or operating real estate at a operations level. But it’s also pretty core to informing which kinds of real estate assets you should buy, meaning technological trends, as well as sociological and demographic trends to inform asset class and geography. But I don’t think most real estate owners truly got that so prepend. I would still describe PropTech as kind of somewhat theatrical in some cases for real estate firms. I’d say they’re starting incubators or doing one off deals, but it wasn’t the core part of their business. So it was it was just gestating that real estate needed to be this core. I think what the pandemic did is it really highlighted for thoughtful, self-aware real estate owners that tech is not decorative, it’s not theatrical. It doesn’t need to be the small incubator program. It needs to be at the core of owning and operating.

Brendan Wallace (Fifth Wall): Real estate is actually at the core of being a real estate company. And I think that’s partially because a lot of the assumptions that have kind of girded the real estate industry and allowed it to ignore the onset of technology in every other industry were questioned. The kind of anchor of those assumptions was questioned when we don’t know if people are going to return to. In any form like they did pre pandemic, we really don’t know how oversupplied retail we are, we might have thought we had an understanding of it, but clearly we don’t. And I think we’re about to see that we clearly did not anticipate the demand for industrial real estate and data centers. We clearly did not anticipate the demographic reshuffling that has been affected by this kind of work from home or work remote dynamic. And so all of those existential questions are now colliding with the real estate industry. And I think tech is it provides tailwinds to all technology, the PropTech in particular. So I think what you’re seeing right now is a maturation of product from being somewhat decorative and theatrical in terms of how real estate companies engage with it to be existential and core to their businesses.

Michael Brooks (REALPAC): I think they’re you think they’re a certain kind of buckets. When I think back to the early days and there were platforms for use of your boardroom, platforms for use of your house, Airbnb, and then there was stuff that would help you operationally like leasing platforms. And it seems like that was so different than the dotcom boom bust of 2000 – 2001 where everybody talked about disintermediation. It’s like no one really got disintermediated on this one. But everybody’s business model could be enhanced by technology. Do you think of it in terms of major buckets of innovation that we’re the first generation?

Brendan Wallace (Fifth Wall): You know, I understand what you’re saying and I think we’re just at different stages across different asset classes. So the kind of disintermediation dynamic you’re talking about is kind of one the OTAs cropped up and Hilton and Marriott basically were disintermediated from their end customers by the price lines and the expedients. And obviously those companies have gone on to create enormous amounts of enterprise value and price transparency, none of which is actually good for the underlying hotel industry. And I think we saw permutations of that in office. You can kind of think of we work as, frankly, being just a decent mediator for this kind of SMB, more granular tenant base. Airbnb was kind of the same thing in a different way, just kind of almost re-enfranchising a certain asset class, in this case residential, as actually being hospitality. Right alongside that, you’ve also seen enormous growth of enablement technology, which is like the voices of the world that are just simply rendering more friction, less the process of leasing space or buying space or financing space in the business of doing real estate. So this kind of technology enablement, I think the other major buckets that we think are really exciting is just financial service innovation. So real estate capital markets are the largest capital markets on Earth and they’re probably some of the most antiquated financial markets on Earth. And so a lot of what you’re seeing now is like real fintech innovation on the consumer side. So the process of buying a home, getting title insurance, getting a mortgage, getting home insurance, notarizing the asset, discovering the assets, selling the assets, all of those processes have now seen real tech enabled solutions emerge, which I think have added more transparency and enhanced the home buying and selling experience in the US.

Brendan Wallace (Fifth Wall): We haven’t yet seen that collide with commercial real estate, but we’re about to call that just technologies to make more frictionless the operations of real estate capital markets. But the last bucket that I think is surprising to a lot of people is that the line there’s kind of a hard line drawn between what is a real estate company and what is a tech company. And that line is getting pretty blurry right now. It actually has been blurry for quite some time. I just don’t think the real estate industry recognized that. So if you look at, for example, industries like cold storage, cold storage is in operations in a tech business that that is fundamentally what it is. But it’s now characterized as a real estate company. Same thing with data center, same thing with cell towers. So at one point those were tech companies. Now they’re characterized and structured like real estate companies. And so a lot of the business model innovation that we’re seeing today, which we kind of call tech enabled real estate, which is like living coworking on demand self-storage. And a lot of these businesses are actually real estate businesses. And the real estate industry is doing what most incumbent industries do for quite some time. They deny that it’s a competitor. They say it’s a different product until it’s very obvious that it isn’t. And I think you’re going to start to see companies that are like in the Fifth Wall portfolio that we’re investing in, out of a venture capital fund, competing directly with many of the large real estate incumbents. So that’s a whole other theme where that line between real estate and tech gets quite murky and quite blurry.

Michael Brooks (REALPAC): It’s really exciting and really interesting, and I just spent this morning scrubbing fax clauses out of some contracts that we’re working on and there’s still some doctor’s office where you have to fax in data on your blood work and whatever. So, boy, still a long way to go in some sectors. Let’s talk about for a moment your 125 million dollar retail fund. As I understand it, that fund seeks to invest in emerging brands and retail concepts to accelerate brick and mortar expansion. So this is maybe consistent with your theme of tech merging with real estate now early in the pandemic, because we saw it on the valuations and on our on this meeting today, there’ll be a lot of people in the public markets who saw their valuations drop like a stone in the retail sector. But starting to come back now. What’s the vision for this fund and how will it be impacted by the Amazons of the world?

Brendan Wallace (Fifth Wall): So it’s a great question. And I think it’s a fund that is adjacent to our tech strategy. But, you know, retail is this really embattled sector of real estate. I think the death of retail is something that we read about in the papers and in the press constantly. And it’s an interesting dynamic because, you know, in the US, about 90 percent of all consumer commerce takes place offline. And actually consumers are buying more stuff than ever before. But for some reason, retail is dying. So there’s this kind of disconnect and like this macro trend and what’s actually happening in retail, real estate. And I think what’s happening is that a lot of the incumbent retailers, the big box retailers, as everyone has been reading about over the last five years, they struggled, they got overstored, they got over levered, and they are in turn going back up and they’re disappearing. But no one’s talking about is that in their wake, there’s a lot of new emerging challenger brands that are being built online and offline and what is today called omnichannel. Most of these brands actually start building a consumer identity and building a product, distributing that product online. What they quickly discover is that 10 percent of commerce, which is online, is not enough to build a big business. So they have to go offline and become omnichannel. But the challenge is that because they’ve always been native digitally, they don’t know how to. So he said, can we build a fund that would engage with the largest owners of retail real estate who want to attract these emerging clients and want to attract them to their centers and help these brands go offline for the first time? Because the challenge today, let’s say you own a mall.

Brendan Wallace (Fifth Wall): It used to be that you could probably have two hundred conversations with the two hundred largest retailers and fill that entire mall today. That doesn’t work. You’d fill probably a third to half of the mall. This is a question of how do you feel the other half and the other half is now filled by thousands, soon to be tens of thousands of brands. So the granularity has gapped out as consumer choice is tapped out. And so the problem is it turns the real estate owner into something like a venture investor, because if you’re a retail landlord and you’re signing a five year lease with an early stage venture backed business that’s out of money in one year, you are taking venture risk. You’re just not getting compensated for it. So we built a fund to kind of bridge that and say, can we actually invest in an equity level in these new emerging tenants, these younger businesses, higher risk, oftentimes cash flow, negative businesses that are growing and kind of recharacterizing what the future of the brick and mortar retail will look like. And so this is everything from consumer products companies to food and beverage to fitness, to wellness, to health care. But they all really have a kind of omnichannel component, which is they’re both online and offline and existing incumbent retail landlords are struggling to access them. So that fund invests in that thesis. And we’ve made probably 20 investments in and around that thesis.

Michael Brooks (REALPAC): It’s fascinating. When you said venture risk and you started to talk, you started to describe this about owners becoming de facto venture capitalists. I thought about the early days of we work and there always are almost like two solitudes in the office owner market. There were those landlords who were prepared to take a risk on a we work covenant, which was often a single purpose company, no guarantee of the parent. So there you were in a situation where maybe it was perceived as a high risk. Some wouldn’t do the least because there was no parent guarantee with any substance behind it. Some did. Recognizing that this is a trend and let’s just ride this and maybe we got some empty space is not doing anything anyway, so let’s go with it. So I mean, for some that worked out well, others, of course, maybe got caught by we demise. But there are other more successful examples. What about risk for the retail landlord? And is this really what the role is? At Fifth Wall, you’re curating what you believe to be successful retail startups for them through this fund? Have I got that right?

Brendan Wallace (Fifth Wall): That’s exactly right. And I think the WeWork example was really apt because I’ll draw the parallel to retail. WeWork example: I mean, the real estate industry, I don’t have a lot of sympathy for people that are having leases rejected by WeWork because they knew any dynamic where you have capped fixed upside in the form of your lease, but unlimited downside, which if you didn’t understand that, that is a very good chance this company will disappear and will then therefore reject your lease and you’ll have nothing. If you didn’t understand that dynamic, honestly, you shouldn’t be in the real estate business. So I have to believe every real estate owner went into that with their eyes wide open and they were just on the wrong side of a trade. Now, in retail, I think what happens is the same dynamic. You appropriately noted it, which is a lot of these brands that are opening stores won’t survive or won’t become big. So you have existential risk at the brand level. They also have existential risk at the center level, meaning it is also possible that the malls, they’re leasing space and become dead malls, or dead retail streets. So the question is actually one of how do you align interests? So you have downside protection if unlimited down, you have no downside protection of unlimited downside.

Brendan Wallace (Fifth Wall): But how do you create that alignment on the upside? And I think that comes through a construct which we haven’t leaned enough into in the retail industry, which is % rent. So % rent is a way of capturing the sales activity, the cash register activity inside a store. It’s a way of aligning the incentive between the landlord and the tenant. But if you think about what % rent is, it’s just effectively atomized equity in the brand. It is done at a very kind of micro level. And the reality is for many of these brands, the performance of that store is critical. It’s existential in terms of their risk. And the performance of that brand in the mall is also existential. If you don’t have shoppers coming to your mall or coming to your center, come into your street because they don’t care about any of the brands. That’s also existential. So really, what investing in an equity level into these brands is, is just the next logical extension of that. It’s just saying, well, the clearest way to align incentives is to actually invest in the success of these businesses. You can do that in % rent and you have kind of this atomized, very specific, very idiosyncratic synthetic equity instrument around a store. You don’t have it across the entire brand. And for the brands, what they like is that it kind of aligns their interests with the landlords. They don’t have to beat each other, debate each other over a fixed rent. They know their margins. They can identify a percent rent level. That makes sense. So the natural or kind of logical extension of this is that retail landlords and certainly the kind of command and control retail landlords, the owners of centers and strip malls and kind of the owners that control entire districts, whether they like it or not, their venture capitalists. And very soon they’re going to realize that venture capitalists. And so the problem is they’re not very good venture capitalists. They’re leasing team. They’re not great venture capitalists. So how do you bridge that gap between leasing expertise, which is underwriting spaces and sometimes, you know, the duration of different brands and how that drives center activity and center for traffic and center sales with actual equity investments? And that’s what a retail fund does. We say where that bridge we helped drive that alignment by actually enabling you to take an equity position in those emerging retail concepts.

Michael Brooks (REALPAC): It’s a fascinating approach. And I mean, two thoughts came to mind. One is, of course, the owners will say, well, I can’t finance % rent only leases and that’ll be a barrier to me in their malls. But the second thing I’m thinking, Brandon, is that a lot of the asset managers and you talked about people who manage, they don’t have the insight into the digital world to appreciate what has legs and what doesn’t. So I’m thinking of, OK, how are people going to do disintermediate Fifth Wall? And unless they have the knowledge of who the winners and losers are, and that’s almost another staff position for a lot of these owners, I would think.

Brendan Wallace (Fifth Wall): Yeah, I mean, it’s the struggle of, you know, and this is not just true of retail brands. It’s also true PropTech itself. I mean, real estate owners make terrible venture investors. I mean, in some ways, Fifth Wall is we are entire success as an explanation of that reality that the best venture investors, the best people that are investing in operating businesses do not work with real estate companies and they never will. And that’s kind of a challenge for real estate companies, because whether they like it or not, they’re taking those kind of risks increasingly in whether the same thing that we’re seeing in retail. You’re also seeing an industrial you’re seeing it office of the same dynamics are afoot in some way, shape or form in every industry, and so the problem is, as the business of being a real estate owner starts to look and actually operate a lot more like a venture capital firm taking venture capital like risk, having to make venture capital like due diligence and underwriting decisions. How do they do that? And that’s really where I think Fifth Wall has emerged and positioned itself and said, you know, we’re going to step in, we’re going to hire the best in class investors. We’re going to internalize the priorities and the needs of these large real estate owners. And we’re going to invest in what we think are best in class businesses that can grow in scale. And I think if you look at a fifth of those investments out of our retail fund, you look at a lot of the emerging leases that mall owners lease space to. They look a lot different, meaning the business of investing in high risk businesses is not easy and it’s very difficult. Being a venture capitalist is very difficult. And so it’s a challenge. And I think some real estate owners have appreciated that, but not all of them have.

Michael Brooks (REALPAC): It’s a good point. And I can remember discussions with some of the early investors in Fifth Wall and others who whose motivation was they wanted a window. They wanted a window into that world. And this was one way for them to understand who’s out there. What have they got to offer? How does it work? Could I use it in my business and have an informed intermediary like you to help interpret back and forth? So it makes a lot of sense to me. Let me pivot to the to the most recent one, the Climate Tech Fund. And I think you you’ve had a new Canadian investor in in that particular fund. What’s the thought behind the climate tech fund? What are you going after and how do you think you can bridge the gap that we have in emissions reductions for building? I’m assuming that there’s a tech solution in there.

Brendan Wallace (Fifth Wall): Yeah, I mean, in some ways, you just you said the thesis. It’s that the real estate industry is 13% of the US economy. It’s 40% of US CO2 emissions. So the real estate industry is the single most culpable or responsible industry in the climate crisis. And historically, for some reason, the real estate has kind of skirted the spotlight. I don’t think most people intuitively would say, yeah, the real estate industry’s most responsible for the climate crisis. But by the way, all the technocrats, all the scientists, they all know this. But now the public is understanding this. And so the public is turning its attention to the real estate industry because they understand how profound the carbon impact on an embodied level in an asset, but also on an operating level, how profound the real estate industry’s contribution to the crisis is. So that kind of reality dawned on me a few years ago as we were working at Fifth Wall. And then I would talk to real estate companies. I was like, what are you doing to mitigate this? And you’d hear lots of things about awards and Energy Star and LEED certification. But I got I got a weird sense meaning I had one of those. You can just tell someone’s kind of buzzing you. I got it from everyone. And I was just like, I just don’t think this is really the answer is like, you know, getting an Energy Star certification.

Brendan Wallace (Fifth Wall): So we hired someone on our team that understood climate tech. And as he began evaluating this, he was like, you know, even with the best technology and owner of an asset today, even a modern building, if they wanted to deploy all the best technology that they could to mitigate their operational carbon footprint, they’d only get about 50% of the way there. So 40% of real estate industry emissions go to 20% – still massive. And assume that, OK, this is a massive technical gap there. How do we close the other 50%? You’d expect the real estate industry to be invested into the science, the material science, the alternative energy science to mitigate that. But they’re not actually no one in the industry is. And what I think that creates is an opportunity for really forward looking real estate owners to invest against that and reposition their businesses, both from a branding perspective to say, look, we’re contributing to the science that will help decarbonize and mitigate our industry’s contribution to the crisis. But secondly, we actually think this is going to give us a competitive edge, because at the same time this is happening, the public is kind of recognizing this. Tenants are recognizing it like the largest corporate tenants now have carbon neutrality laws and carbon neutrality aspirations that basically. Prohibit them from leasing space from energy pig owners, and so that’s going to be an inflection point.

Brendan Wallace (Fifth Wall): And regulators now are coming to tax the real estate industry. So these local carbon neutrality laws like what happened in New York and what happened in Los Angeles is going to happen all across the US. And so real estate owners generally are kind of caught pretty flat footed. And when you look at the industry, you’re like, OK, for an industry that contributes to the climate crisis, whereas it’s like Elon Musk wears like the person that is kind of like rebuilding the industry, revisioning it with a carbon zero future. And I just didn’t see that. And so the view we always take is how do we then help real estate owners who are not that become that by encouraging them and enabling them to proactively invest in the science, invest in R&D, investing climate tax to help mitigate their carbon footprint? That’s exactly what the fund does. Yes, Ivanhoe Cambridge from Canada made a very significant investment at that fund. And we have a number of other large international pensions that are coming into that fund. And actually a large number of US REITs and private real estate companies and financial investors. So that fund, I imagine, will be probably one of the most heavily subscribed funds we’ve had because, you know, the real estate industry’s climate problem is only getting worse by the day.

Michael Brooks (REALPAC): Yeah, it’s fascinating, it reminds me of the early days of green buildings when tenants would say, I want a green building, but I’m not going to pay a nickel more in rent for it. And there was a bit of a standoff for a little while until owners realized that the risk to them was building obsolescence, not getting the nickel more in rent. And so a pivot had to happen. And what you’re talking about is another debate coming up. Brandon, look, we’re almost out of time here. It’s been a fascinating discussion and frankly, could go for another half an hour. It’s very inspiring to hear from you, all of these conversations. And we look forward to continuing to hear about your success in this specific space, particularly the ESG and low emission, low emission economy is top of mind for us as well as an association, and I’m sure many of my sister associations around the world. So thank you so much for coming today and for being on this with us.

Brendan Wallace (Fifth Wall): Thank you so much for having me.

Michael Brooks (REALPAC): Well, this is Michael Brooks and that’s it for this week’s episode of REALtalk. Be sure to visit us at realpac.ca/realtalk and subscribe wherever you get your favorite podcasts. If you have an idea for a topic or a guest, please send me an email at podcast@realpac.ca. And if you like what you hear, give us a 5-star rating. Thank you for listening and tune in next time.