When I started my business in 2015, I had no real estate experience. I had never owned a home or any other piece of real estate, and no one in my family was in the business. But I had experience in technology and product design, and saw an opportunity to meet a housing need that the real estate industry wasn’t addressing.
So to build Common, I surrounded myself with smart people who knew a lot about the real estate business and also learned some things myself along the way. In fact, I’ve learned a lot, and these are a few of the most notable things about the real estate business that might come as a surprise to an entrepreneur who, like me, was entering the industry for the first time.
Real estate is a fragmented, local business.
When I first founded my company, many people told me that real estate is controlled by a small cabal of families with multigenerational wealth. For practical purposes, this is a myth. While family real estate businesses have power, the industry is incredibly fragmented. Families, wealthy individuals, REITs, institutional asset managers and public entities all own meaningful real estate assets, and no single owner has market power.
The largest apartment owner in the United States, MAA, owns 99,792 units out of a total U.S. apartment housing stock of 20.8 million units. That’s a 0.4% market share for the largest player. If we look beyond apartments and consider all 139 million housing units, it drops to 0.07%. By comparison, Marriott, the largest hotel conglomerate in the U.S., owns about 15% of the market.
The industry is fragmented for a few reasons. One, it’s massive. Estimates place the professionally managed real estate sector at a $8.5 trillion market globally, and the total value of real estate holdings somewhere in the $280 trillion range.
Two, succeeding at real estate development requires deep local expertise. Land prices, market trends, construction costs, contractors, building codes and regulatory frameworks all vary not just by city, but by neighborhood. Being a successful developer in City A does not mean things will go well in City B. Good developers know this and tend to stay close to home. Big developers who have scaled across markets may take a franchise-like approach to incentivize local ownership and decision-making.
Savvy entrepreneurs will learn to take advantage of the industry’s fragmentation. The industry is deep. Even today, we are still meeting new real estate developers — players with meaningful scale — in our most established markets. So business owners can be less concerned about turning away a mediocre, time-wasting opportunity , or even firing a “bad customer,” than in a more concentrated industry.
Downside protection is a big deal.
When you work in a tech startup, you face a world of unlimited upside and a near-religious focus on that upside: Get bigger, take more capital, burn more money, get bigger faster. Downside protection is for suckers and “lifestyle businesses.” Some startups will fail, and that’s OK.
Real estate is much different. A developer’s personal finances tend to be closely intertwined with their projects — much more so than you’d see in tech. In many cases, developers put personal guarantees on completing a construction project on time and on budget. History is riddled with stories of real estate developers who over-levered, misjudged the cycle and lost everything — the savings, the house, the family. This risk profile yields a conservative approach.
Too many real estate tech products are focused on making or saving an owner money, but the real business is in decreasing their risk. Find a way to make an owner sleep better at night, and you can build a strong business selling to them.
Debt can be an exit.
The differences in financing structures between real estate and tech are significant in surprising ways. As an operator, taking on debt can be a low-cost but high-risk way to finance expansion. For instance, as startups grow, they often partner with banks and other lenders to take on venture debt: loans that are cheaper than venture capital but more expensive than often-inaccessible traditional bank loans. Venture debt can be a great way to supercharge growth without selling equity in your startup.
In real estate, low-interest, long-term loans are regularly used to “exit” an asset, cashing out early investors and lenders. It works like this: Once a building is fully occupied and producing predictable cash flow, banks will lend against this stream of cash flow at fixed ratios. A typical debt service coverage ratio is 1.25, meaning that $125,000 in annual cash flow from a building can be used to take on up to $100,000 in annual interest payments. Depending on interest rates, this ratio tells a developer how much money they can “take out” of the asset by taking on long-term loans. For career real estate developers, the proceeds from those loans are often re-invested in doing more deals. This financial strategy might not be obvious to a tech entrepreneur, but understanding how developers make (and lose) money is key to winning their business.