In 2018, the U.S. housing market increased its value by $1.9 trillion, bringing the total market size to $33.3 trillion, with an annual sales volume of $1.7 trillion. With fees around real estate transactions that can consume up to 10% of the property sale price, the size of the new dynamic sector that I will write about below can total up to $170 billion per year (with technology eating $100 billion of it as per venture capitalists). Obviously, half of the fees are going to realtors, who are very much needed to guide consumers. However, 2.5% of the commission that is received by the agent is not going to the pocket of a hardworking person; part of it goes to the brokerage, which needs to verify every single transaction. Additionally, agents cover the costs of things such as tools, insurance, and marketing. The other significant part of fees goes to the bank and title company, which also have to verify the transaction and process the closing, often manually. These businesses have a lot of expenses. Even more, due to the lack of data integrity, work is often repeated by these participants.
Currently, there is an evolving trend. A new wave of proptech (property technology) is rising, where real estate intersects with fintech (financial technology).
Until this year, software-only-based proptech companies failed to attract enough venture capital. It is because, unlike asset- and labor-intensive companies such as WeWork, proptech firms could not get rapid revenue growth. One example is Redfin. VCs in Silicon Valley loved the idea of disrupting realtors; however, Redfin struggled to obtain revenue and growth as per VCs’ expectations. Thus, it turned into a brokerage.
Currently, a proptech startup in the residential space can only make money if it turns into one of the following market participants that charge the most in transaction fees:
- Mortgage Provider,
- Escrow/Title Company.
We do not know how drastically technology will shrink the roles of traditional real estate market participants in favor of automation or change their roles. However, certainly, many traditional real estate service providers will not look the same way that they look today.
So, what is the next big thing in proptech? Why is the new wave of real estate innovation attracting so much attention?
Automation, The Emerging Real Estate Tech Trend
According to Paul Levine, formerly the President at Trulia and currently a venture capitalist with Sapphire Ventures, the past was all about the Internet-enabled businesses. We have seen Zillow, Realtor.com, and Trulia innovate on the front end of the transaction. As for the back end of the property sales process (including financing, closing, home insurance, etc.), Levine stated at Proptech CEO Summit 2019, “To me, [the real estate transaction itself] is a 10x bigger opportunity than the opportunity that Trulia and Zillow and others sort of got so far.” At the 2019 Las Vegas Inman conference, he also noticed that automation of the transaction process is potentially a $100 billion opportunity.
Venture capital is warming up to the real estate transaction process itself. One opportunity resides with businesses innovating within the closing process. In the future, these closing process innovations will allow real estate to take part in the e-commerce arena.
We are now approaching a new era of transaction automation, and we are seeing specific trends leading to this point. E-signatures are now the industry norm in the United States. E-recording and e-notarization are also becoming new industry standards. Of course, there is also a downside of digitalization that should be mentioned: the increasing financial losses due to cybercrimes. Reported losses were $1.4 billion in 2017 and $2.7 billion in 2018, in effect nearly doubling over one year.
Recent technological advancements on the transaction end can change the game for high-value assets like real estate. Ideally, the payment and ownership transfer should happen simultaneously. In the world of traditional shopping, you make your Amazon payment, and you receive your new pair of shoes in the mail. Amazon makes the model work by acting as a trust layer. If your shoes do not arrive, Amazon covers the losses. For high-value assets such as real estate, if the exchange could happen automatically, there is no need for trust layers, and then real estate could become a part of the e-commerce marketplace.
The concept of automatic exchange works for high-value assets like real estate, because the ownership is represented by a document and not the asset itself, unlike the pair of shoes delivered to your address. (In the last part of this article, I will explain how automation of the real estate closing process is possible.) Now, let’s review why venture capital has not backed this idea in the past.
Venture Capital In Proptech
Reasons for the delay in transaction innovation lie in the current maturity of the market and in how venture capital operates. Over the past decade or so, new real estate startups have mostly entered the space in the three niches mentioned above: brokerage, mortgage provider, or escrow/title company. There are many examples of such companies. For instance, Redfin aimed to build tech and disrupt realtors. However, to make money and raise the next round, Redfin had to become a brokerage. iBuyers (such as Opendoor, which was founded by Keith Rabois and Eric Wu, Properly in Canada, and Knock) buy houses to resell. These iBuyers are practically tech-driven flippers and enforce transaction automation as participants of the deals and thus are able to charge as brokers. Companies like Better.com made their way as digital mortgage lenders. Divvy Homes is another mortgage tech startup with a different business model. Other startups like Modus and JetClosing have escrow or title licenses and thus can charge as title/escrow companies while they use technology to provide digital experiences for their customers.
Many pure technology SaaS companies in the real estate industry were working without extensive venture capital for a while. For example, Snapdocs, a SaaS company that helps mortgage providers make the closing process faster and more transparent, was founded in 2012 and only now in 2019 sees high growth and the series B round of financing by VCs (which is typically done in 2-3 years). Similar stories are found in the histories of companies such as Notarize, RealScout, Glide.com, Disclosures.io, and DocuSign (which initially focused on the real estate vertical). Due to venture fund structures and LP expectations, investors need to back technical solutions that provide faster returns on technologies with almost immediate mass adoption, which is often not the case with real estate technologies.
Recently, however, we have noticed venture capitalists waking up to the potential of automating the real estate transaction process. For example, in a TechCrunch survey, Connie Chan from Andreessen Horowitz expanded on the current real estate tech market and the lack of technology to support the real estate process by questioning, “Yes, we turn to Zillow or Redfin when searching for a home to buy or rent, but what about everything that happens before and after that?” Additionally, Brendan Wallace from Fifth Wall stated, “I would characterize the last five years as being an ‘Age of Enlightenment’ for major real estate owners, operators, and developers.” Indeed, recent investments such as those from Sequoia Capital and Founders Fund for Snapdocs, as well as those from NFX and 500 Startups for Modus, prove that the ‘Age of Enlightenment’ is here.
The Future Of Real Estate Solutions
New technologies like machine learning and smart contracts reinvent the transaction beneficially. Shortly, automated real estate transaction will become the new industry standard. The improvement will result in far greater ease and consumer security. Furthermore, it will reduce the busywork that so frequently typifies the realtor’s job.
Let me dive into how exactly technology can make a change in the real estate closing process and create an “Amazon”-like experience. Today, automatic exchanges of money and property ownership are possible with smart contracts that are based on blockchain technology. These smart contracts do not replace traditional paperwork. Instead, they ensure that the connections happen between the digitized paperwork, wire payment, and ownership transfer. Of course, the use of blockchain technology alone is not the key to transaction automation. Transaction automation is a complex task that may involve a number of other technologies, such as e-signatures, e-notarization, and cloud solutions.
The application of relevant tech innovations, such as settlements on smart contracts and e-signatures, allows for the possibility of automating all steps within the real estate property closing process. It means that when the payment is released, the ownership is passed on to the buyer in the same step.
With all stages of the process guided by advanced technology, buying a property can become a pleasant experience. Tech-driven brokerages like Compass, eXp Realty, and Keller Williams Realty are working on improving the experience by investing in proprietary technology. However, the technical solutions that will thrive in the future will be brokerage-agnostic and title-company-agnostic.
Whether or not the incumbents mentioned earlier in this article will be replaced is unclear. However, what is certain is that the real estate industry is becoming more technology-intensive rather than labor-intensive, opening up a $100 billion opportunity for innovators (as per VCs participating in the 2019 Las Vegas Inman conference). Venture capital is warming up to those who are focusing on creating technical solutions to automate routine transaction processes, opening doors for job opportunities that support the new real estate technologies, and ensuring cybersecurity.
Author: Natalia Karayaneva