Think about the word “landlord.” It connotes a relationship in which the power dynamic is very much tilted in favor of the property owner. Highly coveted space in prized locations is offered up, and rent is paid for the privilege of occupying it.
That centuries-old dynamic is now being questioned, with the coronavirus having forced people into a massive remote-work and remote-shopping experiment. The pandemic has wrenched real estate’s ingredients for change out of the slow cooker and into the Instant Pot, according to the head of the largest real-estate focused venture-capital fund.
Brendan Wallace is the co-founder of Fifth Wall Ventures, which has over $1 billion under management and has backed startups such as Opendoor (iBuying), States Title (residential closings), VTS (CRE cloud-based portfolio management), Industrious (co-working) and SmartRent (smart homes). The Real Deal caught up with Wallace to discuss these key shifts as well as hear his take on why retail real estate needs a government bailout.
This interview was conducted May 3. It has been condensed and edited for clarity.
We’re talking right before what would’ve been retail real estate’s prom night, ICSC. The future of retail just looks really, really patchy right now. You’ve made some big bets on brands that started out online [Allbirds, Cotopaxi] and are now moving into brick-and-mortar. [Retail-focused REITs] Acadia, Macerich are some of your investors. And you’ve written a piece on Medium I thought was quite interesting, where you asked for a $30 billion retail bailout. Let’s talk some of those things out.
I think what you’re looking at is a potential systemic crisis. The retail ecosystem is comprised of so many different constituents. You have the landlords, but then you obviously have the retailers of all different sizes. All different types and flavors, from the emerging new omnichannel retailers that our fund invests in to the established big-box retailers. Then you have the mortgage lenders, insurance companies, local jurisdictions who collect property taxes. You have the employment base of all the retailers. You have the underlying vendor ecosystem. And I think what’s a little daunting here is that you are, to some extent, looking at a systemic crisis. You have the Covid-19 crisis itself. Literally no people are walking through retail assets.
There’s still that fear. There’s still that sense that this is not a safe space.
Yeah. And that ties into some of the broader, more, almost sociological and psychological shifts that are afoot. The largest forced adoption of e-commerce since the invention of the internet just happened in the last 45 days. Versus March of last year, e-commerce transaction volumes are up 74 percent. So many of those customers used e-commerce for the first time. It’s almost like we accelerated the e-commerce adoption curve by five years. Plus we compounded it with a psychological fear around being in a public place.
On top of that, you have a broad freeze in capital markets for both retailers and retail landlords. You just have to look at the publicly traded equities and the debt values of many of these companies to assess how frozen those markets are. And all of that is taking place in an environment where many people have discussed the death of retail, which I’ve always thought is an overplayed phrase in the press. But what I think is true is that you have retailers that are large rent payers that are both overlevered from a debt perspective and over-stored. Retail footprints are too large and so many of these retailers needed to contract anyway. So when you add all these forces together, you face what could be a pretty systemic crisis.
In a more loosey goosey way, it’s also the fabric of a city. What makes a great city is activity, is shopping. If you think of New York, one of your images is probably going to be Madison Avenue, Fifth Avenue.
You’re right, it’s the fabric of a city. The street life, the streetscape of having stores is critically important. It’s the ambience of a city. But it’s also a functioning supply chain. If you were to stop goods and services from reaching consumers close to their homes, that’s a national security issue. You can’t stop goods and services from getting to consumers. We have to keep that flow going.
You need a brick-and-mortar retail ecosystem to be functioning just to provide the goods and services to consumers. Today, most people are surprised by this, but 10 percent of all U.S. retail is e-commerce. So if all we’re relying on is e-commerce, we’re going to face a national security issue, a public health crisis in and of itself. This is what I would call a social imperative for the government to take action. And it was surprising that they didn’t.
But [the Paycheck Protection Program] was a debacle, right? The way the funds were allocated, the graft that happened. Public companies got money from the government when it’s supposed to be for small business loans. So I find it difficult to grapple with, given that we just had this debacle, we’re talking about injecting a further $30 billion into another new program, which again, could be ripe for abuse.
There’s probably a big distinction between the PPP and providing government capital to retailers themselves. One distinction is the granularity. The granularity of the PPP program is what makes it very challenging. A lot of these local banks struggle with the volume of applications. And you’re dealing with oftentimes very small businesses. I know there were some exceptions, which is, I think the graft that you’re referring to large companies that probably should not have gotten PPP loans did. And that should’ve been prevented. But the vast majority is going to small businesses.
Could you draw a parallel between what you’re talking about and the bailout of the auto industry, where a lot of people have argued that we rescued an industry that didn’t deserve rescue?
The similarities are related to jobs. Protecting American jobs is obviously very important. But a portion of the bailout of the automotive industry was around outsourcing. And moving a lot of the production plants abroad, which you can’t really stop from happening. You can’t move a shopping mall abroad. That’s the unique feature of real estate. You can’t move a building. So real estate is inherently local. It depends on immediate access, the walkable or drivable distance to an asset, exactly, as I was describing for that supply chain to function.
So I think the dynamics are similar in the sense that we’re trying to protect a spike in unemployment right now. But they’re different in the sense that there actually is long-term viability to making sure that we don’t see a systemic crisis in the U.S. retail industry right now. Because we really don’t want that to happen. And I know your readers are a lot of real estate owners.
One of your solutions I thought was quite interesting: Get the five largest retail landlords into a room with the government and hash out some best practices. Standardized forbearance agreements, for example. You’re backed by the likes of Macerich, Acadia, some of the big players in the retail space. Have you had this conversation with them? Like, “Hey, Macerich or Acadia, would you be down to sit with the government and work something out with your competitors?”
So I can’t comment specifically on the conversations we’re having. But what I can say is why I do think it makes sense. There’s two stages to it. The first is landlords need to act together to solve their collective-action problem, to solve the over-storing problems and the overextension problems and the overlevering problems of retailers. And that needs to be solved systemically. So if you’re dealing with a retailer that’s in crisis, solving their real estate problems with one landlord doesn’t really solve the issue. You need to work with all landlords together.
The second thing is that these rent concessions themselves are a form of equity investment. If you think about it, if you give a rent concession it’s equivalent to paying equity, it’s just negative fixed costs, which is the equivalent of positive cash inflows. So it’s a form of equity. To be biased, one thing we’ve always advocated for is that the relationship between landlord and tenant change — landlords should think of themselves and conceptualize themselves and build relationships with tenants as an equity investor. I think this is a unique opportune time to affect that.
It’s not a simple relationship between the tenant and landlord. Ownership is often such a Byzantine structure. Private equity is such a big player, particularly with some of these big retailers, Victoria’s Secret, JCPenney, you name it. So how would that work?
I think it’s complicated and it’s going to require a lot of discussion. But one way you could conceptualize it is if you were to say, “I’m going to give you a particular rent concession. I’m going to reduce your rent by 30 percent over the next three years to help you survive. Or I’m going to let you out of this particular lease. So I’m not going to get rent income, but you’re going to save that particular cost.” If you were to take a net present value of what that represents to retailers, it’s a form of equity investment. Now it’s not useful if any landlord does it on their own because it’s too small. It represents too small a percentage of the total retail footprint of any retailer.
But if all the landlords come together and work with the retailers and say, “Hey, let me understand how you’re thinking about the go-forward state of your business. Do you think you have too many stores today? Do you think you’re paying too much rent because sales are too low on a handful of your assets? And let’s sit down with you and collectively holistically solve your problems for you by either reducing rent or maybe letting you out of a handful of leases. But in exchange for that, we become your equity partners.”
What happens today without that taking place is that rent concessions are being negotiated in hand-to-hand combat, one-offs between landlord and tenant. And when you get a rent concession as a retailer, your landlord doesn’t get any equity ownership. So in many ways they [landlords] help that retailer survive, but they don’t capture the upside.
I feel like lenders have worked with a lot of the retail landlords we’ve been speaking with. But you just don’t know how long that will go. Maybe in a couple more months, they’ll be like, “Look, we need to get paid as well.”
Yeah. And I think it’s a reconceptualization of what it means to be a landlord. This has been true of all of real estate. It’s something we [Fifth Wall] have advocated for a while, which is: The relationship between landlord and tenant needs to change. It’s no longer sufficient to have a purely transactional relationship. The tenants, whether in office or industrial or retail, care about a more full-service relationship with their landlord. And part of that I think means aligning your interests with them.
And maybe there’s a buy-sell in the future. Where when things normalize and capital markets normalize, these landlords can get out of that position. So that’s one component of it. And then you asked about how that would relate to government action. And I do think there’s a strong imperative for the government to take action here because of jobs and because of tax revenues and sales taxes.
The collective action also assumes that retail landlords would want to get in even deeper with the retail industry — and let’s just talk major cities right now where retail real estate can be repositioned. A mall is a very different proposition — there’s not very much you could do with a mall. What you’re talking about is an even longer, deeper, more intimate relationship in retail between landlord and tenant. Do you think they [landlords] would even want that?
I think the right question is, do they need that right now? Right now, the top of the funnel in the retail ecosystem is solvent, revenue-generating, cash flow-generating, rent-paying retailers. And right now, the assumption that that is a cohort that is going to continue to exist is no longer safe.
There was this trend that had been gestating for years, where landlords were saying, “I want to have a more intimate relationship with the retailers.” That was existentially why we created the retail fund.
These emerging digitally native brands want to have a deeper relationship with their landlord. They want to have a partnership relationship. They want to have an equity relationship. They want their landlord to intimately understand their business and make recommendations about how they should expand. And the best way to do that is through equity ownership.
What we’re facing today is that there’s many retailers who never would’ve thought of their landlords as being equity owners in their business. There’s many landlords that never would’ve thought of their relationship with certain retailers as coming to look like anything like equity. But if we’re going to affect the sustainability of the retail industry, as close as it could look to what it looked like at the end of 2019, that needs to happen.
My analogy is, you’ve got a bad employee. They’ve been with you for five years and then they come to you and ask you to pay for their MBA. It’s like, “Do I really want to invest again in this person’s future?”
It’s such a huge portion of the economy and I’m not sure it’s the time to be asking ourselves, do we want this part of the economy to exist? This part of the economy that literally employs one in four Americans.
Your vision for saving retail, does it have space for the mom-and-pop retailers that a lot of people will argue make up the fabric of a city? Or are you saving a Red Lobster over an independent mom-and-pop?
I don’t think it’s an issue of either/or. I think we should all be rooting for all of retail to be saved. But what I think the CARES Act didn’t specify is programs to solve the large retailers’ issues. And the large retailers employ tens of thousands of people. Collectively they employ millions. So if all we do is build programs to solve the mom-and-pops, that’s great and I strongly support that. But the issue is we just have large retailers that are right now confronting crises of being over-stored and overlevered.
It’s just that a big portion of where the government should be focused and where landlords should be focused is on these medium and large retailers that are huge employers of people. Because the social imperatives there are in some cases larger. And I actually think you solve, to your earlier question, the granularity problem. You’re not talking about 10,000 retailers, you’re talking about in the hundreds of retailers. It’s a solvable problem. Now it’s complex because you need someone to underwrite these assets and understand what is their pro-forma state — what do they look like in the future? You need someone to help reposition them, but it’s a much smaller number that we’re talking about. Now, the dollar number is very large.
That’s your $30 billion number?
It’s kind of a swag to be totally candid. I think any amount that you can put in, it’s in the tens of billions of dollars. To contextualize that, $25 billion today, or I should say in February, was paid in retail real estate rents in the United States. Every month. Today, I think it’s a safe assumption to say that somewhere between 70 and 100 percent of that is not getting paid. What that does to capital markets, it freezes them. So you’re just trying to unfreeze it and you can’t unfreeze it unless your order of magnitude response is commensurate with the amount of rent being paid.
What role can you see Fifth Wall playing in getting this to go?
What we’re good at doing is convening the industry to solve collective-action problems. That was why we created Fifth Wall. We realized that individual landlords forming their own corporate venture-capital programs were not optimal. They were oftentimes small, they were not super professional. So what we said is, instead, if we put the whole industry together, many of their problems are common. They’re dealing with the same technology pain points. The same technology opportunities. What if we could convene all of their collective intelligence, all their collective distribution? That was how we created the first real estate tech fund that we launched in 2017. That was our $212 million fund. And we had seven landlords in that. What happened in the course of the next two years was that more owners said, “Well, should we do this ourselves? Or should we work together? Should we join this consortium? Because it’s more efficient and there’s economies of scale in doing it all together.” We went from seven in the U.S. to 54 across 11 countries.
You’re talking as LPs?
Real estate owner-operator-developers as LPs. So when we took that learning, we said, “How can we solve this for other categories, other pain points that real estate owners have?” And then more recently we started the Carbon Impact Fund. Which again, it’s a collective-action problem. Individual landlords becoming carbon neutral don’t make a massive difference. The industry becoming carbon neutral makes a huge difference.
On the retail fund, are you even thinking of deploying capital right now?
We’re actively deploying capital. I think we want to support our existing portfolio companies. This is a time where you really want to lean on your investors that have the long-term interest of your startup in mind. So this is the time when you really show your stripes.
Those from the real estate industry are with you guys in terms of betting even now?
Absolutely. I think what this has done is accelerated a lot of the technological disruption forces that were already well afoot before this crisis. So I don’t think this is a repudiation of, “Oh, we shouldn’t adopt technology.” I think if the conclusion a real estate CEO makes from this crisis is, “Okay, thank goodness. I don’t have to adopt real estate technology for my assets,” I don’t think that CEO is going to have their job for that long.
That is not the appropriate conclusion to this crisis. So I think if anything, it underscores how can we make technology work to solve some of these big public health and collective-action problems. And actually, that’s exactly what we tried to do with our Carbon Impact Fund. We said the similarities between a public-health crisis and the climate crisis are in some ways uncanny. The timelines are quite different, but the dynamics are very similar.
Brendan, even though it has to be said, a lot of real estate CEOs do not believe in climate change. This is just the way it is.
And that may be true. I don’t want to comment on the political beliefs of real estate CEOs.
This is not political. This directly impacts the response something like this would get. So I’m not talking politics.
I would agree with you. However, here’s the dynamic that’s happening right now regardless of what you believe as a real estate CEO — whether you believe the climate crisis is happening, or you believe climate change is happening or not. What’s happening is that within your political jurisdictions, you have mayors that are increasingly green. And even though Trump pulled out of the Paris Climate Accord, many mayors are putting their cities right back in. New York did it, Los Angeles did it. And here’s the dynamic: Just like we talked about with retail, you can’t move a building. So it doesn’t matter what your political beliefs are. If you’re going to get taxed and you’re going to get fined for not being carbon neutral or not meeting certain carbon-neutrality standards, it doesn’t really matter. That’s now an economic incentive.
What’s interesting is that when you look at certain states, if you look at an electoral map of the most red state, the most Republican state in the U S., and you look at voting maps, you’ll see a lot of red and you’ll typically see blue dots over every city.
And if you look at where most of the real estate value is concentrated in those cities, it tends to be in the blue dots. So oftentimes cities have green Democratic mayors. So regardless of the political beliefs of landlords, it doesn’t really matter. Because if their buildings exist in jurisdictions where climate change becomes an imperative, where carbon neutrality becomes an imperative, it just becomes an economic issue for them. And in some ways, that’s what we should be looking at government to do. Government in part exists to solve collective-action problems.
And to make unpopular decisions as well.
In the long-term interest of society. And I think we all know there’s a different time horizon in the tenure of real estate CEOs and the tenure of the climate crisis. So what I think we are seeing and what we will continue to see is that local jurisdictions will enact carbon-neutrality laws that are very much on standard for the Paris Climate Accord. So it doesn’t matter what happens at a federal level. Cities will move towards carbon neutrality standards that will force real estate owners by the simple fact that they cannot move their building to conform to that. So I’ve said this before, but I fundamentally believe it. Wherever sustainability sits on the priority list of a real estate CEO, I said by 2025…
That timeline, has it been accelerated or has it relatively stayed the same given what’s just happened? Where we’ve had a near-shutdown of the economy for the last eight weeks.
In the short-term, the number one focus for any real estate CEO should be and ought to be the response to the Covid crisis, the public health dynamics around that. I think if we start to look a year, two, three years out, if again, the conclusion a real estate CEO draws is that, “Oh, now I don’t need to focus on sustainability” — I don’t think that’s the right conclusion. I don’t think that is a long-term conclusion. I don’t think that’s a long-term CEO.
I think sustainability falls into one of the top three priorities for every real estate CEO, certainly in the U.S. and most likely in the entire Western world, within the next 24 to 36 months. And we are seeing it. We are seeing it on all sides. Because these landlords are. This is being impressed on them by the many constituents of the real estate industry. It’s coming from tenants.
I think that’s the really interesting thing. It’s coming from investors too.
It’s coming from capital markets. It’s coming from debt and equity providers. It’s also coming from the insurance industry. The insurance industry is saying, “We’ll give you lower rates for more climate-resilient assets.” It’s just good business for them. So building more sustainable assets is just fundamentally a good business. You’re able to lower your cost of capital. But I think the unknown is the pace of regulatory change. And I would say we’ve been enthused and encouraged by what’s happened in New York and Los Angeles. Those are obviously coastal cities with democratic mayors. But there’s a lot more coastal cities with democratic mayors. And there’s a lot more inland cities with democratic mayors out there that are looking to the response of real estate owners to what happened in New York and Los Angeles.
And going to your question about, what have we learned from the Covid response? What is the relationship between real estate owners and their local political jurisdictions? I think what they’re seeing is that government can make a difference when it acts decisively. When they act in unison. There are really profound effects that happen. So I think a lot of mayors are going to be emboldened by seeing the response to the carbon neutrality laws in New York and Los Angeles. And they’ll say, “Can we take this to solve more long-term collective action problems? Are there insights we can apply to solve this issue and this imperative we have to become carbon neutral by 2030?
I will predict that your Carbon Impact Fund is probably going to — whatever target you had for it — it’s probably going to be bigger by a factor of two or three. I think you are hitting on something quite significant. But let’s talk Fifth Wall’s other bets. I’m thinking of Opendoor. It’s a really capital-intensive business. I think going in you knew that profitability is a long road with a business like that. A lot of the established players [Zillow, Realogy] have moved into this space as well. And now it’s frozen.
I don’t want to comment on any portfolio company and its performance. But what I can comment on is the sector of iBuying and how I think this changes it. And I think what’s happened is that you do, as you appropriately put, have a freeze on activity. And I think that’s obviously incredibly unfortunate. But I don’t think this in any way undermines the need for an iBuying solution for consumers. When you back up and you say, what is iBuying? You have the U.S. residential real estate market, which is the largest peer-to-peer market on earth. It’s a gigantic eBay for homes, the most expensive asset most consumers ever purchased.
And as a result, the information, the transparency, the speed of transactions are all suboptimal. You can get more information about what’s the best running sock to buy on Amazon than you can about the quality or the condition or the economic outlook of a home you’re buying. So I think what iBuying is just philosophically, it’s saying that we shouldn’t just have a peer-to-peer market. We should have a C-consumer to B-business market. And a B-business to C-consumer market, which is exactly how iBuying works. A consumer sells a home to Opendoor, Opendoor flips it, and ultimately sells it to another consumer.
What that gives them is the ability to capture data, provide transparency around the sale. So you just have a higher level of quality, a higher level of experience. Because you’re dealing with an institution that’s in the business of constantly selling homes. It’s in the business of providing a standardized quality to those homes. And I think on both sides, it’s giving security of close. Right now it takes, I think it’s close to 140 days to typically sell a home. That’s a very long time.
I understand the bet that you made and why you made it and why you’re relatively bullish about the sector. But I was more asking about whether it will be able to withstand a sustained shutdown given how capital-intensive it is.
The short answer is I don’t think anyone knows. That’s the nature of startup investing. I think we’re really optimistic about Opendoor in part, because a lot of the demand for selling a home very quickly with a guaranteed price is driven by expediency on the consumer side and driven by a need for security. So at some point Opendoor will start operations again. [Editor’s note: Opendoor resumed iBuying one day after this interview was conducted] And when they start operations again, I think you’ll have buyers or sellers that are thinking more pragmatically about, “If I want to sell a home, do I really want to price optimize right now? Or is what I really want the security, the guarantee to close on a timeframe that works for me? To move my family, to get the equity out of my house, whatever my needs are. I want some security around that.”
The other thing I think is really important to note is that while you do have a lot of iBuyers out there, what matters is the quality of the institutional investors. And I think one of the things Opendoor pioneered was institutionalizing the capital markets for iBuying. The quality of the lenders that are actually providing capital to enable them to buy homes more efficiently. And return capital to investors, according to a certain return profile. They institutionalized that to an extent and to, I think, a level of integrity that you hadn’t seen in this space before.
Your co-founder, Brad [Greiwe], comes from that background, comes from Invitation Homes.
And Invitation Homes is in many ways the exact same story. Many people from 2010 to 2014 were buying single-family homes. And there was this cottage industry that emerged of local regional buyers that were buying homes. What Invitation Homes figured out is how to do it institutionally with speed and scale. And I think if you look at iBuying, no company – to the extent Opendoor has – has figured out how to institutionally buy homes with speed and scale. And that’s partially driven by the fact that they were first and they’re the largest. But I think it’s in large part driven by the quality of the institutional investors that backed them.
It’s also their main event, which is both an opportunity in terms of refining it and a threat. Because if that’s all you do and you can’t do it anymore, we’ve seen big layoffs at the company, for example. So it’s both things. On a more positive note, I think people are just getting more open to the idea of virtual, just because they don’t want anyone in the house going through everything.
I think you’re exactly right. We’re seeing an acceleration of those trends. I think in some ways it underscores why I think a company like Opendoor is really well-positioned. Which is if you’re going to be buying a home virtually, you want to have trust in who you’re buying it from. It’s the same thing with e-commerce. I feel a lot more comfortable buying a pair of socks on Amazon than buying them from another person that’s selling socks on eBay. It’s just the nature of standardized information. And that relates to everything you mentioned. The virtualization of appraisals, the virtualization of tours. Frankly, digitizing every aspect. The closing of a home transaction, insurance, title insurance, mortgage, notary, all of those things ought to be digitized. It’s hard for an individual seller to adopt all that. You don’t need an individual seller of a home to become an expert on setting up a virtual tour. Setting up a 3D tour. Building relationships with every virtual transaction company out there. We want a company to intermediate many of these transactions, because it provides a higher quality standard and a higher degree of trust to consumers.
I want to circle back to the changing landlord-tenant relationship. How else will that evolve in the post-Covid age?
Part of it is what we’ve always talked about, which is reconceptualizing what it means to be a landlord. And taking responsibility for the wellbeing of the occupants of your assets. One of the mindset shifts that you will see is that landlords, I don’t think, thought of themselves as micro-mayors. In the sense that we know that our mayor is responsible for the wellbeing of the people in their jurisdiction. If they’re drinking polluted water, that is the mayor’s fault. That is the local political authorities fault. But if a building owner is not providing safe air or potentially contaminated air to their tenants, I don’t think they internalize that responsibility previously to the extent they could have or should have. And I think coming out of this crisis, landlords will see themselves as, “We have a responsibility to the wellbeing of our tenants, that…”
You don’t think that’s wildly optimistic? You’re talking about institutional landlords or all landlords?
I think it’ll start with institutional landlords because they have to, but no, I don’t. And I’ve had conversations with many of our 54 real estate company CEOs in the last two months. And I would say the gravity of their social responsibility has dawned on them. And the importance of protecting their tenants, not just with respect to the elements. Protecting your tenants from rain or snow or cold air is always how real estate has conceptualized itself. But now we’re protecting it against microbes. And we’re protecting the well-being of tenants around things we had never previously conceptualized as falling into our responsibility as landlords. And I think landlords are saying, “We need to internalize that.”
I do think a big part of the solution will be technology. And I think it prompts really existential questions about what it means to be a landlord. And when I think it starts to collapse is the distinction between just a transactional relationship with your tenants and having a social and a health imperative to protect them, which is very much like being a micro-mayor. You have jurisdiction over your assets.
That’s catchy. Then something like a cloud portfolio manager — VTS is one of your portfolio companies — I guess I could see some of that being filtered through a software like that as well. The responsibility of looking at a portfolio in terms of wellness.
I think any company that can digitize information about a building and provide transparency both to the tenants at the corporate level, but also to the individual users through their devices or through notifications, that’s going to be very important. And I think those are questions that employees are going to ask of their employers. And therefore employers or tenants are going to ask of their landlords. So the response is coming. This [pandemic] has effectuated a change in the psychology of everyone. And it will in turn effectuate a change in, I think how landlords conceptualize themselves. And they’re going to take a more, I hope, and I actually believe this, a more holistic view around their responsibility to the well-being of their tenants. It’s not just about keeping the bad guys out and the rain out and the lights on. The relationship between landlord and tenant is much more intimate. And it has a social profundity that I don’t think was appropriately captured as little as 90 days ago.