Real-estate startups are retreating from a growth-at-all-costs model, casting aside an approach that has worked for many internet companies but has sputtered in the concrete world of office buildings and lodging properties.
Startup companies often prioritize growth to establish dominance in an industry before competitors can get a foothold. But in industries like co-working and hospitality, the costs of leasing or renovating space can make pursuing rapid growth expensive and inefficient.
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We Co., the parent of co-working giant WeWork, has reversed course most dramatically after launching more than 500 locations. Since its failed effort to go public last fall, the company has stopped expanding in some money-losing markets and laid off thousands of employees in a bid to cut losses.
But even before stock-market investors turned away from WeWork—in part over concerns that its pursuit of rapid growth and market share didn’t offer a clear path to profitability—other property startups were also hitting the brakes.
Residential real-estate broker Compass, which has raised $1.5 billion with a fast-growth model, hasn’t expanded into new markets since 2018. Knotel, a flexible-office company that grew aggressively, slowed down its expansion in the fourth quarter, according to a report by CBRE Group Inc., and recently laid off 5% of its staff, the company said. The hotel company Oyo also recently laid off employees and signaled it would moderate the pace of growth.
“Growing at the pace at which Oyo has in the past few years, we sometimes went ahead of ourselves,” Chief Executive Ritesh Agarwal wrote in a recent note to employees that was published by the Times of India. “This year we are taking steps to address this.”
The shift in strategy reflects a break from how companies like Amazon.com Inc. and Google have pursued rapid expansion. In recent years more Silicon Valley startups chose to burn through cash to grow. The rationale: Online marketplaces and social networks can more easily and cheaply add customers once they reach a certain size.
But for real-estate companies, the cost of leasing or building means rapid growth is often more expensive, and grand scale matters less in terms of quashing competitors. Facebook’s giant network of users gives it a crucial advantage over any startup offering a social platform. But small hotels or co-working firms can still compete head on with Marriott International Inc. and WeWork in their local markets.
Real-estate companies have had cash to burn largely because venture-capital firms are investing record sums into the sector.
Last year, real-estate startups raised $31.56 billion in equity and debt, according to CREtech, a more-than threefold increase from 2018.
In some cases, startups were able to raise that money by convincing VC firms that they were technology companies, which would better justify the faster growth rate and higher valuations. They pointed to investments in software like smartphone apps.
Jamie Hodari, CEO of co-working company Industrious, said it is a challenge to focus on profitability when potential backers demand rapid growth above all. “It’s hard to stand your ground. It’s hard to stick by your convictions about what the right thing for your business is when these incredibly wealthy, incredibly experienced people are telling you something otherwise,” he said.
Not all VC executives agree with such aggressive growth strategies. After 16 years of booming venture investment, investors are willing to take more risks, and startups choose to expand before they have figured out how to be profitable, said Greg Sands, founder of venture-capital firm Costanoa Ventures.
“Premature scaling in a capital-intensive business is insanity,” he said.
Some real-estate startups tapped the brakes early on. Industrious and co-living company Common shifted from signing long-term leases to revenue-sharing agreements with landlords. Leases are often easier to close for startups, allowing for faster growth, but they also create massive liabilities in the form of guaranteed rent payments.
Even WeWork plans to do more arrangements that limit risk, such as joint ventures, franchising and management agreements, a spokeswoman said.
“Real estate is not like a social network,” said Jason Fudin, chief executive of WhyHotel, a pop-up hotel operator that signs management agreements.
Other real-estate companies are growing more cautiously. Sonder, which leases apartments, adds furniture and sublets them by the night, initially compared itself to Amazon in an investor pitch posted online. It said it hoped to add 4,100 units a month to become the world’s largest hospitality brand by 2025 and “dominate” supply of short-term rental units. The San Francisco-based company raised $225 million at a valuation of more than $1 billion.
CEO Francis Davidson said in an interview that while he is still rapidly expanding, growing at maximum speed “is less of a thing for us going forward,” in part because the risk of rival startups raising large sums of money is now lower.
One challenge the company ran into as it grew is changing local regulations. Sonder shut down more than 100 units in Boston last year, after the city changed short-term rental regulations, and donated the furniture to charity, the cheapest form of disposal. A Sonder spokesman said “many of the units would have been off-boarded anyway,” because they no longer met the company’s standards.
Write to Konrad Putzier at konrad.putzier@wsj.com
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