As founders of the coliving operator Ollie, my brother and I took 400 pitch meetings over three years before we would arrive at our first “yes” in 2014. Four years later, this “yes” would eventually rise 42 stories from the ground in Long Island City as the largest purpose- built coliving project in North America. Upon raising Ollie’s Series A round, the bet we made was that this building, known as Alta, would demonstrate the depth of demand for coliving and the viability of its economics to building owners, shifting the attitudes of risk averse institutional real estate investors, and in the process, bending coliving’s expansion trajectory.

Alta served as the perfect case study for our thesis: 422 beds of coliving spread across floors 2 through 16, co-located in the same building as conventional apartments on the floors above. The coliving floors achieved 98% occupancy in virtual lockstep with the conventional apartments, yet at rents that translated into a 30%+ NOI premium per square foot versus conventional apartments. Likewise, at no stage of the project’s financing, from construction to recapitalisation to the permanent loan, or anywhere in the capital stack, was there ever a coliving penalty - not in the debt yields, not in the loan-to-cost ratio, nor in the cap rate used for sizing the equity recapitalisation (the next best thing to an asset sale). While there were certainly important lessons learned along the way and items that would require future iterations, by most measures, coliving’s debut in an institutional scale asset could be considered a smashing success.

From there, we braced our team for an explosion of interest. We began measuring media impressions in the billions. Within a matter of months, the front-end of our funnel swelled to over 125 projects. To keep up with demand, we asked a lot of our team and we hired aggressively. In the process of preparing for our trip to the moon, we discovered too late that our rocketship had no thrusters. Our margins collapsed under the combined weight of competitive pressures, our own unquenchable thirst for deal flow and weak negotiating leverage - absent control over real estate co-investment capital - that would prove insufficient to protect our fees, to defend our brand standards or to ward off re-trade attempts even on deals already inked.

Worse yet, a look under the hood of our 125+ deal pipeline would eventually reveal another coliving conundrum: adverse selection. Specifically, as word circulated that coliving could enhance multifamily yields by 75+ basis points, it seemed every multifamily developer with a busted deal wanted in. Unfortunately, the developers were not advertising their deals as “busted” upfront and vetting these opportunities was an arduous process involving countless hours of our team’s time and an incredible amount of the firm’s resources - a particularly damning dynamic for a young, cash-burning startup that hadn’t yet crossed the critical breakeven threshold.

‍

‍

Despite the case study at Alta, the multifamily industry’s natural risk aversion meant that institutional investors would still need to be paid for taking a chance on a new strategy - a premium yield above conventional multifamily return thresholds. It wasn’t enough simply to take a busted deal and make it pencil to a conventional multifamily return. The starting place for us needed to be a conventional multifamily deal that was already viable without coliving.

Throughout, we gained a fuller appreciation for the myriad of challenges developers face on a day-to-day basis. Land bought too high: not anticipating the added real estate tax burden or the increased set-asides for affordable housing units. Import tariffs impacting steel costs. Labor markets tightening, pushing construction costs to new highs. Environmental reviews and traffic studies becoming more onerous. Introduce coliving and the headaches only compounded further from there. In the most liberal cities, homeless advocacy groups would argue that coliving wasn’t doing enough to address the crisis. In tony neighbourhoods, their conservative counterparts would argue that coliving threatens to undermine the character of their neighbourhood by inviting undesirables into the area.

While Ollie’s intellectual property is now in the care of Starcity, a coliving peer, it is doubtful that Ollie’s experience was unique. To this end, the pioneers of asset-light coliving may have a problem… one that isn’t COVID-19. Despite the consumer embrace of coliving, proliferation of the strategy remains underwhelming amidst the aforementioned multitude of supply-side constraints, leaving industry operators tens of thousands of beds away from profitability.

Couple these supply-side constraints with bloated corporate overheads, a vestige of the blitzscaling strategies promulgated by early-stage venture backers, and the result is an even greater reliance on market share gains. In the chase for market share, however, fee compression invariably ensues, kicking off a vicious downward cycle. While the near-term treatment - endless rounds of venture funding - simply numbs the pain, what remains elusive is the type of product with ubiquity and self-sustaining scale that enables asset-light operators in other segments, like hospitality, to survive on management fee streams alone.

Instead, asset-light coliving operators find themselves in a foot race against the inevitable return of sobriety in venture funding markets. For these operators, longevity hinges on more than another round of funding and will require more than just consolidation or cost discipline.

‍

“Even with the benefit of horizontal expansion into conventional property management white space, consider this: we may well land a human on Mars before asset-light coliving operators land a dollar of profit.”

‍

‍

So, what is an asset-light coliving operator to do? Despite the industry’s failure to launch, there is reason to be optimistic about the future of the strategy, particularly in light of its demonstrable track record of generating enhanced asset-level returns (30% NOI lift, 75+ bps of yield enhancement versus conventional multifamily development). While some operators may seek to exit via consolidation, an alternate path may be emerging on an asset-heavier coliving model that stands to be more sustainable and create better alignment between owner and operator.

In short, the arrow-riddled pioneers of asset-light coliving must abandon the illusion of their VC-worthy moonshots and instead become comfortable as settlers of the land right here on earth. They must translate their intellectual property into actual property, whereby real estate cash flows, not merely property management fees, directly support the overheads of their operating platforms. To do so will require re- aligning themselves vertically as “captive operating companies” either within institutional real estate investment firms or within appropriately capitalised development platforms.

‍

‍

On this front, as we look ahead to coliving’s second act, post-pandemic, conditions may be ripening for the emergence of such vertically integrated captive operating companies, with three factors in particular helping set the stage for institutional real estate investors to embrace this approach: 

• Firstly, for risk-averse institutional investors, fear of the unknown is often more crippling than the worst- case scenario itself. Not only did the pandemic induce the mother of all recessions, but its direct targeting of the urban core, dense congregate living situations and social connectivity essentially placed a bullseye squarely on the back of coliving assets. While coliving assets have not emerged unscathed, the relative risk profile is no longer a dreaded unknown. Indeed, many coliving assets have fared only marginally worse than conventional multifamily. And, on the backside recovery of the pandemic, they are arguably better positioned to be among the most resilient given their appeal to a younger demographic cohort who will likely be the first to return to city life.

• Beyond this, with the Fed Funds target rate at the zero lower bound (0.00-0.25%), yield-seeking institutional investors have fewer attractive domestic alternatives for their capital. With equities and bonds both priced at record high valuations, portfolio re-balancing stands to favour alternative asset classes - and a bonus to asset classes like real estate that provide a potential hedge against medium-to-long term inflation risk. Yet, within real estate, two of the five main food groups - retail and office - raise concerns of secular decline, while the cyclical hotel recovery may take years, leaving industrial and multifamily assets as the potential key beneficiaries. But, even these two sectors are priced at historically high valuations, leaving much to be desired. Against this backdrop, asset allocators may seek specialised sub-segments that offer a combination of secular tailwinds and yield enhancement versus the more traditional real estate food groups. By the same token, the specialised nature of these sub-segments points to heightened execution risk, thereby placing greater importance for investors to align their capital with credible operators.

• And lastly, the pandemic-induced recession has not shaken the ESG theme out of increasingly impact-minded investors. To the contrary, it has served to accelerate the trend. With coliving broadly seen as an antidote to the housing affordability crisis, the loneliness epidemic and climate change, this trifecta of positive social impact puts coliving in an enviable position relative to many other emerging sectors competing for investor mindshare, particularly within commercial real estate — a tailwind that seems unlikely to abate any time soon.

Altogether, the fragmentation of the real estate industry and the resultant wide range of divergent interests amongst its investing constituents may well mean that there will never be a one-size-fits-all approach to the OpCo/PropCo discussion. Nonetheless, the mounting, quantifiable proof points in support of coliving’s asset- level performance, particularly in the face of its worst imaginable stress-test, a pandemic induced recession, coupled with expansion expectations doomed to re-enter earth’s orbit, are likely to rebalance future sources of operator funding - from moonshot seeking venture capital to institutional real estate investors who are more comfortable keeping their feet planted firmly on the ground.