The Freemium Future of Real Estate

No, it’s not a scam!

It’s free real estate!

Is there a future in which real estate might be free?

I don’t mean the ownership. I have a hard time envisioning that. Long gone are the days of the government handing out Western lands for anyone willing to settle on them (though there is one major exception to that in the world today, if you’re willing to give up your US citizenship and learn the Cyrillic alphabet).

Instead, I’m imagining free rentals. What would it take to become economical for a landlord to give away residential rental space? Is it even possible?

This is an idea I’ve had for a while, but thought maybe I was crazy. That is until I heard Dror Poleg, author of Rethinking Real Estate, mention his own ponderings of a possible free-real-estate-future.

Dror was talking with Nate Smoyer of the Tech Nest Podcast. It was a very interesting conversation as a whole that did not focus on “freemium” models, and nor, to my knowledge, does his book touch on the subject (it was just released and I haven’t read it yet). But the comment was validation that I’m not the only one thinking about a possible freemium future and gives me permission to let my mind wander on the subject here.

Rethinking Real Estate

by Dror Poleg

The Freemium Model

There are obvious reasons why a freemium model doesn’t seem a natural fit for real estate.

Freemium models are most often seen in the software industry. Software is an industry with a very low – close to zero – marginal unit cost. That means it costs very little for them to “give away” their product in the goal of expanding customers.

And make no mistake, expansion is the goal That is really the only purpose to a freemium model – to expand your user base by making the cost barrier to using your product literally zero. That’s important in software and gaming, where there are hundreds of thousands of competing products.

Moreover, large user bases are especially important to gaming software in particular because of network effects. A multiplayer app becomes more valuable if it has a large and active user base. Freemium models improve the chance that you can build your user base and take advantage of these network effects.

Real estate doesn’t have many network effects. The marginal unit cost is definitely not zero. And it’s generally not a race to add users. Once you’re at capacity, it takes capital to add more capacity. Too many eager users signals it’s time to raise rents, not give away rent.

Even in an era of radical abundance, when normal economic laws break down, real estate would still be the exception to the rule. Per Mark Twain, buy land! They’re not making more of it! (Or are they?)

So why would real estate adopt a freemium model if it doesn’t fit the business?

The answer: if real estate accommodations were a successful lead generation machine for other businesses and models that are willing to pay dearly for those leads.

Which industries are these? Usually, they are the sector of the economy willing to pay the most for a lead, with high Google Ad CPCs and the largest affiliate commission offerings: Financial products.

The benefit from selling these types of leads and advertising would have to offset the lost rent from offering free housing.

Freemium Real Estate Services Already Exist

It’s not actual real estate itself. But as this Inman article from Sebastian Frey points out, real estate services already operate on something of a freemium model.

Like your favorite phone app, you get most of the features of a real estate agent for free! Most agents will show houses, give advice, present CMAs, and work through an entire transaction without your paying a dime!

The premium upsell is if you ever go through and actually close. That’s when you owe the agent something.

But that’s not free real estate.

Let’s look more at what living for free would look like.

The Alternative Future to a Universal Basic Income

I am very much against a Universal Basic Income, or UBI (but am cautiously in favor of replacing welfare with a single tax credit, which is similar but different – that’s a different conversation).

The reason I am against the concept of the UBI, popular with fans of current Democrat nominee wannabe Andrew Yang, is that the UBI seeks to preserve the economic status quo at the expense of future model innovation.

What do I mean by that?

UBI enthusiasts envision more and more automation, displacing more and more American workers (though there is no evidence of that yet with historically low unemployment despite the immense tech innovation and job displacements of the last twenty years). Their response to these dangers is to prop up an artificial economy by giving everyone, regardless of employment status, money. That will preserve something that resembles the economy we see today?

What does that have to do with freemium?

Well, I tried to accept the premises of the UBI argument, but then imagine what would happen if we did nothing. What I imagined was not the dystopian hellscape UBI advocates seem to fear.

Instead, without the higher taxes necessary to fund a UBI, businesses could lower costs. Their marginal costs would fall. Automation would drive those marginal costs even lower. Many industries that are not ideal for freemium models today could very well be candidates when automation reaches these levels of efficiency.

Imagine going to a grocery store where half the food is free – and the other half is premium stuff you are upsold on where they make their money. They get you into the store by offering free food. And they make their money on the few items that are not free. All this could be possible thanks to agricultural, transportation, and service industry automation (and, in the case of the grocery example, vertical farming).

Do you prefer the UBI model, where you still show up and pay money like we did in the 1990s? Or would you prefer showing up to your grocery and paying nothing except, if you wanted, for some premium odds and ends? I think the latter is a far more interesting and appealing future.

What Would Freemium Housing Look Like?

Welcome to Wal Mart Apartments! Your free living accommodations!

You are one of 1000 residents in 600 units, all living in studio apartments of barely 300 sqft. It’s cozy, but you use it to sleep, bathe, and not much else. Your apartment comes with the option of being fully furnished, financed over 12 months.

You get your groceries (with a resident discount!) delivered to your door from the neighborhood Wal Mart. You frequent with your friends the on-site restaurants, which pay Wal Mart airport-like leasing terms for the privilege. Ditto for the onsite gym, massage parlor, movie theater, and pool complex.

For onsite services, you are required to use your Wal Mart credit card. But it has competitive rates and terms, and you don’t mind signing up for free real estate!

You frequently get promotions from the apartment manager for different monthly subscriptions. A pet treat bag. Razors. Beauty supplies. Basic homecare essentials. All optional, of course. Wal Mart earns either providing these directly or charging vendors for the privilege to market to its residents.

And you can afford all of it, because you are paying no rent! That has freed up many hundreds a month to make use of these other services that you almost surely enjoy more than spending your dollars on rent. Indeed, an entire entertainment industry is now flourishing as more of our dollars are diverted from rents and mortgages and into experiences and lifestyles.

And, unlike a typical apartment or HOA, you only pay for what you use. Don’t need the indoor skating rink? Don’t pay for it!

Wal Mart’s target demographic is not the homeless or poor. In fact, you are still obligated to verify income, credit, and a background check as would any other tenant.

Instead, Wal Mart Apartments targets suburban professionals like you. Real estate is cheaper in the suburbs, and it’s easier to bring (premium) amenities to the apartment like onsite gyms, restaurants, and rec centers. Meanwhile, single young professionals need less space, are used to dorm-like living, and have discretionary income.

But just like freemium phone apps, there are hundreds of your neighbors who are free riders in Wal Mart Apartments. They don’t pay for the upcharge services but still benefit from free accommodation, supported by the few who do pay.

For those who see the corporatism and despair, keep in mind: this is free. At no point are consumers obligated to purchase goods and services. They are free riders on a system that corporate America nourishes under the hope that, when the day comes, they can capture that customer’s willing business.

Is that worse than Section 8 vouchers, collecting a transfer payment that the government raised by levying taxes on the producers in an economy?

What Would Need to Happen First

Density

There’s a lot of talk about what the end state of housing in America looks like, to the extent that there is an end state. We’ve certainly gotten denser, but we’ve also gotten accustomed to larger homes, and indeed are spending more on housing than did our grandparents as a percentage of our income.

Freemium real estate is a niche product, unlikely to supplant the main ownership model, so we may already be sufficiently dense to try this experiment in cities like San Francisco, Seattle, or NYC. The trend of extending roommates and the “dorm life” well past college is now well established in these cities, setting the stage for easy adoption of a freemium model.

Massive Consolidation

Imagine these headlines.

That’s when you’ll know when the prospects of a “Freemium” model are getting serious.

For the model to work, you need a lot o upsells and opportunities to cross-market services. Most likely financial products.

Right now, real estate is one of the most decentralizes and unconsolidated industries out there. A top agent in a market has less than 5% market share. A portfolio of a mere 30,000 residential units would make you one of the largest players in America, the size of a small West Texas town.

There are online websites with larger audiences and lead generating opportunities.

I don’t know what the tipping point is, but I could see firms partnering or combining. With 1,000,000 residents under management, there could be some serious opportunities to monetize your “audience” in novel ways, and a new business model that could attract investment from the next SoftBank (but hopefully with a rosier conclusion).

Consolidation applies not only to the companies themselves but the size of these developments. Currently, the largest apartments in the world have about 1000 units. But this model would benefit from housing with even more units – large complexes that behave like a small city, offering diverse and attractive walkable amenities sustained by the sheer number of residents.

Lowered Cost of Housing

It’s hard to imagine this model working in this environment. Housing is too expensive.

I believe one technological change that could make housing dramatically more affordable in the future:

The self-driving car.

Currently, people are willing to pay a lot for location, location, location. But what about when your destination is a pleasurable one hour drive during which you are working, sleeping, or entertaining yourself? Suddenly the pain of the commute is not high on a home shopper’s needs list.

The consequence is an explosion away from high price real estate with a premium for “location” and acceptance of commutes to cheaper areas in metropolitan areas.

This will allow a would-be freemium developer to select cheap real estate outside of town, bring many of the location-dependent necessities to the campus, and users are still content to live an hour or so from the other amenities of city living.

Meanwhile, the premium roadway real estate that restaurants and other commercial enterprises paid so dearly for will depreciate in value. What good is it to have your sign on a road if all the “drivers” are asleep or looking at their phone apps?

Instead, they’re willing to pay a premium for the commercial real estate on your land, walking distance from the residents themselves. These integrated population centers will be the new “busy corner” commercial lot.

All thanks to driverless cars.

Some Sample Math

I’m not a finance guy, and I imagine it will show. But I’m going to paper napkin it and see what I come up with.

If you were to move to a freemium model, it would only be because you could earn more than you’re earning in the current model.

The tipping point would be when you are earning more money from ancillary services than you are the primary service.

An emerging example of this is airlines. In 2018, Delta made more money from credit cards than they did selling seats on planes. They are essentially turning into credit card companies. In fact, depending on how often you travel and use your cards and points, it’s possible that airlines are already effectively a freemium model now: you fly for free for no other reason than using a particular credit card for your day-to-day purchases.

Meanwhile, if real estate began adding enough ancillary services and upsells that became a disproportionate share of revenue and profits, the next logical step would be to compete for “customers” – in this case, residents. What better way to compete than to drop – or eliminate – rents?

Let’s assume a studio rent of $500/mo. Remember, we aren’t living in a downtown highrise but a suburban campus at a modest sqft. To eliminate that rent, we essentially have to come up with the same amount through other means.

That works out to $3.6M a year in gross rents at 100% occupancy for 600 units that need to be replaced somehow.

Let’s imagine a utilization rate of 25%, meaning at any given time 25% of residents are paying for upsells.

So now we have to come up with a plausible $2000 in ancillary upsells every month to offset the rental income entirely. And not revenue, but profit.

Much of this profit would presumably come from the increased value of the leases for the commercial and retail real estate that is appended to the apartments.

Entertainment would be another big driver – hosting paid shows and events, onsite entertainment amenities, and paid group activities. Like a senior center for Zennials.

Lastly, as mentioned financial services would likely need to be involved to make that kind of money. Financial obligations like loans, bank accounts, investment portfolios, insurance, and credit cards are very long term commitments that are profitable, though likely only if the profits are entirely in house (e.g. the landlord needs to be in the insurance business, not just an affiliate).

Or an apartment could offer an “Ownership” program in which residents bought shares of their own apartment building via a REIT or similar structure? It is a way to sell the benefits of homeownership (equity) without the transaction costs and permanent roots. It would be optional, but give residents a sense of ownership, built-in savings plan, and a great way for the apartment owner to crowdsource capital and save on interest expenses.

So let’s do the math.

Well, I didn’t quite put sums on these. Even at generous assumptions, I have a hard time imagining $2000/mo, enough to replace rental income.

That may be reason #1 why it will never happen. But those numbers can easily change if the balance of our consumption changes and we spend a larger share on entertainment, convenience, and lifestyle. That seems like a safe bet to happen. Eventually.

Reasons It Will Never Happen

A freemium real estate future is quite possible, I believe. Even before the true era of radical abundance or when we’re all holed up in cubicles the size of a coffin and living our entire lives in the virtual world.

But there are some hurdles to adoption besides the money.

It would likely be a niche offering. Most homes will always cost money, and most people I’d wager would prefer to live in the kind and size of home that would cost money. Plus the spaces are unlikely to appeal to families, especially larger ones (though family size and formation continue to dwindle).

In fact, the current trend is still the opposite of what I’ve described. The HOA has become the predominant organizational body for America’s communities in the past 30 years, which is the freemium model in reverse: you pay rent and dues monthly to get “free” premium services like dog parks, pools, and clubhouses. Is this the model Americans prefer?

There is also still a massive appetite for new construction, renovated, and highly customized homes. The one-size-fits-all of dorm and apartment living is not for everyone.

Lastly, there is the question of the low barrier of entry. People generally like barriers to living in their communities. Historically, this has included ignominious barriers that are fortunately now fair housing violations. But less nefarious are the kinds of barriers communities seek out that include things like gated HOA communities or age-restricted neighborhoods. And price points, whether we like it or not, are a barrier that the affluent use to sort themselves into communities. I am not saying this is desirable by any means, but it is a current reality. Can the affluent and upwardly mobile find the free real estate appealing? I think that would be necessary to make the experiment work.

Conclusion

Is there any parallel in American history, in which consumer spending habits so radically changed?

There are small changes, like the freemium entertainment offerings on your phone that were not available 20 years ago.

But we also spend far less today as a fraction of our budget on food and clothes, and far more (ironically) on housing and entertainment. In fact, the estimated budget spent on food in 1900 versus 2003 fell from over 40% to less than 15%.

As our appetite and the availability for entertainment rises, it’s quite possible that this can further supplant our other spending priorities over time. A freemium real estate option might be well-positioned in some future year to take advantage of that shift.