5 reasons why SaaS companies are like income-producing properties (IPP)

SaaS stands for "Software as a Service". Basically, SaaS companies have a proprietary technology that can be used by end users (either enterprise or individual) at a cost that is charged on a regular basis, mostly monthly. Some of the famous ones are Netflix, Amazon Prime, and LinkedIn Premium - anything that costs you something every month so that you can continue to use it.

Doesn't that sound familiar? An income-producing property charges a monthly rent for the use of the premises - that's already an underlying similarity.

Now let's dive into the performance metrics:

1) Lease rollover vs Customer retention rate

As we are concerned about when a lease ends and who will take it over, SaaS companies get measured by the churn rate or customer retention rate every year. The lesser the lease rollover in any one year and the higher the customer retention rate, the better.

2) Lease renewal rate vs Net dollar retention

For rental properties, the lease rate impacts a key performance indicator - the capitalization rate for the investments. The higher the lease rate, the higher the net operating income (NOI) and capitalization rate (measured as NOI/Market Value of the property), which implies a higher return on the property investment. On the other hand, if the buildings are renewing leases at lower rates, it is an indication of slow rental markets or poor management/condition of the property, which drives down the cap rate and results in a lower yield. For SaaS companies, net dollar retention is total revenue minus any revenue churn from existing customers, plus any upgrades/cross-sells/upsells from these customers. It is a measure of the company's ability to maintain and grow revenue from the existing customer base. Net revenue retention rates above 150% are considered best-in-class companies, almost like you are renewing the existing lease with a higher lease rate - a credit plus for IPPs.

3) Tenant concentration vs Customer concentration

Large, diversified tenant/customer base are both desirable for real estate and SaaS companies. The top 10 tenants/customers % are calculated and evaluated to ensure any concentration risks are adequately mitigated. Accounts receivable collection risk is universal. As a result, investment-grade/good-quality tenants/customers are highly desirable.

4) Lease agreement vs Customer contracts

Long-term lease agreements with AAA tenants are ideal and credit-friendly. It is also common for anchor tenants like grocery stores (e.g. Walmart, Loblaws) to enter into long-term leases after all the leasehold improvement and retrofit spending. It is not common to see long-term contracts with SaaS companies given how quickly technology changes; contracts that are between 1-3 years are typical in this space.

5) Real estate location/property condition vs Tech stack

Location and property condition are fundamental for real estate investments. They are so important that commercial properties even have classifications based on these two factors and categorize them into "Class A", "Class B" and "Class C" buildings. This is equivalent to tech stack for a technology company. Based on how sophisticated and which specific area the technology serves, it also has classifications like deep tech, proptech, ad-tech, fintech, etc. The tech stack is always a necessary element that tech lenders look at. The "Class A" tech stack combined with a robust go-to-market strategy is definitely favoured and pursued by all tech investors and financiers. Just like how a good investment property could eventually achieve appreciation and result in significant capital gain, an A-grade tech company has the potential to appreciate tremendously and realize a high multiple in its valuation. While real estate valuation remains high in the current Canadian economic environment, tech companies are experiencing a valuation lower than in the last couple of years. It will be interesting to see how the valuation of these two types of asset classes will unfold in the coming years.