WHAT IS REAL ESTATE TOKENIZATION?
As an asset class, real estate has a lot going for it. Appreciation gains, tax benefits, regular income and relative stability are just a few of the reasons why so many investors choose to deploy capital in real estate assets. Total commercial real estate (CRE) values in the United States alone sit between 14 and 17 Trillion dollars, as estimated by NAREIT.
However, as Axl Rose once stated, every rose has its thorns, and real estate investments are no exception. Illiquidity is a major issue present in the buying and selling of real property as well as the complexity of real estate transactions, which tend to have a lot of moving parts and different professionals involved—from brokers to loan officers to title agents, and everyone in between.
Physically buying real estate property is rarely, if ever, a “One Click” Amazon-type experience, which is a problem particularly in this era of app-driven instant gratification. But securitization, the process of pooling different types of contractual debt, like home or commercial mortgages, has sought to bridge this divide by packaging and selling investment property portfolios along with other real estate interests, making substantial progress toward fast yet efficient investing.
But there is another wave on the horizon that has the potential to not only match securitization assets but also to exceed it and truly revolutionize how properties are bought, sold, managed and invested in: real estate tokenization via blockchain technology.
What is the Tokenization of Real Estate?
Tokenization is the process of creating a digital token that is a representation of a real estate asset or interest in a real estate project, profit-seeking venture or debt security, essentially replacing much of the infrastructure and processes that are traditionally used to transfer and manage real estate. Think of the digital tokens like you would shares in a company; you put some fixed price down for the real estate investment and get a token that represents your ownership in the asset portfolio.
The possibilities for tokenizing real estate are near endless, including everything from transferring single-family homes between residential buyers to tokenizing interests in a large Triple Net (NNN) investment fund of properties around the US (like Liberty Real Estate Fund).
Other opportunities include:
- Direct ownership of real US property for investors anywhere in the world
- Capital investments in CRE projects
- Tokenized Real Estate Investment Trusts (REITs)
- Managing lender cash for CRE projects
- Increasing buying and selling optionality for both Accredited and Non-Accredited investors
Related: Security Tokens Explained
What Are The Benefits of Tokenization?
The market already has systems in place to track and maintain direct and indirect ownership of real estate property, as well as centuries-old methods of regulating real estate ownership interests, assets and projects. So, why are some actors in the industry considering or actively adopting real estate tokenization practices instead of sticking with the status quo?
One of the biggest problems for real estate is that it is an asset class in search of a liquidity solution. The title transfer methods mentioned above that are currently in place for real estate remain comparatively illiquid compared to other popular asset classes, like stocks and bonds. The difficulty in transferring real estate into capital quickly is among the chief reasons why some investors shy away from investments in the space, resulting in an illiquidity discount on real estate assets. Real estate is known for its long-term stability and security of wealth, not its fast-acting returns—patience is a virtue that needs to be applied.
However, tokenizing real estate can solve this liquidity issue in a few different ways:
- Unlocking the investor pool: Real estate will open up to a new pool of investors, many of whom lack the know-how or ability to participate in large-scale, complex real estate transactions (often due to the fact that they reside outside of the country or target market(s) of property assets).
- Lower entry costs: Currently, cryptocurrencies and even traditional equities are now sold as fractional units, meaning you do not need to buy an entire Bitcoin (BTC) for $60,000 or an entire share of Amazon for $3,000—you can buy a small fraction of the asset. Tokenizating real estate investments can offer the same ability to fractionalize ownership.
- Transactions become streamlined and standardized: The blockchain technology that backs the digital tokens enables the use of standardized smart contracts that, unlike traditional real estate contracts, do not need to be individually negotiated.
Processing is handled digitally with real-time capitalization (cap) table management alongside automatic governance and distributions, increasing settlement speed for investors while decreasing organizational costs for firms at the same time. Terms are implemented automatically, on a set schedule, lowering transaction costs (as well as potential headaches).
Enhanced Price Flexibility
Currently, pricing information exists and is utilized through paper-based systems, ones with uneven informational access for all involved parties. Tokenization creates a digital secondary market, one in which individual real estate properties are priced based on real-time order books rather than archaic paper systems.
Transparency is critical for any investment asset—the more, the better. Blockchain-based systems allow for the digital programming of data, rights and restrictions concerning the property or properties represented by the tokenized digital asset(s). Tokenized real estate assets can be connected to off-chain valuation systems to provide 3rd-party verification and the greatest level of transparency for investors and other stakeholders. The Smart Contracts record all buying, selling and trading of the real estate tokens, giving you access to any transaction information in real time.
Immutability is an essential benefit offered by blockchain technology. Once a transaction has been confirmed and recorded, it basically cannot be changed. This provides a greater level of security and helps to protect investors from falsified transactions. It works in reverse, as well, proving fraudulent transactions near-impossible to reverse.
Blockchains run on distributed ledger technology (DLT). Distributed ledgers are a consensus of replicated, synchronized and shared digital data, typically distributed across multiple sites, institutions or even countries. Unlike standard distributed databases, there are no central administrations and no single person, group or entity in control of the ledger. These DTLs instead rely on advanced cryptography to secure the network with individual private keys that provide security for users. The key consists of a string of random numbers, letters and characters that are near-impossible to break with current computer technology.
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How to Digitize Real Estate
The process of real estate digitization seems complex, but it is really quite simple. It involves structuring the deal, selecting your technology and, finally, creating and distributing the tokens representing your real estate asset ownership.
How a deal is structured depends on several different factors, including but not limited to: asset type, shareholder type, applicable regulation and jurisdiction. Currently, many issuers choose to tokenize existing deals to free up liquidity for current investors. They then work to raise funds for new offers. In the deal structure phase, asset owners need to determine which assets they wish to digitize, as well as the legal structure that protects the individual securitized properties through an investment deal.
Common structures include:
- Real Estate Funds
- Project Finance
- Single-Asset Special Purpose Vehicles
Additionally, deal structurers will have to look at:
- Shareholder Rights
- Investor Types
- Execution Regulation
After setting up the overarching legal and deal structures, it is time to make technology selections. There are four aspects you should take note of when considering the available technology, including:
- Defining which blockchain the token will be created on, as well as deciding which transfer and data restrictions to include within the token itself.
- Choosing a physical custody solution that will be able to effectively store the new tokens.
- Choosing a KYC (Know Your Customer) and/or AML (Anti Money Laundering) vendor that can integrate the digitized security infrastructure and the primary issuance platform.
- Determining which marketplace to offer the digitized security on, as well as which exchanges you want them to trade on.
Token Creation and Distribution
After you have structured the deal and made your technology choices, you’re going to work to launch the new real estate token and get it to investors.
These are a few things to keep in mind during this process:
- What funds will you accept? Fiat currency like United States dollars? Will you take cryptocurrency or stablecoins?
- How will you launch the token? Will you use a web application or design your own infrastructure?
- What will your KYC/AML process look like, in addition to your overall investor onboarding process?
- How will you distribute the token? Via a primary issuance platform? Or, will you send tokens directly to investors?
Final Thoughts on Real Estate Tokenization
Tokenization creates a great deal of flexibility for investors, property owners and other stakeholders as well as reduces the traditional illiquidity of real estate, which has the potential to dramatically streamline how real estate projects are developed, invested in and managed. Tokenizing real estate gives owners and investors choices—most importantly, the choice to raise and invest capital in a way that makes sense for their bottom line.
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