The Use of Blockchain in Real Estate
Summary: Blockchain technology can be applied to real estate transactions to save costs on fees, speed up transactions, and provide additional security. Start-ups going alone after the opportunity are less likely to succeed than those that create consortiums with existing industry players.
What is Blockchain?
Blockchain is a technology built around open data. It is a protocol accessible to multiple parties that can record identities, reputations, and transactions in a public marketplace. Wait, what does that mean? Essentially, Blockchain technology allows for the creation of a public record. Take bitcoin, the first application of Blockchain, for example. Blockchain allows different parties to exchange bitcoins, and, keeps tab on every exchange.
For all bitcoin blocks, you can see previous owners. What’s special about the setup is that everyone on the platform can see previous owners and can validate transactions. In traditional marketplaces, thieves could steal a title or good and make up verification that contradicted the owner whom they stole from. In the Blockchain, all parties would need to be deceived, an unattainable proof of work.
A public ledger that uses blockchain has a few crucial components besides open data. A second element is that parties need a form of identity. This identity can be created through the verification of others and through participating in transactions verified by others. Identified buyers and sellers transacting in a marketplace with repeating occurrences creates reputation of participants. Hence, a successful public ledger can be defined as identified and reputable parties exchanging value in an open system.
Where in real estate is the use of blockchain most applicable?
The current sales process for both residential and commercial real estate involves the transfer of titles and holding money in escrow during this process. Essentially, the buyer hands over money to a third party, who keeps it in escrow, and the seller hands over a real estate title. The third party, an escrow agent or title company, will distribute the cash to the seller and the title to the buyer as well as file the title with the government in the buyers name. This process can be up to 2% of a home’s value in the form of fees, and, in the case of commercial real estate, hundreds of thousands of dollars per transaction. Commercial real estate acquisitions also normally involve a multi week diligence process on the title, researching past title holders.
Using blockchain would speed up the purchase process for both residential and commercial real estate. The two verified parties, buyer and seller, could transact on the public ledger, with the buyers having the title verified by past title owners and the generally community instantly. Sellers could put money in an escrow, which would be verified by the community that such money is in the account, and as soon as title verification is complete, the money would be deposited with the seller. Both sides and the community would record the new buyer as the owner, and the public data about the property would continue to list all past owners, as well as the new owner, i.e. the buyer.
While the process is improved and faster for both residential real estate transactions and commercial real estate transactions, I see significantly more benefits for the commercial side, as well as a more definite strategy to implement this technology at scale. Residential real estate buyers would save on fees, and would have transactions move more quickly, especially during the weekend when escrow agents often do not work, than in the status quo. However, commercial buyers, who often pay significant fees, in absolute terms, to third party title and escrow companies, including sizable title insurance fees, and dedicated resources to due diligence would benefit the most from a blockchain based title and escrow system.
The current fee structured is justified by the large downside commercial real estate buyers face in the event that the property is not legitimately owned by the seller or if the seller fails to transfer the property to the buyer. However, a paradox occurs in the title insurance fee, where the third party demonstrates that it does not have certainty in the seller’s title legitimacy, and hence charges insurance to the buyer in the event that the third party’s own title management is wrong.
In addition to expedited transactions and reduced fees, the reduction of fraud would be a major benefit. Specifically, sellers could not sell properties that were not verified as theirs by past transactions and/or the third party community. A seller’s reputations on the ledger act as a major data point for any potential buyer. From a technical standpoint, in the current system, a seller could sell a property that they own to a buyer, and then strike a deal with another buyer before the title has been transferred to the first buyer. This risk would be reduced in an environment where transactions were instantaneous, and all parties were not waiting for weeks for title updates in the government registry.
While Blockchain may reduce the risk of certain types of fraud, does it introduce new challenges? Can the blockchain be hacked? The objects on blockchain are immutable, so agents cannot go in and change past events. There is no admin to override past authentications. Conceivably, a group with huge computer power could create multiple new accounts and transactions, but would still have trouble burying past data. The increasing adoption of blockchain technology by major banks to handle sensitive financial information gives significant weight to the power of blockchain as an authentication system.
Aware of the benefits blockchain can provide, the government of Honduras has recently moved to have the government real estate registry run on a blockchain based platform in order to combat the frequent use of fraud in real estate transactions. It is a powerful signal that the support of blockchain may be first adopted by governments in developing nations with the least sophisticated federal title registries and the highest cost of fraudulent transactions. Similar calls for the use of blockchain in land registry has been made in Ghana as well. However, it remains to be seen how effective less advanced governments are in implementing this technology. In Honduras, the blockchain based land title project has been largely stalled.
Why don’t we see blockchain integrated into real estate like it has been in payments and finance?
Blockchain is a six-year old technology that has the benefits we have discussed. I would argue that for residential transactions it is difficult to get parties on the platform at scale. Like most startups, organizations such as IBREA face the classic chicken and egg problem of any two sided marketplace.
Although consumers are buying homes more frequently, they are not engaged in enough repeat transactions to justify pushing for a change in the status quo. Corporate real estate, although fragmented, has much larger buyers and sellers, including developers, REITS, private equity, and sovereign wealth funds with a more sophisticated approach to cost reduction than individual residential real estate buyers. It is more attainable to attract scale on the corporate side since the industry is far less fragmented.
I believe the challenge with start-ups going after the corporate real estate opportunity is that they are not effectively working with industry insiders and are going up against entrenched title and escrow companies with strong industries ties. In the financial space, an increasing number of blockchain companies have begun working with banks.
Notably, R3 leads a consortium of 42 financial institutions including Goldman, BBVA, Bank of America, JP Morgan, UBS, and others access the same ledger to exchange funds. I believe a similar approach in the commercial real estate space is warranted, with the largest real estate institutions, and potnentially local and federal governments, working together to create scale.
Additionally, I believe for large real estate players to come onboard, there will need to be a period where both the new blockchain authentication system and the current status quo will exist in tandem. During this period, it would still be beneficial to have the blockchain system, especially on foreign commercial real estate transactions where an added layer of security and verification can provide significant value, given the lack of discipline and reliability in private and government record keeping.
How would the blockchain get stated? During the initial period, the consortium would onboard established real estate entities and fiat them with strong reputations. Although not a purist approach, it may be necessary to overcome initial verification challenges. Smaller entities could join the platform but would have to build reputation through transactions as would all later entries.
What does blockchain use in real estate imply for the industry and beyond?
The use of blockchain will not eliminate the need for all third parties or, at least short term, for government registries. It is possible that title and escrow companies could still have a place, running the transactions on the blockchain ledger on behalf of their clients. However, their fees would be significantly lower, and for more sophisticated commercial real estate players, in the near term, fees could be cut out entirely.
While governments are increasingly adopting new technology and gov tech is a fast growing category, it is likely that private entities will need to prove out the viability of real estate on the blockchain before mass government adoptions. It is possible that certain countries where fraud is particularly rampant and government systems are more volatile, that a blockchain ledger for real estate transactions could become the primary ownership registry.
A successful implementation of a commercial real estate consortium approach could encourage the residential real estate buying process to adapt and copy the consortium approach. Specifically, governments and larger residential real estate players could provide scale and create a critical mass. For example, a palatable solution for large residential escrow companies (First American Title, Liberty Escrow) as well as financial institutions (Chase, Wells Fargo) with significant residential home ownership could be a consortium approach where escrow companies still receive reduced fees to cover minor legal disputes (e.g, neighbor’s driveway is on the property) but not charge for insurance against major title fraud or charge excessive fees for title filing. Google could play a potential role in the residential consortium, seeding the platform with consumers as the company moves into real estate tech and continues to have a mandate to be a leader in all things search.
Residential buyers would have to create identities on the platform. These identities could include passport, taxes, and credit information. The implication of financial identities for consumers on a blockchain system would span beyond real estate. At Airbnb, my former employer, we stressed that Facebook login and identification helped scale the platform and provide trust for both hosts and guest, although we also lamented not having more information to verify transactions.
Creating a virtual financial identity for consumers could impact how we shop, make payments, and loan money. Starting with blockchain for commercial real estate could be the first step towards making the technology go mainstream for consumers with practical applications for e-commerce, finance, and real estate.
I am currently researching this topic for an independent project at Harvard Business School and am not currently affiliated with any mentioned companies.