Blockchain and the Future of Real Estate

Engadin, Switzerland

In our previous article we explained how the current Swiss Land Registry works.

In this article we explain how blockchain technology can make this system even better. However, before we get into how blockchain will affect the real estate industry, let’s quickly go over what blockchain is and how it works.

It might seem confusing at first, but once you understand how blockchain works, the possibilities for disruption become clear. Blockchain is often talked about in the context of Bitcoin and other cryptocurrency, but in its essence it is simply a system and it can be used for a wide range of applications — including real estate.

How Does Blockchain Work? A Quick Explanation

We all know that blockchain is a hot topic at the moment, but it’s important to really understand it so that you can unlock the potential.

In traditional financial transactions, there is a “trusted” (centralised) third party who is responsible for verifying the transaction. For example, if you send money to someone else it will be verified by a bank and the bank will charge a fee for doing this.

However, blockchain is open-source technology that removes the need for an intermediary or “middleman” when making transactions. Instead, data on every transaction is stored in “blocks” which are time-stamped and linked together to form a “chain.”

All of the data stored in the chain cannot be changed or removed, which means that it is secure and immutable forever. It is a ledger of transactions that, instead of being stored in one specific (centralized) location, is stored and encrypted on thousands of computers around the world. This trusted digital ledger is visible to all participants and it shows every element of the transaction.

This removes the need to rely on a middleman to make secure transactions.

There’s no need to trust a bank. As long as the transaction is recorded, everyone can see it and come to a consensus to verify it.

So, for example, if you wanted to send Bitcoin to a friend the transaction would simply be a piece of code. After checking that you have enough Bitcoin in your digital wallet, it would state that you sent X amount of Bitcoin to your friend. This is a digital contract that is self-enforcing, with no need for a controlling authority. (Hence the term “decentralized.”)

There are many advantages to this, including:

  • The system is immutable. No one party can make changes to data.
  • It is impossible to corrupt the system. The network is based on consensus, which makes it impossible to tamper with.
  • The system is secure, as it has no central point of failure. This protects it against hacking attacks.
  • There is also no risk of downtime. The app will never go down and cannot be switched off.

This article explains the concept with the analogy of a village. In the traditional system, one person in the village is responsible for tracking all transactions on a ledger (which makes this individual susceptible to bribes and the temptation to charge fees for his service). In a blockchain system, everyone in the village keeps their own ledger, then meets in the town square to verify by checking their ledgers against each other.

Of course, the world is no small village. It took computer programs to be able to create this village-square system in a scalable way, so that it could be used for widespread applications around the world.

What is Ethereum?

Although it was originally used with Bitcoin, blockchain technology is simply a large electronic system that can be used for many different applications.

However, previously building blockchain applications was much too difficult for the average person as it required a complex background in cryptography, coding and mathematics.

Enter Ethereum, an open software platform that allows developers to build and deploy blockchain applications (called DApps, in form of smart contracts). It makes building blockchain applications a lot easier and more efficient. Rather than having to build an entirely new and original blockchain for every new application, Ethereum enables the development of thousands of different applications on one platform.

Essentially, any services that are centralized can be decentralized using Ethereum.

This platform can be used to build for example a DAO, a Decentralized Autonomous Organization. This is an organization run by programming code with no single leader. The Organization is owned by everyone who purchases tokens and these tokens are contributions that give owners voting rights.

Ethereum and Real Estate

In October of 2017, Michael Arrington (founder of TechCrunch) made blockchain history when he used an Ethereum smart contract to purchase an apartment in the Ukraine.

It was considered to be one of the first times ever a real asset other than a cryptocurrency was transferred on the blockchain. This could be a very important first step in automating the process of real estate purchases and eliminating the need for one single powerful entity that controls the entire system.

Real Estate and Blockchain — What are the Possibilities?

Blockchain technology has a lot of potential and it doesn’t just apply to the world of finance. It can be used in any multi-step (high value) transaction where it is essential to have visibility and traceability.

If a smart, digital contract can eliminate the need for a third party when sending money, it can also disrupt a range of other industries where intermediaries are currently required to provide trust. This has an enormous amount of potential for the real estate industry.

The main benefits of blockchain — speed, trust and removing a central authority — can all apply to the real estate market.

At the moment real estate is the largest asset class in the world and it is worth approximately $217 Trillion every year. However, the market is fragmented, which makes it difficult for investors to purchase a piece of a real estate property.

Real estate ownership has previously been quite elitist. Most working class people can barely afford to purchase one home, let alone invest in multiple properties. In order to qualify to buy a home, buyers must have excellent credit and be able to demonstrate their solid financial standing in the form of a good job and a reserve of assets.

In the past the commercial real estate industry has kept a lot of its operations quite secretive, including property prices, valuations and comparable lease rental rates. A blockchain system would make everything completely transparent, so that all transactions would be viewable to the public.

Plus, when it comes to purchasing a home there are enormous fees associated with making the purchase, which are paid to the middlemen in the transaction. Blockchain technology could eliminate the need for these fees. This will streamline the industry and make real estate more affordable.

For example, research in Sweden revealed that recording property transactions by using blockchain technology could save Swedish taxpayers over $100 million per year, simply because it would do away with paper contracts, speed up the conveyancing process and reduce fraud. The Swedish system uses fingerprints to verify the documents, creating security while eliminating the need for any middlemen.

Also, real estate is very illiquid, which means that when people buy a property they tend to hold onto it for quite some time. Liquid opportunities represent only approximately 1% of the asset class in the real estate market.

Tokenization of real estate property eliminates the issue of illiquidity. It is possible to convert real estate value into “tokens” that represent an asset (such as an individual real estate share) and trade and sell those tokens instead, at any moment in time.

How Does Tokenization of Property Work?

Tokenization is when sensitive data is replaced with a unique symbol to identify it, which has all of the essential information without compromising security.

So, essentially asset-backed tokenization means converting the rights to an asset into a digital token. When you tokenize a property, you generate a token on a smart contract and then you associate a value with that Token which corresponds to the real asset.

Could it be possible to tokenize a house or an apartment building on a blockchain?

That is the current vision for the future — on in which small pieces of a property could be tokenized in this way and then traded and tracked on a shared blockchain database.

This idea has a lot of potential applications. It would allow a homeowner to sell some of the equity in their home if they need extra money and it would also allow the equity in the home to be freely traded, until the home was sold. At that point, the homeowner and the equity owner would both enjoy any gain in the value of the home.

The main benefit of tokenization is liquidity. When an asset can be represented by a digital token that can be transacted through an exchange, this opens up a huge range of possibilities.

Why Liquidity is the Advantage

Although the idea of selling shares in a property is nothing new, the public blockchain makes it cheaper and more efficient. It is now possible to securitize the asset for a fraction of what it would cost previously.

However, most importantly — home equity has now become more liquid. Liquidity is the ease of getting in and out of an investment. It is an issue in the real estate market, because buying and selling a property is a long process and investors tend to sit on the properties they have bought for the long term. The traditional real estate market typically offers no liquidity and in the odd situation when it does, the flexibility comes with financial penalties.

The liquidity offered by blockchain technology is the main advantage, as it allows investors to quickly rebalance their portfolio if the market changes.

Investors will no longer be bound by long time frames on investments, like they would be for traditional funds. The market for investors would be much larger, because capital can flow more easily across borders. Real estate investors would not need to be locked into a property for decades and they have the option to sell or buy a fraction of the property if they want to.

Also, since investors would be able to invest with cryptocurrencies in capital that flows across borders, this could open up the market internationally. The potential to transform the real estate market is huge.

Why Are Others Failing to Do it Right?

Although there is an enormous amount of potential for changes in the real estate sector, there are few actual projects or applications of blockchain technology that have achieved success yet.

There are currently quite a few hurdles in the future of blockchain in the real estate industry.

First of all, the highly complex laws around real estate are making things quite difficult. For example, in the USA, every state has a different way of keeping records around real estate ownership. While real estate laws are complex for countries in the developed world, when it comes to countries in the developing world there is the opposite problem — land ownership is barely tracked at all, which is another big advantage a blockchain solution could bring (eliminating corruption by introducing a decentralised land registry).

When they are tracked, these processes are still mostly paper-based and are in the hands of many intermediaries including notaries, brokers, property managers, lawyers and other financial advisors. If the different participants in the system don’t have pre-existing relationships this will result in mistrust.

Also, as explained in this Coindesk article, some believe that using cryptocurrencies for real estate transactions could have issues. They fear that it would bring in the type of “magical thinking” that we saw in the housing market, resulting in uninformed investors making reckless decisions.

Existing legal structures, systems and industry players

Startups that go alone are less likely to succeed than those that create consortiums with existing industry players. Any innovation involving real estate and blockchain must deal with the current players and regulations.

After all, it’s easy to tokenize a real estate asset but making sure that it is legally valid and holds up is another matter. It will be essential to work closely together with government and local authorities and financial market authorities.

In order for it to work, the right authorities must take an interest in using crypto tokens for real estate. For example, a city in Vermont has launched a pilot program to determine whether or not putting land titles on a blockchain would be more efficient. The city of South Burlington will partner with the blockchain startup Propy to store their land record management data.

Partnerships with existing industry players, such as banks, real estate funds, real estate development companies and management companies, will lay the groundwork for a successful relationship between blockchain technology and the real estate market.

So, what does this mean for the future of real estate? Does it mean that you could buy a fraction of another home halfway around the world while on your computer?

Perhaps, although this doesn’t necessarily mean that banks, realtors and mortgage companies will cease to exist. It is more likely that blockchain technology will allow them to offer a simpler and more efficient service to home buyers, as they have a more streamlined “backend” for transactions. Also, the improved auditability and transparency has the potential to reduce fraud, which is of great benefit for consumers.

After all, in order to be successful it will be crucial for the early blockchain innovations to integrate with the existing regulatory bodies and partner up with existing industry players.

Blockchain and the Swiss Land Registry System

There are already many proven solutions in place which can offer excellent benefits when they are combined with blockchain technology. A fantastic example of this is the Swiss Land Registry system.

Explained simply, the Swiss Land Registry is a publically accessible listing of every square inch of land in Switzerland. It uses carefully recorded survey data to parcel up all the land in the country and links each land parcel to one specific owner. This precise data, available to anyone who wants to access it, safeguards land ownership.

A Swiss Grundbuchauszug (Land Register Record) is very similar to the small “blocks” of data in a blockchain system. It is a document that contains all of the details of a company or private person who currently owns the land. This detailed record cannot be changed or erased, only added to. Plus, it is only associated with one specific plot of land. (Here’s an example.)

All land records in Switzerland are publically accessible via online geo-portals. Everyone has access to legally binding and easy to comprehend information about every plot of land in Switzerland. There is huge potential for blockchain to integrate with the existing Swiss Land Registry system.

The ideal real estate blockchain solution will work in parallel with these solutions — phase by phase. Here’s an high level overview of how these phases would work:

Phase 1
During the first phase, the blockchain real estate innovation would work in parallel with the existing working system. Investment objects or development projects will gain the most traction as it is a perfect use-case to start with.
Phase 2
The second phase would involve integrating blockchain into the current system. For example, the system could be enhanced with smart contract numbers for real estate transactions. Inside the smart contract the existing land registry number (Grundstück) can be used as an unique identifier. Private real estate property trades can now be realized.
Phase 3
The third phase would involve full integration of the blockchain solution with the current real estate system. It could also integrate property taxes as well. Tax would be automatically and directly deducted from certain transactions, saving time and cost and bringing full transparency.

This probably leaves room for many questions, which we will address in a separate article — closely related to our roadmap — keep following us, as we are currently working on it and will publish it soon.

What Will it Look Like?

Here’s what the organization of the current Swiss Land Registry system looks like:

current Swiss Land Registry System (blockimmo white paper)

A system adopted to blockchain will increase efficiency and reduce costs, fewer employees are required, transactions can be processed faster and more transparent yet the legal structure is kept in place.

Here’s what the system would look like, from the operational side, with a blockchain-style method of organization (high level).

blockimmo’s Platform illustrated (high level)

Regulations and Restrictions on Buying Property in Switzerland

Of course, when we talk about a blockchain solution for real estate in Switzerland, we have to keep in mind that not everyone is permitted to buy property in Switzerland.

It will be crucial for any blockchain solution to incorporate this, so that all real estate transactions are guaranteed to be correct and legal.

The Lex Koller legislation is a law that limits how foreigners can buy property in Switzerland. Also, simply owning property in Switzerland doesn’t give owners an automatic right to a Swiss residence permit.

For example, foreigners are able to buy holiday homes in Switzerland but they need special permission to do so and several factors need to apply. The dwelling must be designated by the cantonal authorities as a holiday resort and there are also restrictions on net floor space.

Another example of a restriction is that a foreigner may buy only one single-family home or owner-occupied apartment in their place of residence without having to obtain official authorisation. The buyer will need to live in the dwelling and cannot rent it out, even in part.

Since there are so many regulations on who can own property in Switzerland, it is important for any blockchain system to incorporate these regulations. This can be regulated by giving out specific types of tokens which represent the legislation.

For example, a private home property token can only be traded if the conditions are met, according to Swiss Law. So, an investor who is a foreigner and doesn’t live in Switzerland they won’t be able to buy or trade a token for a private home. This will ensure that regulations are met, even when buying and trading real estate on a blockchain platform. We explain the Swiss regulatory landscape in detail in this article (link).

Conclusion

Imagine being able to trade 1,000 asset tokens of a huge office building, in the same way you would trade 1,000 shares in a company such as Google or Apple. Imagine being able to purchase a house almost instantly, without having to go through the complex paperwork of the purchasing process, while still sticking to the country’s law and regulations. Imagine funding your real estate development project faster and securer than ever before.

How could this change the world of real estate investment? What possibilities would this open up for you?

We believe that the existing Swiss real estate market is ideal to be integrated with a blockchain solution. It’s land registry already has many of the features that make it similar to blockchain — it is a publically accessible, detailed, granular record of land ownership, similar to the way blockchain records financial transactions. The country’s openness towards blockchain technology motivates us to bring this to the real estate market as well.

Our ambition is to use blockchain technology to facilitate an accessible, streamlined Swiss real-estate market — it is our vision for the future.

A good example to start with would be a commercial real estate project. The project owner can basically raise the funds in Ether (Ethereum’s native currency), no useless “utility” platform token is required. On the other hand the investor receives asset backed tokens which represents a part of the real estate property (Fractionalized Ownership). Each investment object or development project is a security token offering (STO) facilitated through the blockimmo platform.

We are building this exciting blockchain solution in the heart of Crypto Valley (Zug) as we speak! Are you curious? Want to learn more about it? Contact us today!