Blockchain: The Anti-Villain That Real Estate Needs
The anti-villain, a villain with heroic traits whose evil means never justifies their admirable ends. Viewed from the perspective of many traditional industries, that would be an apt characterization of blockchain technologies: A villain who comes in to disrupt the status quo and redistribute the spoils to the rest of society, a Robin Hood of sorts if you will. However, unlike the lone arrow slinging villain of folklore, this change will be more of a power reshuffle driven by the disenfranchised, think the French Revolution or V for Vendetta if you want to stretch it. Of course such a revolution will bring with it all the complexities it entails but like all good villains, it forces the system to face the uncomfortable truths.
The uncomfortable truth for the real estate (RE) industry, especially commercial real estate, is that the industry has become overly complacent in their walled-off gardens made possible due to the significant industry-wide inefficiencies. This contributes to, and concurrently benefits from, the shared belief that property as an investment class has minimal downsides. As such, this self-perpetuating cycle enables the RE industry to justify the large amounts of workflow redundancy caused by siloed and opaque databases. Blockchain, being just a fancy distributed database, will be the foil forcing the industry to evolve as it rebalances the power dynamics inherent in traditional businesses.
Privatizing profits, socializing costs
The most important change that distributed ledger technologies (DLT) is also it’s most boring aspect: the digitalization of RE records on a shared ledger. Although seemingly mundane given how revolutionary blockchain solutions are supposed to be, it is important to note that in the large majority of cases, publicly available digital identities of properties are confined to the databases of national bodies. This does not take into account the amount of private property data that many of the industry’s incumbents build their competitive advantage on.
While data discovery is incentivized via this model, the long term implication of such a model is that no single database ever carries complete information about a particular building. Moreover, with each database having their own version of the property’s digital identity, this creates significant data redundancy. The worst part of this is that such redundancy cascades down the chain as any transaction referencing the property (leases, service contracts, etc.) essentially further distances that digital identity from the shared one (think of it like a tree diagram with non-interacting branches).
The result of all this is that all participants in the RE cycle are essentially working with incomplete information. A tenant searching for a place will have to conduct their own due diligence by contacting multiple agents. The agents will have to check the multiple databases within their organization and cross-check it with the publicly available data. Banks will have to repeat this process for due-diligence. With only basic property data available, a vendor bidding to take over property management will not be able to benchmark their services nor price in the risks. Consequently, the industry thrives on unnecessary frictional costs in order to cover :
- Consistent manual updates to realign property info across databases
- Inefficient market matching due to fragmented listings and outdated data
- Paper-driven, manual and offline record keeping and billing process
- Convoluted financial, legal, and title clearance processes
- Due diligence for administrative tasks prone to data loss and errors
As with most industries, the profits are privatized while the costs are socialized. In this case, the tenant ends up footing the bill via agent, due diligence and legal fees. Such costs are also inflated due to the need to price in risk, insurance and financing premiums. This is in addition to stamp duties indirectly financing the maintenance of the public building repository. It should be noted that such costs are not purely pocketed by RE companies but rather workers in the industry subsisting with comfortable margins due to the amount of unnecessary manual work required.
Prior to DLT, there was no incentive to change as the first mover stood to lose their competitive advantage by exposing their hand. For many of the sales functions in RE, a broker‘s work was rewarded via compensations per deal. On the property and facilities management side, vendor’s would have special service agreements with various service providers. The result of both of this is that pricing was relatively opaque as information control was key to managing the network of relationships.
DLT: A big carrot, an even bigger stick
DLT disrupts this status quo not because of the significant cost savings to be realized but because companies who do not adapt to the new standard will be left behind. Once DLT adoption achieves critical mass, landlords will no longer require the majority of market making services which RE firms offer as there will be a standardized publicly searchable shared ledger. Essentially, data gathering is no longer be limited to an agent’s network but rather a searchable database akin to airbnb.
The first and hardest stage in this process is the standardization of protocols for digitizing property on the blockchain. This is more than just ensuring data structure consistency and authenticity when recording properties on the blockchain. Critically, two of the most important parties in a transaction, the landlord and the buyer/tenant, must be incentivized to choose this solution over the current process. Irregardless of how the other stakeholders in the industry might try to maintain the status quo, the market will naturally migrate to the solution that provides the best cost-to-convenience ratio, two aspects which RE has been historically bad at.
The benefits to buyers/tenants in this case is more obvious as they will have a single source where they could search for the most updated and unbiased property information. For landlords, such a platform will vastly expand the potential tenant pool at the risk of being obscured by search algorithms. In both cases, in addition to the massive efficiencies brought about from having easily comparable data, market matching no longer depends on isolated broker networks. Moreover, with robust search algorithms and filter options, broker opinion is only limited to those who actually require it.
Once a digital identity has been established, other records such as titles and contracts can then reference this property data. This will not only establish a property’s history but also opens up the possibility for digital invoicing and record keeping linked directly to a property rather than to a RE company’s database. This is a subtle but important change as the data is owned by the community utilizing the chain which significantly increases efficiency via eliminating capital controls on data. With increased transparency, less resources will go into data discovery enabling the industry to instead concentrate on generating actual value. Although such data could be hashed to hide the info, dollar amount, or participants in the contract, it is likely that the community will choose a fork which is more transparent.
Another consequence of this is that the chain will also end up recording the network of participants who came into contact with the property therefore increasing accountability. As such, any public blockchain solution will likely involve some form of reputation management. This will not only aid with increased performance transparency but also mitigate spam and fraud on the network through user curation. Although this will benefit the industry as a whole, it must be noted that the timescale which the RE industry functions on (2–3 year turnover for leases, significantly more for ownership), might significantly limit the effectiveness of any rating system. Nevertheless, such a system will likely bring about benefits as it significantly lowers the barriers to entry for smaller players on both the buy and sell side.
Whichever the case, the benefit that will most likely drive the adoption of DLT will be that of cost savings via smart contract functionality, specifically increased savings for landlords, tenants and buyers. RE is ripe for disruption here as the majority of RE functions require ledgers with contracts that have relatively simple conditional clauses. Moreover, the potential uses of smart contracts will increase exponentially with the growth of IoT in the RE space acting as the triggers to the contracts. This will also be key in eliminating the administrative burden that forms barriers to the peer-to-peer market. The precursor to this is that robust data structures as discussed above will have to be implemented first.
It must be noted that RE companies could actually optimize costs via smart contracts without the need for a public blockchain but this requires the contracting parties to have similar technology standards which severely limits its applicability. As such, it probably makes more financial sense for RE companies to form a consortium involving the regulatory board in order to come up with industry standards which will allow all participants to commit smart contracts to a public chain. Cost sensitivity will ensure that transaction documentation, communication, and execution efficiency will eventually be maximized via smart contracts. As such, DLT pushes the industry to be more competitive through diminishing capital controls on data. This essentially reduces the economic rent charged by the RE industry and transfers this value via reduced out-of-pocket costs for market participants.
A much needed option
DLTs are set to disrupt RE by changing the power dynamics of the industry. It introduces an alternative model in an industry that has become stale. This being said, DLT is not an all-or-nothing proposition nor is its’ adoption a given without proper governance and off-chain enforcement.
Given the heterogeneity of RE, there will be physical aspects of property which will never be able to be recorded in a database. This is accentuated by the fact that RE turnaround times limits the effectiveness of rating systems. The RE marketplace is also not a pure price market with participants usually looking for stability over highest returns or lowest costs. This might change with the introduction of tokenization as discussed here but the industry as a whole is likely to maintain its position as a stable asset with a self-fulfilling belief that it has minimal downsides.
What all this means is that there will always be a market for middlemen in RE but DLT ensures that such services are optional and has actual value-add. Moreover, although side markets will form around RE with niche requirements, the increased transparency will greatly aid an industry which is a well-known money laundering pipeline. The new value streams brought about by increased data and network resolution will ensure that the RE industry remains competitive by eliminating opportunities for rent extraction. Blockchain might just be a fancy database but it democratizes data and as per the cliche, knowledge is power.
Thanks for staying till the end. Would love to hear your thought/comments so do drop a comment. I’m active on twitter @AwKaiShin if you would like to receive more digestible tidbits of crypto-related info or visit my personal website if you would like my services :)
For those interested in diving deeper, I would recommend looking at Rentberry (p2p rentals), Atlant (tokenization), and Imbrex (shared ledger) as starting points. These are chains which serve specific purposes and provides an indication of where the industry is heading towards.
