Tokenizing Real-Estate: What Are the Benefits, Pitfalls, and Misconceptions of Tokenizing Assets?
The real estate market is very complex. The reason for this is that there are always multiple stakeholders involved, large amounts of money on the line, different people that specialize in different areas, and regulations that are dependant on jurisdiction. All these factors contribute to the complexity of the sector.
However, the complexities alone wouldn’t be such a huge issue, but the fact is that they create many different dysfunctions while the market keeps on growing. This is why a large number of companies, startups, individuals, and even government institutions are turning to new solutions, one of them being blockchain tokenization.
What is tokenized real-estate?
Real estate tokenization allows property owners to issue tokens through blockchain platforms. These tokens represent a certain amount of shares for some real estate asset.
Other investors can purchase these tokens, and by doing that, they become partial owners of that asset, which further allows them to be involved in cash flows and asset appreciation.
At the same time, they have the freedom to sell any amount of their shares whenever they want and they can do this even through some other online markets. Even though the whole concept seems pretty simple and straightforward, it raises a lot of interesting questions concerning the future of the real estate market, as well as blockchain technology.
What are the benefits of tokenizing real-estate?
There are a lot of people talking about many different kinds of benefits that tokenization can offer. However, a lot of those are still theoretical and they haven’t been proven through practice. Still, this doesn’t tell us whether they are definitely viable or not, we will have to wait and see.
So, let’s stick to what we know and talk about three general benefits that are evident:
1. Blockchain immutability proves ownership
We already know that blockchains have immutability and this feature transfers really well to tokenization. Having a digital history of transactions helps every stakeholder and investor prove their ownership. At the same time, this kind of structure also helps reduce the chance of fraud.
If a token owner tries to sell a certain token multiple times — trying to transfer a single token to multiple investors, this kind of structure will show the exact history of ownership and makes it impossible for someone to falsify transactions and trick investors.
2. Programmability allows automation, improves transactions, and share management
The ability of smart contracts to contain different business logic refers to programmability and it helps establish automated events when certain conditions have been met. This means better pre-established rules. Tokenization also makes investor management easier.
By relying on third-party exchanges, it is possible to track secondary transactions without any complications. Investors can also effectively use any other processes such as voting. This programmability can be very helpful at speeding up settlements, as tokens can contain built-in compliance.
3. Improved liquidity
On its own, tokenization increases opportunities for fractional ownership. A fiat like the US dollar can only go as low as $0.01, but tokens can have up to 18 decimals, meaning that they can go much lower unless some barriers are implemented.
This means that the investor entry is much lower and that there is more room for fractional ownership. For example, instead of having to invest $100,000 for a certain real estate, investors will be able to pay $5,000 for their tokenized fractional ownership.
The process of tokenizing real estate and current issues
For tokenization to take place, it is important to achieve 3 fundamentals:
1. A platform that has the rights to store assets on the blockchain
To tokenize a house, you must find a properly regulated blockchain platform that has the rights to store ownership onto their tokens through proper authorities.
2. Ability to transfer the rights to assets legally through the blockchain
Apart from being able to store rights to real estate onto tokens in a legal way, the platform should also allow the owner to transfer those rights to anyone and transfer the complete ownership to someone else in a legal way.
3. The tokens need to be exchangeable for value
Like with any type of security, the owner needs to be able to exchange the token for a certain value so that each asset can receive its proper value represented in tokens.
Even these things seem fairly simple, there are a lot of issues that go along with them when looking from the real estate angle. Some of them include:
If a tokenized property has a mortgage, the issuer will need to pay it off or get a permit to do so.
Token holder tracking
Token issuers will have to know who owns their token and how many people have them. This means involving security-token exchanges that have the ability to track ownership and secondary trading.
Countries have different KYC and AML rules as well as unique securities laws. The token issuer needs to be aware of the regulatory regimes that change. For example, a European security offering might be completely legal in EU countries but illegal in the US.
Still many are hoping that the use of smart contracts can come very handy in this case and help overcome these obstacles.
Examples of startups working on tokenizing real-estate
Even though real estate tokenizations presents many obstacles, there are already many examples of serious startups that try to make use of these kinds of investments and try their versions. Here are some examples:
Governance, misconceptions, and legal issues
Real-estate tokenization offers flexibility and even though this is a good thing from a business point of view, it creates legal complexities. Let’s dig a little deeper. Owners can tokenize different things when it comes to real estate, including direct real estate ownership, rental income rights, or usage rights (property rental).
This creates 3 different rights categories when it comes to tokenization including:
- Governance — in this system a group of people makes unified decisions for the greater good.
- Claim rights — includes claims to a specific asset or its uses.
- Ownership rights — asset control and ownership of equity.
Apart from these individual claims, tokenized assets can have a combination of multiple claims or even all and this creates legal issues.
Legal issues caused by different rights
A big cause for legal issues could be the separation of ownership rights and claims rights, which would lead to misaligned incentives of the two parties involved.
For example, if token holders had ownership rights over tokens, it would create issues. It would be difficult for all token holders to make a collective decision that is best for all their assets. A possible solution for this would be delegated decision making or even voting.
Legal entity issues
Real estate securitization has been traditionally done through PSV or special purpose vehicle and chances are that tokenization will go in the same direction. SPVs are legal entities designed for a single purpose like managing or holding a real estate.
An SPV can represent limited partnerships, trusts, corporations, and other entities, all of which have their own pros and cons. If used in the right way, SPVs can be separate from the developer concerning liabilities and assets, which allows tokens to exist as independent investments without considering the developer’s creditworthiness.
Still, this is a very complex process of structuring SPVs and it will require the knowledge of experienced professionals.
What steps do we need to take to make this viable?
Even though tokenization has lots of potentials when it comes to improving real estate investments it is a complex structure that comes with a lot of practical and legal issues that need to be tackled. If any of those is ignored, the whole thing can fall apart. The first thing that is obvious for any project in this direction is compliance.
Some startups are already developing automated compliance solutions for KYC and AML, which are essential for these kinds of projects. All token issuers need to comply with Know Your Customer and Anti Money Laundering regulations and laws, no matter where their tokens are offered.
The general need at the moment is for governments to get involved and work with private companies to establish better infrastructural solutions that will improve payment capabilities, reduce settlement risks, and improve operational efficiency. Blockchain has revolutionalized various industries, perhaps real estate is next?
This article is part of our blockchain awareness posts where we try to help newcomers and people interested in blockchain use cases enter the space more easily. Follow us and subscribe for more upcoming articles such as this one, and feel free to join the conversation on Twitter and LinkedIn.