This House Was Built On Blockchain
How tokenizing real estate creates wealth by destroying fees
In the last installment of New Alchemy’s Security Token primer series, Galen Moore’s guest-post discussed some of the skepticism surrounding Security Tokens and presented two reasons why tokenization is worth the trouble: Liquidity, and fractional ownership. In this article, we show what improvements those two attributes of tokenization can make possible in the real estate industry.
One of the most complicated responsibilities when operating a business is securing real estate. Whether it’s buying land for a farm or renting space for an office, the process of getting all the necessary information and approvals, as well as orchestrating all interactions between financial and municipal entities, is always tedious and costly.
Any tiny mistake or delay — a high possibility in the paper-heavy back offices of most real estate services, even today — can derail the entire process. The fact that purchasing ‘Title Insurance’ (i.e. paying to ensure that nobody else can claim your property as theirs) is often a necessity, is a testament to just how unreliable the system for managing asset ownership can be.
It is because of these operational costs, high friction and trust gaps in the real estate world, that businesses often work with middlemen to close deals. The result? Even higher operating costs. When raising investment capital for purchasing or investing in, let’s say, commercial real estate, issuers can expect to pay more than seven percent of the total raise in fees to ‘middlemen’ entities.
So what’s the solution? At New Alchemy, we say: tokenization.
In last week’s guest post (as part of our Security Token series), “Tokenize Securities? Why Bother,” Galen Moore discussed two attributes of tokenized securities, — liquidity, and fractionalized ownership. Both of these present opportunities to reduce costs and friction in the real estate investment process.
Killing real estate fees softly, with tokens
For investors who are not accredited, their access to participating in the real estate asset class is strictly limited. Many choose to invest in Real Estate Investment Trusts (REITs). For the investors who are accredited and can more easily participate directly in the real estate market, their individual investments are often beholden to sales restrictions, like year-long lockout periods or infrequent “liquidity events.”
By using a Security Token Offering to raise capital for investing in real estate, it becomes possible for issuers to automate some of these restrictions and improve accessibility for their investment. If an issuer designs their STO under Regulation A+, for instance, non-accredited investors may be able to participate.
When more of the processes involved in issuing a sale are automated, the operating fees involved for all participants should decrease.
By tokenizing securities, real estate capital issuers and investors could benefit by reducing operational costs, such as when preparing tax documents. Plus, depending on the type of security it represents and technical implementation of the token, investors in real estate STOs could be given more choice in how they sell their investment, such as directly for fiat, for a cryptocurrency, or for another digital asset.
Security Token Offerings for facilitating ownership of real estate interests, including different forms of recurring payments, can be issued today using public blockchains such as Ethereum and a token (like an ERC-20 protocol token). The purpose of the tokens would be to maintain the ledger of owners for the corresponding asset, and to provide those owners with the ability to prove or to transfer their ownership, and for this they may not need to be accredited.
The type of infrastructure and software needed to support sophisticated tokenized real estate platforms are in operation today, and companies like New Alchemy are able to build complex tokens and related ecosystems today with compliance in mind.
However, to accomplish all the of the improvements for the real estate market industry which tokenization could enable, there is still a great deal of industry body planning and determinations made by regulators which needs to be accomplished. This work will pay off through the benefits of fractional ownership.
Why you will want to own 0.00001% of a building, but also have to wait
We mentioned REITs above. The sales pitch for these assets sounds great for passive or novice investors: own a share of company which in turn owns thousands of commercial properties, or shares of those buildings, and earn a corresponding share of the profits and appreciation.
A major setback to this convenient investment tool, however, is that investors don’t have the choice of which individual properties they are investing in, and so rely on the investment strategy of the directing entity for the REIT. This investment oversight, bear in mind, is expensive.
A system which would give investors more agency in creating their own commercial property portfolio might accomplish this by tokenizing equity for individual buildings, and then selling those as shares on a secondary market. Investors purchasing these tokens would in effect be creating a portfolio of commercial property, and as Galen Moore entertained in his article, could use such methods to “long Manhattan and short Brooklyn.”
Such a system could be created using Security Token Offerings.
However, as of yet, there are no licensed securities exchanges or Alternate Trading Systems which can enable this for a public investor base.
Examples of significant issues being discussed around the implementation of security tokens include: How to comply with Anti-Money Laundering and Know-Your-Customer laws; how the technical processes for “custody” of a crypto asset should work; and what assurances these platforms should be required to provide users.
It is likely to take a long time before a widely accessible platform for investors to purchase, bundle, and trade tokenized real estate securities could be launched, but the value creation of such a system should be immediately recognizable. Such as in the early 1900s, when innovations in technology and finance enabled many investors to enter the public stock market for the first time, blockchain technology and Security Token Offerings could do the same for commercial real estate.
When something like this occurs as a significant trend in a country or globally, it is considered by economists a kind of “wealth creation.” Such a change could leave our economy more stable and less susceptible to catastrophic events like the housing crisis in 2008, if it involves spreading risk more evenly among investors, or at least, enabling more efficient data collection for industry bodies.
In summary, what tokenization, STOs and blockchain technology represent to the real estate industry is a cost-efficient and technically sophisticated method of maintaining a property ownership ledger, tools which could enable a more liquid and equitable commercial real estate industry.
This is Part 4 of a Security Token Primer series.
At New Alchemy, a leading blockchain strategy and technology group, we are preparing for the tokenized future of securities by partnering with a cutting-edge securities broker-dealer, Entoro Capital. Get in touch with us at Hello@NewAlchemy.io or contact us to learn how our token technology and services suite can work for you.
