Tokenization of Real Estate: A Guide
The global real estate market is growing. Experts forecast over $3,741.06 billion in growth by the end of 2022 and a whopping $5,388 Billion by 2026.
Even as the conventional real estate market continues to grow, real estate pegged on blockchain technology is also on the up. This upcoming real estate segment is made available to potential owners through tokenization. We shall delve deep into what real estate assets tokenization is and how you can invest in the next sections of this piece.
The benefits of asset tokenization are numerous. From increased liquidity, and fractional ownership, to increased accessibility. Tokenization is gaining momentum and offering a once-in-a-lifetime opportunity to a new breed of investors. Blockchain tech could also potentially offer new forms of risk management in property investments, such as smart contracts for leasing agreements or rent payments.
Let's now take a deeper dive into tokenization in real estate.
What Is Tokenization of Real Estate Assets?
Real estate tokenization uses blockchain technology to divide and represent ownership in real estate assets.
Using a blockchain platform for real estate tokenization allows for fractional ownership in real estate properties, allowing more people to invest in real estate.
Companies specializing in real estate tokenization allow users to buy a tokenized version of an investment asset, ranging from single-family homes to commercial buildings.
Investing in Real Estate Using Blockchain Technology
A blockchain is a distributed, decentralized ledger that tracks the ownership of digital assets. Like any other digital asset, you can tokenize a real estate asset and then trade it on a peer-to-peer network.
The process starts with the blockchain tokenization of the investment property or real estate project. A self-executing smart contract is created to enforce terms and conditions of the ownership rights, such as liquidation rights or priority for payment if there's ever a default.
How Does Real Estate Tokenization Work?
Here's how real estate tokenization works:
Identify the Asset to Digitize
You can do so individually, through a Special Purpose Vehicle (SPV), Real Estate Funds, or Real Estate Investment Trust (REIT).
Identify the Blockchain Platform to Use
Ensure you choose a platform that supports smart contracts, such as Hyperledger Fabric or Ethereum. Create digital tokens on the blockchain, representing ownership shares in the property.
Marketing and Distribution
Whether individually, through SPV, or REIT, list the tokens on a platform where investors can buy and sell them. Alternatively, they can hold them in a wallet or digital vault on the blockchain.
Trade and Recording
Investors use their tokens to participate in revenue sharing, such as rental income generated by the property. They can also sell their tokens through an exchange that trades security tokens as prices fluctuate according to market conditions (in many cases, without paying transfer taxes).
The blockchain records each transaction. The smart contracts automatically execute transactions between parties based on predetermined rules encoded into these agreements when an event occurs, such as an investor selling their tokens.
Understand Real Estate Tokenization Better
For a moment, dismiss the idea of blockchain and smart contracts. Let's assume you are looking to invest, but you are $50,000 short. On the other hand, you have a single-family home valued at $100,000. You can utilize your home to raise the remaining finances for that investment through tokenization.
However, the house is valued at $100K, and you need only $50K.
How does that work?
Through a blockchain platform, convert your house into tokens. Think of it as cutting your favorite pie into sizable delicious chunks.
Now you have 100 tokens, and each token represents 1% ownership of the house. You can now sell the tokens (percentage of house ownership) to raise what you need. If an investor purchases 10 tokens, they get 10% ownership. If they buy the 100 tokens, they get 100% ownership of the house.
Categories of Real Estate TokenizationThe various types of real estate tokenization in the industry include:
- Commercial real estate tokenization – tokenizing commercial property while observing all legalities. For instance, a commercial office building or warehouse.
- Residential real estate tokenization – tokenizing residential property, such as an apartment building or family units.
- Trophy real estate tokenization – tokenizing trophy assets, such as iconic buildings. In most cases, these trophy assets are located in key real estate locations.
- Single real estate tokenization – tokenizing single real estate assets and reducing the liquidity premiums by 25%.
Benefits of Real Estate Tokenization
Tokenization is a fascinating concept. Unfortunately, it's been relegated to the realm of large institutional investment firms. However, that shouldn't be the case.
Whether a misunderstood concept, challenging to high-maintenance, asset tokenization offers a plethora of benefits, including:
Think of real estate tokenization as an actual asset class. You can invest with relative ease and have access to investor financing for your project or business.
It's a liquid financial instrument allowing investors to add liquidity and diversify their portfolios by investing in real estate.
Tokenization makes investing in real estate more accessible to individuals whose investment minimums might have previously been restricted.
Blockchain technology also breaks down geo and time barriers to offer more inclusivity. An investor can trade in tokens, regardless of their location.
Efficiency and Reduced Costs
Blockchain technology automates all processes, eliminating any intermediaries. There aren't any brokers or agents involved in any real estate transaction. Additionally, tokenization ensures investors don't incur costs from bureaucracy, management, transfer, ineffective communication, or lengthy document processing.
The smart agreements reduce, if not eliminate, costs typical of standard real estate transactions.
Reduced Barriers to Entry
Over 80% of investors agree that investing in real estate is a great way to diversify a portfolio. Sadly, numbers show only 7% of the global real estate market is open to retail investors, and only 3% have invested.
Fractionalization through tokenization has eliminated/reduced challenges to real estate investment. Barriers such as inflated initial investment costs, lack of funding, reduced transparency, and inefficient processes are outdated.
Blockchain Is an Immutable Public Ledger
A blockchain is essentially a public ledger. It records all transactions between parties involving a particular token.
Anyone can create and transfer tokens but cannot manipulate or edit them in any way, boosting security. In addition, anyone can view these transactions, which increases transparency and accountability.
Drawbacks to Real Estate Tokenization
Sure, tokenization of real estate assets is gaining momentum globally. However, not without some friction.
Some barriers the industry is fighting to overcome include:
Legal and Regulatory Barriers
Courts and regulatory authorities worldwide have barely created or settled clear laws and statutes governing real estate tokenization. While some regulation exists, such as the Executive Order for Responsible Development of Digital Assets and others, there's still a lot of uncertainty. It's unlikely the existing laws on real estate tokenization will be updated in the future despite the technology gaining momentum by the day. If any changes occur, it's unclear how these laws will change.
There are inconsistencies among regulators on classifying real estate tokenization, creating confusion deterring investors and growth of the sector. Some regulators, such as the SEC, classify them as security tokens, while others view them differently. The IRS views them as taxable real estate, the U.S. Department of the Treasury's Financial Crimes Enforcement Network views them as currencies, while the Commodity Futures Trading Commission categorizes some tokens as commodities.
Lack of Public Knowledge
Blockchain and cryptocurrencies have drawn incredible public attention and participation in recent years.
However, despite the bucket loads of benefits associated with asset tokenization, it hasn't garnered enough public attention or support.
Despite how far blockchain technology has come and evolved, it remains volatile.
As an emerging market, blockchain is still a developing technology with a long way to go. In addition, investors (some are fragile and fresh) bet and speculate on fluctuating prices to make profits, indicating an unstable market.
Last but not least, most blockchain platforms operate exclusively in the digital plan. They lack stabilizers, such as government funding, making them fluctuate in demand and supply.
Factors to Consider In Asset Tokenization
There are certain factors to consider before offering or developing real estate tokens. These factors are complicated, and it's best to seek understanding from real estate, blockchain, securities, or tax professionals.
Some of these factors include:
Cybersecurity threats targeting blockchain entities are on the rise and will increase in the future. Blockchain technology developers offer tight security, but it's not foolproof.
Cybercriminals have sophisticated systems targeting weak points, such as managing private wallets and keys. Before engaging in tokenization, invest in airtight security systems.
Legal Accreditation and Compliance
Legalities and regulations vary as per jurisdictions. For instance, countries and trading blocs have their versions of anti-money laundering and know-your-customer (AML/KYC) regulations and taxation statutes. In the U.S., most real estate tokens fall under securities, and you have to register with the SEC or seek an exemption.
Also, asset tokens might be controlled by varying money service systems and anti-fraud and consumer protection regulations.
Specific Blockchain Platform to Use
There are four main categories of blockchain platforms (private, public, consortium, and hybrid). These categories house numerous individual blockchain companies, some of which don't deal with real estate tokens or accept smart contracts.
Do your homework on regulations involved, deliveries you are looking for, and reliability, among others, before engaging with a particular asset tokenization platform.
Not everyone is who they claim to be. Con artists and scammers can present themselves as investors. Before engaging with any entity, conduct rigorous vetting on all investors, and understand and comply with AML/KYC regulations.
Smart contracts exist in the digital plain as computer code. They automatically implement and enforce agreements.
Since smart contracts are immutable, it's wise to seek professional help and insights before launch. These professionals will ensure the contracts deliver the desires of both parties to avoid conflict.
The Outlook for Real Estate Tokenization
Tokenization of real estate assets is the future of investing. Sure, blockchain technology has some hurdles to cross. The public is gaining more knowledge, attention, and engagement in this great alternative to investing in real estate.
There's still a lot that regulators, government, blockchain developers, and experts must do to stabilize the sector and reduce risks and uncertainties. For now, the future of asset tokenization looks brighter than ever.