The World Economic Forum predicts that within the next 10 years over 10% of the world’s GDP will be stored on blockchain, in a process called tokenization. We take a look at how the token revolution will impact real estate.
What is Real Estate?
Real estate is tangible property. It exists. Usually, people live in it. Though it performs many other functions such as storing goods and services.
Of course, the industry is massive. Savills reported that by the end of 2020 global real estate was valued at $326.5 trillion. This makes it by far the largest store of wealth. Putting this number in context it represents four times the size of the global GDP. It is also larger than all the world stock markets and bond markets combined.
What are tokens?
According to Investopedia, The term crypto token refers to a special virtual currency token. These tokens represent fungible and tradable assets or utilities that reside on their blockchains.
A blockchain is a distributed database or ledger that is shared among the nodes of a computer network. As a database, a blockchain stores information electronically in digital format.
Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions. The innovation of a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.
This security of record data is its key benefit. This allows the technology to be used as a recordkeeper of assets cheaply and effectively. If used correctly this technology can deliver complete transparency and total security as they are impossible to tamper with.
As tokens are digital they can bring complete liquidity to any asset.
What is tokenized Real Estate?
Real estate tokenization is a way of representing a piece of real estate as tradeable digital security tokens. These tradeable digital tokens are secured by blockchain technology.
Real estate tokenization involves creating tokens through blockchain technology and then assigning them to real estate properties that already exist or that are under construction.
Currently, this market is growing very fast. Many advocates believe that real estate tokenization will be very common within a few years due to the advantages that they offer.
Advantages of real estate tokenization
In this section, we take a look at the main advantages of tokenization For the real estate sector. After all, if other assets can be owned digitally then why not property?
Real Estate is expensive. For most people, it represents the largest purchase of their life. The expense of property makes it very illiquid.
Tokenization reduces one of the barriers to buying, selling, or owning real estate, as it can be more easily bought and sold via tokens. It holds the potential to make a property a very liquid asset.
Tokenisation makes fractional ownership of property possible and relatively easy. In some ways, real estate tokenization is a form of digital fractional ownership.
This makes real estate ownership accessible to smaller buyers and investors. People who cannot buy an entire piece of real estate can buy several tokens in it. This opens up the ownership of the real estate to a much wider and more diverse market.
Globalisation of real estate
Through tokenization, anyone can own a piece of real estate. That person could be based anywhere in the world. A person simply has to buy a token to get fractional ownership of a real estate asset. This opens up new markets. For example, people in mainland China can only invest up to $50,000 in overseas real estate. This makes ownership of foreign real estate very difficult in western countries. Tokenization would open up this massive market.
Depending on how the token is structured, the price of real estate tokens should reflect the underlying value of the asset more accurately. It can be assumed that the value of a piece of real estate is the price at which tokens are changing hands at that point in time. The implications for the commercial property could sector drive prices up significantly as experts theorise that larger commercial projects often change hands at lower prices due to the illiquidity of the asset.
For tokens that are investing in several real estate assets, the tokens will trade at a premium to their underlying assets. In effect, they will be trading like shares in property funds and REITs where people buy at a premium in anticipation of future price rises.
Real estate tokens should be easier to buy and sell compared to the real estate itself. To buy or sell real estate you can simply buy and sell the tokens. This reduces the administration. Sales and purchases can be concluded very quickly. Maybe in minutes. This contrasts with the conventional system. Currently, the purchase of real estate often takes many weeks.
Sales and purchases can be completed digitally, via a trading platform and perhaps an app. Potentially this can be done by the buyer or investor themselves. The involvement of real estate agents and other intermediaries (and their fees and commissions) is eliminated. It may also save on transfer taxes.
Real estate ownership would be very secure with blockchain technology. This should make fraud or theft impossible either during or after the transaction.
Real estate tokens can be used for several functions in real estate. Tokens for example offer fractional ownership or entitle them just the rent or capital gain or for both.
There will be a rise in new products for equity release or selling part of your house to fund retirement. There will be the ability to leave some of the tokens for security to obtain extra finance.
Real estate tokens can be attached to a single property, commercial property, or land. Tokens can fund a whole development or even many developments by effectively becoming funds. The applications for tokens in real estate are endless.
Tokenization allows property investors to diversify their investments more easily. Rather than purchasing a share in just one building, for example, investors can purchase tokens in many different buildings in many different countries and of many different types of real estate. Investors can sell all or just part of investment more quickly through a token.
Bitcoin was the pioneer crypto token that has paved the way for many others to follow. With Bitcoin and many other tokens, its underline value lies in its scarcity. By only having a limited number of coins/tokens in circulation it makes it rare. And this gives it value. This is similar to gold.
Real estate tokens in contrast are underpinned by a real physical asset. This should provide a higher degree of security. For tokens that deal with several developments, they are strategically placed to take market share from other tokens which don’t have real tangible assets to back them up. Importantly real estate tokens, will provide investors with an income.
Tokenization offers an opportunity for developers and builders to raise funds for a project more easily by selling the tokens to several or indeed many investors or funders. A single piece of tokenized real estate can be owned by thousands of investors. This is something that is not impossible via conventional ownership methods. Real estate tokens can be an alternative way of raising capital for development from amongst a large number of investors. And potentially raising much more money in the process.
Disadvantages of Real Estate Tokenization
Tokenisation of real estate is not without its problems. In this section we look at these main issues.
Not all countries have a legal framework to allow real estate tokenization or even make it possible. The legal status of tokenized assets may be unclear in many places. Even when tokenized real estate has a legal status processes such as legal transfer or conveyancing and land registry procedures are still likely to be non-digital. So while tokens can be transferred digitally a property still cannot be.
As the industry is in it’s infancy, there is still no accepted model for what a tokenized real estate investment should consist of, nor for a security token offering (known as an STO).
Currently, tokenized real estate investments are not in the ownership of the property itself but in an SPV (special purpose vehicle) which owns the property. This may be a company located in a jurisdiction other than that which the property is located.
Tokenisation of real estate requires a suitable tokenisation provider to issue and manage the tokens. This business is still very much in its infancy too.
Not widely known
Real estate tokenization is still not widely known about or understood. Currently, there are only a small number of knowledgeable potential investors. This could be a barrier to selling tokenized investments. Only small volumes of real estate are sold this way.
As tokens are still in their infancy, people may consider tokens risky. This is despite real estate tokens being assets backed by property. Consequently, tokenized real estate investments are likely to appeal to younger investors who understand the technology. Though as the industry matures this will eventually change.
There is likely to be resistance toward real estate tokenization from organisations that have a vested interest in the current system of real estate ownership. This includes conveyancing lawyers, as tokenization would eventually cull many of their numbers. This is because all information on the property would be stored electronically on the blockchain making the information easily accessible for all.
Fractional ownership already exists
Despite what some of the advocates of tokens say, fractional ownership of property is not new. Investors can participate in property investment by buying shares in established housebuilders, or property funds and REITs.
Tokens will undoubtedly bring changes to the real estate industry due to the benefits that blockchain technology can offer. Though for the time being tokenization of individual properties is still a long way off.
The immediate benefits are going to be in investment, as tokenization could bring total liquidity to special purpose funds that buy real estate assets. Currently, with shares, there is liquidity in real estate but dealing costs mean that very small purchases in real estate are quite inefficient. Tokenisation will change this.