Real estate is one of the highest valued industries in the world and it’s no surprise that there are considerable efforts and resources being put into more efficient ways to invest and transact with this massive asset class.
There is an ever-increasing conversation about the tokenization of real-world assets. We are seeing just about anything of value being tokenized from securities to valuable artworks and real estate.
For this article, I’m going to stick to real estate as I think it is relatable to the widest audience.
Let’s be clear right up front and say that there are definitely some bad actors in the asset tokenization space, people who are using this technology for nefarious means. But, there are also a lot of really good projects that are being worked on and it’s important to remember that there are bad actors in just about every space. The baby should not be thrown out with the bathwater.
With that said, let’s get on with it…
Where to start?
A good place to start is a brief explanation of what we mean when we say ‘tokenizing a real estate asset’.
A piece of real estate holds value. It usually increases in value and therefore is an attractive investment for most people, in most countries. The reality is that many of the attractive pieces of real estate, even the very small ones, are priced at a point that is out of reach for the majority of people on the planet. As a result, most people are excluded from participating in the real estate market.
This is often referred to as the housing crisis, where the gap between the haves and the have nots is growing.
Tokenisation offers a technical mechanism to improve the current situation by dividing ownership of the real estate asset into very small pieces, thereby making it accessible to a much wider group of investors.
This is done by taking these small pieces of ownership and representing them on a blockchain in the form of tokens. Once the tokens are issued on the blockchain they become irrefutable pieces of ownership for the holder with an immutable and transparent ledger, and therefore, an audit trail that is tamper-proof.
In most cases, the tokens do represent the real estate asset itself but rather the legal entity that owns the real estate asset. This is because the friction of fractionalizing the actual asset would be prohibitively complicated and expensive. For this reason, it is very important to understand the ownership and rights structures of any tokenized real estate investment that you are considering.
Simply put, in most cases you would be buying a fraction of a Special Purpose Vehicle (SPV) that exists solely to own one single real estate asset.
Through your ownership of a fraction of the SPV, you would have legal rights and ownership of an equal fraction of the property that the SPV exists to own. This generally means you will benefit from any income that it yields such as rental income and any capital appreciation over the lifetime of the asset.
OK so now that we have the basics out of the way, let’s get into why this matters and what the benefits of tokenizing real estate are.
Most people still can’t afford to invest in real estate – this is a problem.
Property is often touted as the best and first place to invest but the reality is that the majority of people still are not able to get into any kind of meaningful real estate investment as the capital required is beyond their means. By tokenizing high value and high return real estate assets there is an opportunity for just about anyone to participate in the investment.
Let’s put this into perspective with some simple numbers:
- The average home price in the US is $293k (source – Zillow).
- Most lenders these days will be looking for an 80/20 loan to value (LTV) ratio which means you would need to put down a 20% deposit to buy this property, which, in this example, would equate to $58600.
- Then you need to factor in the closing costs, which in the US is between 2% and 5% (in other countries this can be a lot higher). So Let’s take the middle road here and say 3.5% of the purchase price so that’s $10250 in costs.
- So, between the deposit and the costs, your required capital to participate in this investment will be somewhere around $68000.
Just think about that for a second – in order to get into the real estate market, you will need around $68000 of available cash to participate in a very modest piece of real estate!
The reality is that most people just don’t have this kind of free cash at all, let alone available to invest – can you see the problem?
With real estate tokenization, an investor can participate for under $100 and that token will represent a piece of ownership of the real estate asset.
There are definitely many factors to consider when getting into any investment and you should definitely do your research before investing in anything. But it’s clear that this mechanism opens up a previously unreachable investment class to just about anyone, so long as they’re earning a wage and that have a small amount of disposable income.
Increased liquidity for a market that is traditionally very illiquid.
Real estate is broadly accepted as a sensible investment and over time, in most countries, it will usually give you a decent return. One of the major downsides, however, is that it is very illiquid.
This means that the capital that you put in to buy the property and to improve and maintain the property is locked up. In most cases, the only way to free up this capital is to sell the property and this takes time, effort and is costly.
Many investors will place a high value on more liquid investments. This is because of the decreased risk associated with a more liquid asset in the event of a liquidity crisis. Real estate is generally accepted as being one of the most illiquid asset types.
Tokenizing a piece of real estate creates a very high level of liquidity not usually enjoyed by the real estate sector. It does this by turning one big asset into many smaller assets that are represented on a blockchain as tokens.
These tokens are able to be just about instantaneously liquidated into fiat (normal) currency should the token holder decide to do so.
This is still a very new space and we are seeing a lot of innovation around how exactly these legal structures are set up in order to comply with law and regulation.
Reduced transaction costs and complexity.
Traditional real estate transactions generally attract high transaction costs and administrative complexity. Once an offer to purchase is agreed to by the seller and buyer there are multiple parties brought into the transaction, all of which take their fee.
Conveyancers, lenders, real estate agents, and government all get their cut for rendering the services that are required in a traditional real estate transaction. These fees and taxes add up and in many countries can exceed 7% of the price of the real estate asset.
On top of the direct financial costs involved as laid out above there are also considerable time and energy costs to consider. It’s rare for a property transaction to conclude in less than 30 days and in many countries it can take more than 3 months to conclude and settle.
The combination of the direct costs and time and energy costs are considered in the traditional real estate markets and need to be considered when investing in real estate.
Using blockchain technology to tokenize real estate assets will in most cases reduce the direct costs and at the same time also reduce the processing time to just about nothing.
Because blockchain technology offers a mechanism to record every transaction onto a ledger that is publicly available and tamperproof it gives any participant a very high level of transparency that does not depend on a centralized party.
It is still early days for real estate tokenization and it still has a way to go before it becomes mainstream. Having said that, the combination of increased liquidity, increased access to previously excluded investors, and decreased friction makes it a space that’s likely to grow considerably over the next few years, and for good reason.
There are still some major hurdles to overcome, mainly in terms of regulation but as the regulators catch up with the technology and the bad actors get pushed out, I think we will see just about every asset class being tokenized and with good impact.
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