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The real estate world has an innovative tool at our disposal — tokenization — that can facilitate making illiquid assets (like real estate holdings) liquid.
Real estate has almost always been considered a relatively safe investment. As Mark Twain famously said, “Buy land, they aren’t making it anymore.” After all, whatever happens in the stock market, people will always need a place to live and work. Yet real estate transactions also tend to be some of the most complex and expensive, rendering real estate itself relatively illiquid.
In recent decades, securitization has had some success in making real property interests easier to transact. But a new method of engaging in such transactions promises to go even further in transforming the purchase, holding and sale of real property: tokenization.
Tokenization of real estate creates digital securities ownership interest in the entity that holds and/or operates the underlying real estate assets. These securities use blockchain technology to enhance the investor experience, and as regulation permits, they will feature an expanded role for blockchain in the lifecycle, including real time or near-real time settlement. An issuer can utilize a variety of blockchain networks, such as Ethereum or Tezos. Digital securities are typically governed by a smart contract that’s programmed to be compliant with securities regulations.
Tokenization and blockchain offer many advantages over traditional methods of dealing in real estate. These include increased liquidity and transparency, materially faster transaction settlements, reduced settlement costs, enhanced security and simplified management.
Tokenizing real estate is the process of issuing digital equity securities in a holding company that owns the real estate asset. More generally, digital securities can be structured to represent a variety of ownership and economic interests in an underlying asset; it can be equity in a company that owns the asset, an interest in debt secured by the real estate, a stream of income based on cash flows from the asset or an interest in the capital growth of an off-plan project. The types of the real property involved can also vary widely, including single-family homes, multifamily structures, office buildings, warehouses, retail spaces, timeshares and everything in between.
Although this may sound like something from an episode of Mr. Robot, several models of real estate tokenization are being actively developed, such as: ownership of real estate through a special purpose vehicle, shares in real estate funds, investments in and loans to developments and tokenized REITs.
Access to Capital
Because property developers can fractionalize a property efficiently, more investors can participate, resulting in more capital flowing into a project.
More Accurate Pricing
The asset’s price will approximate its real market value, since illiquidity discounts will be significantly decreased. Potential investors can easily trade many assets at low fees in the secondary market.
Real-Time Pricing Information
Because paper-based systems that share data asymmetrically have been eliminated, investors can uncover better trading deals more swiftly.
Since the blockchain-based system is regularly updated, investors know the underlying property’s value in advance.
The Reduction of Overhead & Faster Settlement
With tokenization, intermediaries such as brokers and agents are eliminated. This is because the platform’s entire operations have been converted digitally and been automated.
Participants can invest in multiple properties internationally and enjoy higher returns.
Decreased Opportunity for Fraud
Investor confidence is increased, since no one can change a transaction recorded on the blockchain network.
A Collateral-Backed Investment
Since real estate tokens are financially supported by real-world assets (tangible property), they offer less risk than unstable cryptocurrencies or potentially questionable initial coin offierings (ICOs).
Thanks to regular checks and balances that ensure stability, the security token’s value doesn’t fall below the real estate asset’s net asset value (NAV).
One company that’s been successful in tokenizing real estate is tZero, a leader in blockchain technology for capital markets, which works to tokenize and trade digitally-enhanced securities securely. Its stated goal is “democratizing access to private market investments.”
After digitizing securities (by creating a digital capitalization table that can be efficiently managed with an innovative smart contract), tZero also offers a regulated trading platform, through its regulated broker-dealer subsidiaries, where issuers can make their assets available for trading. (These securities aren’t purchased with or quoted in bitcoin or another exotic cryptocurrency, only in traditional cash. However, tZero is working on regulatorily-compliant mechanisms for investors to be able to convert their crypto into cash that the broker-dealer would then accept.)
“Tokenizing real estate has many advantages,” said Solomon Tesfaye, tZero’s vice president of business development and capital markets. “One is controlling liquidity. If you don’t want a certain party to own more than 10% of your security, for example, through set contracts, you can obtain tailored liquidity. You can also create a ‘sandbox’ where only certain investors are allowed to trade your security.”
“If you’re a real estate owner, you can digitize your building or real estate portfolio and sell shares in it as if you were a large public REIT on the NYSE,” continued Tesfaye. “We’re seeing on our platform 30 times the historically balkanized and opaque liquidity of traditional private markets.”
He cited a useful case study. Last year, tZero was approached by a luxury ski resort in the Western United States that was interested in tokenizing its real estate assets. Last summer, it took tZero less than two months to completely digitize the capitalization table for the holding company holding the real estate asset and onboard the holding company’s securities for trading. This resort continued to maintain continuous automated liquidity during the pandemic with market-driven pricing that was untouched by the COVID-19 dislocation some other publicly-traded hospitality companies suffered.
The idea of harnessing blockchain technology to promote liquidity in real estate markets was the brainchild of Julio Gonzalez Jr., the founder and CEO of Engineered Tax Services, who has over 20 years’ experience in the commercial real estate sector.
“I partnered with tZero to bring tokenization to the accounting industry and its real estate clients to provide next-generation real estate services to the nation, just as I’ve done with cost segregation studies, 179D energy tax deductions, research and development tax credits to a wide variety of industries and 5G wireless cellular antenna installation,” he said. “Tokenization is yet another sign of how technology is revolutionizing the real estate profession. I see it as the democratization of access to asset classes. Now anyone with substantial assets — even collectibles — can convert those illiquid assets into liquid ones and trade them on a regulated trading platform as if they were shares of Apple or Amazon. It’s a potential game-changer for capital markets — and I think it’s a startling new development that could introduce substantial liquidity to U.S. and international real estate markets.”