Real Estate Investing through Security Tokens
Today we’re going to talk about another real world use case for blockchain technology: investing in real estate!
Through the use of blockchain and related technologies, we can turn real estate into tokenized assets in the form of highly liquid digital securities.
Tokenization is the process of representing the ownership of real world assets digitally on a blockchain. Real estate ownership will likely be sold as “security tokens” which means investors must satisfy specific requirements for investing in securities such as KYC and AML.
Security tokens must follow different rules from the “utility tokens” offered through ICOs. Security tokens are considered “securities” in the eyes of most financial regulators. This presents new regulatory challenges. Luckily, there is unlimited creativity in the blockchain space and we’ve already seen new protocols emerge to tackle this unique challenge.
Most security token protocols, such as Polymaths ST-20 standard, will embed the legal and regulatory requirements directly into the code. Embedding legal and regulatory requirements directly into the token enables investors to cut out the middleman saving time and reducing costs. While this industry shows tremendou promise, the reality is we’re just getting started.
In this article we will cover:
- Challenges with investing in real estate today
- Benefits of blockchain in real estate investing markets
- Examine the current state of blockchain real estate projects
Challenges in the Current Real Estate Investment Market
Real estate is the largest global market in the world, currently valued at over $200 trillion. For comparison the global gold market is around $6 trillion. In other words, changes in the real estate market will have the largest impact in economies around the world.
Even a small improvement in the real estate market would drive tremendous economic value. Let’s explore some challenges in the current market and then determine if leveraging blockchain technology can help.
Current challenges in the real estate investment market
- Real estate suffers from a lack of liquidity
- Investing in real estate comes with serious risks
- Investing in real estate is only accessible to the wealthy
- Real estate transactions have lots of friction: they’re slow and expensive
Let’s explore how blockchain technology could be used to solve the problems faced by the current market for using real estate as an investment.
Leveraging Blockchain to Improve Real Estate Investment Market
There are many ways we can use blockchains and security tokens in real estate, including: increasing liquidity, minimizing risks, providing access to a wider range of investors, and reducing expenses related to real estate transactions. Let’s explore each of these more in-depth.
#1 Blockchain Technology Makes Real Estate more Liquid
Real estate as an asset class is notorious for being a low liquidity market. Liquidity is defined as how quickly an asset can be converted in cash without affecting the price of the asset. Finding a buyer for your real estate is challenging and takes time as each asset is unique and requires the “right” buyer. Even if you had the “perfect” buyer on hand, the administrative burden ensures the transaction will take weeks or months to complete.
The ability to freely move in and out of an investment dramatically minimizes risk of investing in real estate. Traditionally, investors would be locked into their investment because finding a buyer can be difficult. By creating security tokens that represent ownership of the real estate, the market becomes increasingly more liquid.
#2 Minimizing Risk of Real Estate Investments
Investing in real estate requires tying up large amounts of capital into a single investment. This makes diversifying your real estate portfolio very challenging. If you tokenize ownership of real estate, investors can own a 10% of a property in 10 cities instead of owning 100% of a single property.
Diversifying your investment minimizes risk. Instead of being dependant on a single real estate market, investors can spread their investment out over several markets each with there own risks. Ideally an investor could identity real estate investments that are not directly correlated. For example, investors can own real estate in large cities and rural areas which may be inversely correlated. Investors could also invest in many different countries with less friction, further diversifying their risk.
Tokenized real estate also enables secondary markets where investors can buy and sell fractional ownership. More diversified means more balanced risk profile.
#3 Increase Access to a Wider Range of Investors
Real estate has been a high performing asset class historically, however it requires a large upfront capital investment. This large upfront investment excludes the majority of potential investors. Tokenizing ownership of real estate enables “fractional shares” of an investment which lowers the capital requirement to own real estate.
Currently, it’s very cumbersome for foreigners to invest in real estate due to cross border payments being notoriously expensive and time consuming. By leveraging blockchain, theoretically anyone in the world can invest in real estate as long as they have an internet connection. According the CEO of Propy, Karayaneva, the foreign real estate market is worth about $800 billion annually.
#4 Reduce Friction in Real Estate Transactions
It’s no secret that real estate transactions are cumbersome. By leveraging blockchain in real estate transactions investors can decrease this friction saving both time and money.
For example, the financing process will be faster because lenders can verify property details easier because all the important documents such as maintenance records, floor plans, ownership history will be attached to the property’s digital identity on the blockchain. It’s even possible to store sensitive information such as transaction records and credit scores on the blockchain while at the same time hiding the specific information like someone social security number.
This enables lenders to quality borrowers in seconds instead of days or weeks.
Current State of Tokenized Real Estate
Let’s explore some current projects that seek to tokenize real estate.
Polymath is a platform that enables anyone to create their own security token that represents real world ownership in a company or asset such as real estate. This is a perfect tool for investment funds to tokenize their real estate.
Polymath partnered with BlockEstate which is a real estate fund that is attempting to use machine learning and predictive analytics to actively manage their real estate portfolio. Theoretically, they can leverage an information advantage to beat the market. While BlockEstate would have been the first real estate fund represented by Polymath’s ST-20 protocol, unfortunately they decided to shut down the project.
Another security token platform, Harbor, claims to be an all-in-one platform for tokenizing private investments, including real estate. Harbor seeks to leverage blockchain technology to maintain transfer, record, and ownership of real estate.
They also seek to provide value by taking care of investor onboarding, compliance, and secondary transfers. As of April 2019, Harbor’s first Tokenized Real Estate Fund (Hub at Columbia REIT) has also been shut down. Harbor claims that the partners couldn’t come to agreement on the terms.
One unique example of tokenizing real estate is ReitBZ. The company backing the project seeks to tokenize real estate investments in Brazil. They claim that timing is right for investors to profit off real estate investments in Brazil as they’re just starting a recovery from an economic recession.
ReitBZ is a good example of opening up real estate investing to the entire world. Theoretically anyone in the world can invest in Brazilian real estate through there token. While the ReitBZ project is brand new and comes with risks, it demonstrates how blockchain technology enables new economic behaviors previously unavailable.
Imagine a future where global commerce is open for anyone to participate. Instead of our geographic isolation determining our economic potential, blockchains enable open access. Good ideas can be capitalized without requiring founders to move to Silicon Valley. Citizens who live in a country struggling economics can invest in other countries to minimize exposure to the economics of their country of origin. The possibilities are endless!
While the blockchain industry has the potential to transforming the real estate industry, the reality is there aren’t many success stories to point to. Unfortunately the current bear market has lead to investors backing out of deals.
Challenges include: regulatory uncertainty and general lack of trust in this budding new industry. This industry is still young and may require more time before we see wide scale adoption.
Like with most transformational technology, it happens “slowly at first, then all at once.” The future is bright, but there are still challenges to be overcome.
The current state of blockchain in real estate investing shows tremendous promise, but it’s important to note that we’re still in the early days. While a few homes have been bought/sold on the blockchain, we haven’t seen any large scale success stories to point to.