In the article titled “Transforming the business of Real Estate Assets through Tokenization“, we have summarized various types of real estate tokens, the challenges it solves, and areas one needs to be aware of when venturing into them. This article focuses on the real estate tokenization process and implementation.
The real estate tokenization process starts with two steps – identifying the deal type and defining the legal structure. Subsequently, implementation involves selecting blockchain technology for storing tokens and choosing a platform where investors can securely purchase digital assets after verifying KYC and AML requirements.
Real Estate Tokenization – Process Stages
Stage 1 – Deal Structuring
The process begins with deciding on the asset kind, shareholder type, jurisdiction, and relevant rules that have a crucial impact in this initial phase of structuring deals. Generally, issuers choose to tokenize an existing deal in order to provide liquidity to present investors before soliciting money for a new project. Asset owners determine the specific property (or properties) to be digitized. The key considerations in deal structuring would be time-period for ROI, cash on cash return, securing investments, and legal and business formations. These more important details along with specific features/ parameters like rental type, rent start date, neighborhood, year constructed, stories, bedroom/bath, and total units are considered in the process.
Stage 2 – Legal Structure
The ownership information recorded on paper is transferred to the blockchain during the digitization stage. Security tokens are stored in a distributed ledger, and various actions are encoded in smart contracts. A legal wrapper needs to be created over the individual property to securitize and form an investment vehicle; a step necessary to digitize real estate.
The most common structures are:
Real Estate Fund: A private equity firm invests in a portfolio of properties, and the token symbolizes fund units. Accredited investors or approved institutional purchasers may only leverage the dividends gained from the tokenized investment.
Real Estate Investment Trust (REIT): Investors can create digital shares in a REIT, and token holders have the same rights to the REIT’s operational revenue that traditional investors do today.
Project Finance: Tokenization is a highly effective method of generating funding for projects. Tokens are made available to consumers and accredited investors during this event. Here the token may represent the ownership or future right to use.
Single asset Special Purpose Vehicle (SPV): Tokens represent shares of the SPV under this arrangement, usually a series LLC, for compliance with KYC/AML rules for LLCs, each token investor needs to be registered as a member of the LLC before investing.
Stage 3 – Technology Selection
After defining the legal structure, the next step is to choose the right technology. The process involves making four choices:
Selecting Blockchain / Token: This involves, choosing the Blockchain on which the token will be recorded, deciding on the token standard to be used, modeling the token data, and defining smart contracts to establish rules on transfer, limits, commissions, etc.
Primary / Secondary Marketplace: Choosing how initial tokens will be mined and provided during the initial offering and defining where and how investors will trade the tokens later.
Custody: Establishing a secure custody system for real estate, including proper maintenance and reporting of real-world updates.
KYC/AML: Verifying investors within regulatory compliance on a periodic basis.
Stage 4 – Distribution and Marketing
The token generation and distribution are the primary focus of this stage, where several payment options are offered when purchasing tokens. Investors may require a digital wallet, available on the web and mobile platforms, to store the tokens. Investors receive these tokens during a live sale.
Primary Distribution: Tokens are awarded to the investors through this procedure in return for investment capital this is also the first time the tokens are minted.
Post-Tokenization Management: This step includes processes for managing corporate activity, such as shareholder voting and dividend distribution. Smart contracts coded on the token can automate these procedures. Management of the tokens will continue after they have been issued until they reach maturity or redemption.
Secondary Trading: Tokenization increases liquidity in secondary trading. A token holder can swap tokens with another investor on a marketplace, through an exchange, or over the counter.
Benefits of Real Estate Tokenization
Real estate tokenization has several advantages that make it a far more efficient investment option than any previously available ones.
- Fractionalization: Tokenization decreases the investment entry barriers by fractionalizing high-worth assets to tokens providing access to a larger pool of global investors.
- Operational Efficiency: ‘Smart contracts,’ or programmable operations on the blockchain enable the automation of several activities, including investor whitelisting, regulatory checks, and post-issuance activities such as dividend distribution.
- Flexibility: Since tokens can be bought and sold easily the investors have increased flexibility in managing their day-to-day exposure to a particular class, region, or type of real estate. This helps them to reduce their portfolio risks more effectively.
- Reduction in Fraud: Since blockchain technology records the transaction digitally as immutable records, they cannot be altered by anybody. Rights, limitations, and data linked with the underlying property may be programmed into the tokenized digital asset. Anyone who wants to look may see everything that has happened in the past. As a result, tokenization increases confidence and trust in the minds of real estate investors.
- Reduced Settlement Time: Investors can settle the transactions in tokenized goods faster than typical financial transactions. Tokenized transactions may be finalized instantaneously, unlike regular ones, which might take days or even weeks.
We can expect Real Estate Tokenization to open the market for real estate assets enabling efficient movement of the funds and effective management of equity besides providing higher reliability, transparency, and security. Real estate tokenization would be the future of real estate assets with Blockchain technology as the underlying foundation and platform making it more robust, flexible, and secure when compared to the traditional models.
Given these advantages, it is no surprise that the RET market is estimated to become a $1.4-trillion market by 2026 (source). This potential can be fulfilled provided the technology is optimized to overcome existing hurdles and issues. Additionally, expert solution providers in tokenization have an important role in expanding the market and helping real estate players navigate the initial stages of tokenization and minimize the risks and costs associated with it.
Chainyard in Blockchain Technology
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