What is Real Estate Tokenization?
Real estate tokenization is a modern-day extension of traditional fractional real estate ownership. It is like crowdfunding in that it distributes the value of a real estate investment into manageable segments to overcome many investment barriers. Each token represents one part of the asset. Each of these tokens is then encrypted with the relevant details, which gives the investor the ownership details based on their share of the property. It is now possible to buy and sell these tokens at their determined value on a secondary exchange.
Global Real Estate Tokenization Market size is expected to triple in 5 years from 2022 to 2027 (Source)
Types of Real Estate Tokens
- Fungible fractional token: Each token represents a part of the overall real estate but does not represent the ownership/usage rights of any specific sections of the real estate.
- Non-fungible tokens: Each token give rights (ownership or utility) over a specific part of the real-estate e.g., a particular apartment unit.
By underlying value
- Security or ownership tokens: Security tokens (also known as digital securities) are digital representations of assets such as stock, fixed income, real estate, investment fund shares, commodities, and structured products. These are exchanged and maintained on a blockchain (a distributed ledger).
- Utility or usage rights tokens: A utility token gives the user a right to use an asset e.g. a hotel utility token can give you the right to book a hotel room for 1 day or have a free complimentary dinner etc.
By type of property
- Commercial Property Tokens: Provides the ownership of commercial properties with legally compliant protocols.
- Residential Property Tokens: Provides the ownership of residential properties with legally compliant protocols.
- Virtual (in metaverse e.g.) Property Tokens: Provide the ownership of virtual properties with legally compliant protocols.
- Undeniable proof of ownership: Real estate tokens incorporate a distributed ledger that is a shared distributed database. Any changes or additions made to the ledger are instantly reflected and duplicated to all participants and the network sends and validates each transaction. This eliminates the problems that current investors face to prove ownership. It can also eliminate multiple legal and ownership documents. If relevant authorities start issuing property rights on the blockchain, it enables provable ownership, even as the tokens keep changing hands.
- Overcoming the entry barrier for small investors: The current real estate market does not attract small investors due to high sentry costs and tedious processes. With tokenization, the barrier to entry is mitigated allowing smaller investors to participate. Moreover, investors can buy and sell tokens without having to go through the overhead associated with ownership transfer.
- Decreasing transaction costs: Blockchain technology platforms for token exchange have the potential to significantly reduce real estate transaction costs. Tokens enable investors to buy and sell real estate ownership without incurring any closing costs, resulting in significantly reduced transaction costs. Real estate investment trust (“REIT”) funds have a similar proposition, but REIT funds often come with higher minimum investments and high maintenance fees.
- Improving transparency and market security: Using the distributed ledger technology improves general transparency and security in the real estate market. Since every transaction is processed and authorized by the marketplace, each transaction is transparent to the network. Furthermore, the market’s security is guaranteed by network consensus.
- Easier fundraising for real estate: Real estate has always been a form of high-value and low-liquidity investment. Primarily because –
- Multiple parties are involved with a tedious paperwork process
- The finances required to fund the projects are very high. and
- More private players in comparison to public companies.
However, with real estate tokenization, it is easy to find more new investors since assets can be fractionalized. Moreover, investments and transactions are more secure, authentic, and reliable. Real estate players can now leverage tokenization as one of the primary sources to raise funds for their projects.
- Discovering properties to invest in: Another challenge that tokenization solves is the rapid search for the property in which you can invest. Once real estate assets are tokenized, they can be listed in one or more centralized or decentralized online marketplaces. Hence, it simplifies the investor’s task because the search for a suitable investment may now take place in a single spot. Through this option, investors will be able to look for possible investments in various geographical locations.
Restraints of Real Estate Tokenization
Despite the Blockchain and Tokenization technology are getting matured, regulations are still lagging There are several challenges due to this, including:
- Stifling investment limits: Since there is no legal framework around investment in real-estate crypto tokens, current regulations only allow investors to invest unlimited amounts in tokens. A non-accredited investor can only invest a small amount depending on their income;
An accredited has
- The net worth of $1,000,000, (not including the value of the primary residence)
- Have an income of at least $200,000 annually for the past two years, or $300,000 for a married couple
- The projected income for the investor for the next year must be the same if income is used to qualify the investor.
- An annual income or net worth of less than $100,000 can invest up to $2,000 or the 5% of net worth or income or annual income (whichever is lesser)
- If net worth exceeds $100,000 the investor can invest up to 10% of total income or net worth, whichever is less. There is a cap of $100,000 on the invested total.
- Regulations and Legal Uncertainty: In many countries including the USA, there aren’t many laws surrounding or claiming the validity or invalidity of smart contracts. To avoid legal issues given the unestablished technology framework many major real estate companies, investors and contractors do not participate in Real Estate Tokenization.
- Tax Implications: Being truly global, real estate tokenization attracts investors from different corners of the world, but related tax policies are either undefined or are not organized in many countries. This creates a worldwide complicated tax web, that makes understanding the legal frameworks confusing.
- KYC and AML: KYC checks carried out on both real estate owners and investors as a standard registration process helps capture useful information about the nature of buyer or seller – as a business or an individual investor. It also helps if steps are taken for vetting the business or individual for known involvement in illicit financial activity. It is also important to screen the investors against the AML Watchlist.
- Lack of Digital Infrastructure: In many countries, the infrastructure is not sufficient to enable real estate tokenization, and this is prevalent in many countries. There is not much awareness about the use of tokens and the risks and benefits, or their possible issues and solutions.
- Cyberthreat: Although owning assets through cryptography technology is considered safe, custody of digital tokens remains a cause for concern. Since the laws are not sufficiently established, cybersecurity and the risk of unauthorized activities are matters of grave concern.
Real estate tokenization on distributed ledgers has the potential to revolutionize the way common people invest.
Being in its early stages, tokenization needs to overcome several concerns to achieve its full potential and requires the effort and contribution of technology companies to make the innovations and set in motion the processes. Companies like Chainyard can help navigate the early stages of tokenization to minimize the risks and costs associated with this technology that carries immense potential.
In the upcoming blog, we will also be covering key processes involved in real estate tokenization, the benefits of real estate tokenization, and how Chainyard can help you in this journey of tokenization.