Everything You Need to Know About Real Estate Tokenization
Real estate tokenization has become popular recently as a novel kind of investment with benefits for both investors and issuers. Currently, the real estate industry accounts for about $400 million, or 40%, of the market for digital securities.
Real estate is referred to as being tokenized when a physical asset is broken up into a number of digital tokens that each reflect the full set of rights and duties attached to the underlying property. Contractual details are addressed in smart contracts. When a predetermined contract condition is met, the algorithm stored in the digital contract initiates the events specified in the code.
Without the involvement of a person, a smart contract, for example, can carry out a transfer in the land registry. By automatically generating a new block and uploading it to the blockchain after validating the operations, it creates another block.
Real estate tokenization turns a property’s worth into a token that can be owned and transferred digitally and is recorded on a blockchain. Each of these divisible tokens represents a little portion of the ownership interest in that property.
How does real estate tokenization work?
Real estate is fractionalized into tokens and maintained on a decentralized database through the process of real estate tokenization. The term “blockchain” refers to this decentralized database, which functions as a kind of electronic ledger for information storage. NFTs and real estate tokens are comparable. A real estate token might stand for any of the following:
- ownership of a portion of real estate
- ownership of the whole piece of real estate
- an ownership stake in a company that manages real estate
- a stake in a loan with real estate as security
- a claim to a portion of the earnings derived from real estate
Real estate tokens differ from Real estate investment trusts (REITs) in that tokens allow a specific investment to link a specific real property, as opposed to REITs which typically support investment into pools of varied real estate assets. In a security token offering, the digital tokens are produced and distributed on a blockchain (STO). To award ownership, each ownership portion is transformed into a token and then encrypted.
The sale of Aspen Coins, one of the first profitable commercial real estate STOs raised almost US$18 million in 2018. These digital tokens represented fractional ownership of the opulent St. Regis Aspen Resort in Colorado, USA.
There are numerous such instances, like a project in the United States that aims to fund $100 million by issuing 100 million tokens at $1 each for a 24-story, 374-unit multifamily residential building in downtown San Jose that is being constructed by Alterra Worldwide.
Benefits of real estate tokenization
● Lower barrier to entry
Real estate tokenization facilitates small-scale investor engagement and decreases entry barriers for retail investors by permitting investing in fractional pieces of real estate.
● Ability to create liquidity
Blockchain technology makes it simple and safe to transfer real estate tokens, enabling investors to diversify their portfolios, lower risk, and increase liquidity in the real estate market.
● Lower transactional costs
Blockchain technology offers the ability to simplify investment transactions and reduce transaction costs through automated procedures and a permanent, unchangeable digital record.
● More transparent and efficient transactions
Blockchain transactions are transparent and irreversible because of the decentralized nature of blockchains, which makes them perfect for the real estate industry with its many parties and intricate processes. Smart contracts that are automatically generated do not include any humans in the transaction process, which makes unfair trades impossible. There is no paperwork or waiting period for transaction completion in a blockchain-based system. Quick decisions and transactions are the outcomes of this. When using blockchain for real estate transactions, there are no set office hours like there are in traditional banking. Instead, the system operates transparently and continuously.
● Opportunity for small-scale investors
Real estate is typically regarded as an exclusive class of investment. However, tokenization has made real estate investment possible for smaller investors as well. If investors don’t have vast funds, the excessive cost of real estate assets sometimes discourages them from participating. But things have changed since real estate is now available to small-scale and individual investors thanks to the tokenization of the industry. Tokenization breaks up enormous assets into smaller fractions, making them more inexpensive and available to individuals who are interested.
● A free-flowing market
Overly regulated and frequently prejudiced centralized banking systems are harmful to market freedom. The real estate industry now has access to a decentralized, bias-free financial system thanks to blockchain-based tokenization. Each stakeholder has some degree of control over the outcome, and they decide as a group. A market that is streamlined and offers all players an equal chance to flourish results from the removal of unjustified barriers.
● Decrease in counterparty risk
It is difficult to track longer transaction chains. The pre-tokenized real estate age presented a dilemma since third parties complicated and distorted the situation. Things are improved from a regulatory standpoint by smart contracts, a crucial component of blockchain-based transactions. The chain of transactions is kept short and free of hazards brought on by weak links with minimal human involvement. Because of this, there is a greatly diminished, if not entirely gone, the danger of counterparty participation.
Limitations of real estate tokenization
● Smart contract security loopholes
The blockchain network is well secure. But in smart contracts, you can find loopholes that need to be fixed. Hackers are always trying to sneak into the code and steal money from smart contracts. If the smart contract has been diligently audited, the money isn’t secure. A simple hack or a system glitch could rob the assets of real estate investors. In the worst case, once these assets are lost, their recovery is impossible.
● Complex licensing requirements
The tokenization of real estate assets needs licensed platforms for the operations and management of STOs (security token offerings) to be regulated. The process of achieving a license is a bit complex. Even before the licensing stage, you need to go through multiple phases of trial and error and recurrent tests so they can be successful.
● Regulatory issues
Many people who are working in regulatory authorities and real estate employees have no idea how blockchain technology works and eliminates the issues the sector is facing. These things lead to a poor regulatory environment and generate hurdles for all stakeholders. Regulatory uncertainty dampens the investors’ trust, resulting in poor growth.
● Tax complexities
Many Tax regimes haven’t clear cryptocurrency tax legislation, which is an issue for stakeholders. Despite the fact that the benefits of tokenization are acknowledged on a worldwide scale, a sound taxation system has not been implemented. Everyone concerned has doubts because there isn’t a single tax system in place.
Some points to be considered!
● Securities law implications
Generally, the tokenization of real estate will be considered security but an analysis of each specific token should be considered at the outset. If the token is a security, the issuance of such a token will be subject to the applicable prospectus requirements or reliance on an exemption, such as the “accredited investor” exemption.
In addition to the prospectus requirements, the issuer must consider the applicable registration requirements.
● Reconciliation with the land registries
Real estate tokenization requires reconciling the applicable transaction with the current systems of land registration. Each jurisdiction of Canada has its land registration system, and an issuer of a real estate token will be required to reconcile the transaction with the land registration systems of the jurisdictions where the underlying real estate is located.
Tokenization’s role in the future
Tokenization offers a practical and affordable way to invest in real estate assets, but because it is a relatively new venture, regulators have not yet established a clear set of regulations. Which regulatory frameworks will be used depends on the type of asset being tokenized.
Real estate tokenization has the potential to revolutionise real estate investment by increasing liquidity in a predominately illiquid asset class, lowering entry barriers for retail investors, and lowering transaction costs. However, market participants currently face challenges related to clear market regulation, reconciliation with land title registries, and the requirement for centralised reporting of transactions.
Real estate professionals, including those in the legal, financial, and real estate fields, should be consulted if investors or owners of real property are interested in profiting from the trend of real estate tokenization.