Real Estate Tokenization: What Is It and What Benefits Does It Offer?
12 March, 2021
Wherever you turn — blockchain is everywhere. The technology has penetrated even the dauntingly complex world of real estate. It has introduced the industry to tokenization, bringing the potential for greater transparency, liquidity, and inclusiveness.
Over the past decade, the real estate market has been experiencing considerable growth, largely thanks to the upsurge in investment. What’s more, according to the report “Real Estate Market by Property and Business: Opportunity Analysis and Industry Forecast, 2019–2026”, it’s expected that the global real estate market will reach $8,662.2 million by 2026.
Nevertheless, property investment has long been considered something reserved for an exclusive group of wealthy individuals. It has also been behind the times in liquidity, automation, and regulation. However, thanks to blockchain and tokenization of real estate, in particular, all these and many other related challenges have been successfully overcome.
The tokenization of real estate property, one of the principal use cases of blockchain in real estate, has yielded tremendous results. It helps asset and fund owners raise their capital more efficiently and provides investors with almost unlimited access to private real estate investments, along with better liquidity, greater transparency, and other eye-catching benefits.
Read on to find out more about the essentials of real estate tokenization, as well as its legal and technical aspects. You will discover the value it brings to issuers and investors and learn about the current real estate tokenization platforms.
What is real estate tokenization?
Tokenization is a term used to describe the process of digitizing an asset. It’s based around cryptocurrency fundraising, during which investors are able to exchange their fiat or cryptocurrencies for tokens.
In property tokenization, the property value is converted into digital tokens with the help of special blockchain real estate tokenization platforms. These tokens, often referred to as “security tokens”, normally represent shares of a real estate property. When the token is offered for sale on the market, it can then be purchased by investors who will be given fractional ownership of the property. These investors also have the right to sell as many shares as they need and/or want. The process itself isn’t very complicated and doesn’t involve costly real estate investment procedures, which makes the industry accessible to a wider range of investors.
What are the benefits of real estate tokenization for issuers and investors?
Tokenization has the capacity to radically transform the global real estate market. It offers both issuers and investors a wealth of substantial advantages over the existing investment options, as well as opening up opportunities for a bigger number of investors to enter the market. Below we’ll consider some of the biggest gains that tokenization is bringing to real estate.
Liquidity is seen as one of the chief advantages of tokenization, as it has the flexibility to achieve additional value that illiquid assets lack. Besides, fractional ownership can contribute enormously to increased revenue in the commercial real estate segment. This can result in billions or even trillions of dollars of equity investment.
Lower entry cost
A security token doesn’t need to be sold as a whole unit. As a result of fractionalization, the code that underpins the token makes it possible to divide it, thus allowing the issuer or holder to sell these fractional tokens at a lower price. Consequently, smaller investors will have a chance to take part in the investment market. Meanwhile, wealthier investors will be given more opportunities for diversification.
Standardization of transactions via smart contracts
The tokenization process heavily relies on blockchain technology. This in turn allows for both the purchase and sale of real estate security tokens via standardized smart contracts. The key advantage of smart contracts is that they don’t have to be individually negotiated. Their terms can be implemented automatically, which considerably reduces transaction costs and the time needed to carry out the procedure.
Blockchain is capable of recording each and every transaction that takes place on it. Whenever a single token undergoes a transaction, all the participants become aware of it. Therefore, investors can look at the token’s history, pricing, as well as other transaction details at any time.
Given that blockchain is a distributed ledger, no person or organization can control it and impose their own policies. What’s more, the distributed ledger technology (DLT) uses advanced cryptography techniques that provide users with heightened security. Each user has their own private key that gives them access to their blockchain assets. This key is generally represented as a line of random characters (both letters and numbers), which makes it extremely difficult, or even impossible, for outsiders to guess it.
The most notable feature of blockchain is that after a transaction has been recorded and confirmed, it doesn’t allow anyone to make any changes and alter the transaction details. This proves extremely useful when investors want to make sure that no one has falsified the information about the transaction.
What should the tokenization strategy include?
Before getting down to the development of real-estate tokens, it’s important to examine the tokenization strategy and familiarize yourself with some of its constituent parts.
Developers of virtual tokens have an opportunity to choose what to tokenize: a real estate property itself, an equity interest within a legal entity that owns the real estate, a mortgage of the real estate property, a right to share in profits created by the property, and so on. In other words, the range of opportunities is enormous and diverse. However, it’s important to remember that depending on the interest being tokenized, regulations applicable to the token may vary. That’s why, before tokenizing your asset, you must make sure that you’re fully aware of the regulations that will affect you.
Based on blockchain, smart contracts are able to automatically implement and enforce agreements between users without the involvement of any third parties. To ensure their smooth functioning, it’s worth taking into account which features the issuer wants for the token. For instance, if token holders wish to receive dividends or share their profits, then the smart contract must be designed in such a way as to fulfill these requirements.
Regulation of securities
Given that real estate tokens qualify as securities under state and federal law, they must be registered by the Securities and Exchange Commission, also known as SEC. In some cases, it’s possible to obtain an exemption from registration. Failure to register could land you with civil penalties and other problems.
It’s important to be fully aware of the requirements relating to tax and reporting. Both issuers and investors are strongly advised to consult a tax professional who will be able to assist them in developing a comprehensive and reliable tax strategy.
Before tokenizing an asset, make sure that you’ve analyzed all its pros and cons. It goes without saying that you’ll be interested in how much revenue it’ll bring to security token issuers and investors — and that’s why you need to include this step as a part of your strategy.
Naturally, the location of real estate property matters. You’ll have to consider the location parameter not only from a practical point of view but also from a legal one. For example, not all countries grant protection for private property rights. As a result, fewer investors will be interested in obtaining property in these locations. It’s important to consider carefully whether the location of the property will satisfy all parties.
If the property that is being tokenized is subject to a mortgage, the issuer is obliged to either get the mortgagee’s consent or to redeem the mortgage. However, if the tokenization of this property is a mortgage itself, you’ll have to consider and familiarize yourself with the relevant laws.
AML/KYC requirements and investor accreditation
When offering their security tokens, issuers should comply with Anti-Money Laundering and Know-Your-Customer (AML/KYC) requirements and regulations. Issuers are also obliged to make sure that their purchasers have been accredited: otherwise, complications may arise regarding the investor’s reliability.
Most countries tend to have their own security laws as well as AML/KYC regulations. Consequently, token issuers are supposed to be aware of the different regulations in the countries where they’re going to launch their tokens.
On the whole, depending on the token’s features, it can be subject to many other regulated money-services laws and even commodity regulations. Therefore, before tokenizing a real estate property, you should carefully and methodically plan the strategy so as to ensure the smoothness and effectiveness of the tokenization procedure.
What do the processes of tokenizing real estate consist of?
Before tokenizing real estate, you need to make sure that you have prepared a well-designed roadmap for both legal and technical processes. We’ll look into the specifics of each process below.
The legal process
First, you should choose a suitable jurisdiction for your tokenization project. All tokenization projects are subject to standard securities regulation, which is supported by many countries. Even so, it’s worth noting that not all countries are in favor of full digitization of securities, such as shares and bonds, due to special requirements regarding notarized transfers and paper-based ownership certificates. Then there are other countries that haven’t yet reached a consensus about regulations.
With the above in mind, you should consult lawyers who can help you keep track of different regulatory developments and updates as well as offer you recommendations about the most appropriate jurisdictions for your real estate tokenization project.
Once you’ve processed all the information and chosen the jurisdiction, you can get down to creating a bank account and a legal unit, also known as the SPV — Special Purpose Vehicle. An SPV is viewed as a legal entity meant for a particular business purpose, e.g. managing real estate. It can be represented as a limited partnership, corporation, limited liability company (LLC), or a trust. Afterwards, you should design the security that is going to be tokenized. In the real estate sphere, this can be a share in the company owning and administrating the property, but it might also take the form of a tokenized loan, profit-sharing right, etc.
To ensure the smooth onboarding of your investors-to-be, you should do your best to design the KYC — Know Your Customer. It’s essential to understand what information investors are to provide so that you can register their ID and address. Beyond this, make sure that the investor provides the relevant information when going through the registration procedure.
Then it’s time to review and determine the type and nature of reports and updates that you’ll need to pass to public transfer agencies, CSDs, and so on. They can be created as custom reports from the platform.
Last but not least come dealing with legal documents. Depending on the asset type, these documents will vary, from a private placement or public offering memorandum to an SEC Form D and more.
Once all the legal processes have been successfully handled, you can move on to the technical stage.
The technical process
We’re now ready to look at the steps that make up the technical process. But let’s make it clear straight away that your key goal for the entire procedure should be full automation.
Based on the data that you’ve gathered during the legal process, you can customize the KYC as well as the contract flow. Automating your contract flow is part and parcel of the whole process: that’s why you should make up your mind as to which contracts need to be used for investors’ signing up and for the subsequent token purchase, including subscription forms, purchase receipts, and share agreements.
The customization process doesn’t end at this stage. You will be responsible for customizing all the content, including high-quality photos and other information in order to present the property in the best way possible.
When you’re finished with this step, it’s time to turn to the payment (card and crypto payments and bank transfer) and custody options customization. It’s highly recommended that you install and tailor the server software and even go as far as ensuring that the issuer administrators undergo the proper training on how to use it.
When you’ve completed the procedures outlined above, your STO campaign can finally be launched. As you can see, both the legal and technical processes feature a variety of important elements to take into account. That’s why, to ensure that you won’t miss out on any vital step, you should reach out to our experts for help.
Companies that have successfully launched real estate tokenization projects
Even though real estate tokenization is considered to be relatively new, there’re already quite a lot of companies and startups across the globe that are getting involved. They are coming up with advanced and effective solutions that offer considerable benefits to investors and token holders. Apart from tokenization assistance, they supply many other blockchain-related services aimed at streamlining complicated real estate processes. Let’s take a closer look at some of the companies and their projects.
Ubitquity LLC, a US-based company that specializes in creating blockchain-secured solutions for real estate transactions, has designed a Blockchain-as-a-Service (BaaS) platform for the secure record and tracking of property. The platform enables title companies, municipalities, and clients to view a record of ownership via blockchain. All the transactions are automatically recorded on the blockchain, which integrates easily with other UTXO-based blockchains such as Bitcoin, Ethereum, and Hyperledger.
What’s more, Ubitquity assists its clients in tokenizing their properties, creating Non-Fungible Tokens (NFTs) as well as developing Decentralized Finance (DeFi) solutions for real estate, mortgage, and title companies.
Red Swan and Polymath
Red Swan, a platform used for investing in tokenized commercial real estate assets, together with Polymath, a blockchain created for security tokens management, has tokenized over $2.2 billion in real estate assets. The tokens that have been issued are for 16 properties, encompassing mid-rise and high-rise apartments in California, New York, and Texas as well as a 150-acre hemp farm in Ontario, Canada. According to the New-York-based Red Swan, it’s planning to go even further and tokenize $4 billion in property, as it hopes to profit by gaining interest from the sold equity.
KlickOwn and Bitbond
To complete its first STO for a property, German KlickOwn, a real estate crowdfunding platform, has partnered with Bitbond, a Fintech that offers security token management solutions. In March 2020, KlickOwn listed a digital bond for the ”Historisches Lüneburg” building located in Lüneburg, Germany. The company has managed to raise €1.5 million for digital security that is expected to yield an annual return of 5%. In addition, thanks to the relatively inexpensive blockchain-based securitization process, investors are able to take part in the offering procedure for just €10.
In 2020, REINNO introduced a marketplace for tokenized commercial real estate, which also involved five offerings valued at over $237 million available to accredited investors around the world. Investors have an opportunity to obtain a fraction of expensive real estate using US dollars or cryptocurrency. Among the properties that can be purchased are medical facilities, apartment buildings, and warehouses. It’s worth mentioning that all properties are managed by expert real estate professionals, in order to maximize the returns from passive investments. As a result, REINNO is gradually getting closer to its aim — to establish an ecosystem for tokenized commercial real estate.
In 2019, Smartlands — a global blockchain-based platform for crowdfunding investments in various asset classes with the help of security tokens — successfully completed its pilot STO worth £12.06 million. It also became the first company to tokenize a UK-based property, a student accommodation block in Nottingham. The key goal of Smartlands is to enhance the investment experience for all the parties involved, from investors and issuers to asset and fund managers, by automating and digitizing different operations related to real estate management.
Overview of some real estate tokenization platforms
As tokenization in real estate gathers pace and becomes an ever more popular use of blockchain, we’re seeing plenty of companies and startups around the world getting involved in the issuance and selling of real estate-backed tokens. Below we provide a brief overview of some existing real estate tokenization platforms.
- Blocksquare is a Slovenian technology company that sets up the infrastructure needed for managing real estate investments online. It also provides a blockchain-powered tokenization platform for commercial real estate properties.
- Atlant, launched in 2017, is a blockchain-powered real estate platform that aims to allow both real estate ownership and P2P rentals to be tokenized.
- Hong-Kong-based Liquefy is capable of bringing about additional opportunities for investing in real assets thanks to its blockchain technology. The Liquefy platform improves efficiency in fractional ownership, thus considerably reducing the previous illiquidity of real estate property and lowering entry barriers.
- RealT is based in Florida and offers investors a simple yet smart way of buying fractional, tokenized properties while leveraging the USA legal system and relying on the permissionless token issuance of Ethereum.
- The FinTech company Uprets offers a platform based on patented blockchain technology. Its real estate digital securitization platform can be used by property developers and asset owners as well as investors from all over the world.
- The Berlin-based Upvest allows its users to create new assets and distribute them at several fractions to end-users. The platform has everything that is needed to provide a wide range of investment products, both on the website and app.
- Securitize is a solution for issuing and handling tokens on the Ethereum blockchain. It’s considered to be one of the pioneers in the tokenization of real estate and was used in the St. Regis Aspen Resort tokenization project.
- Harbor is a tokenization platform that combines full compliance and onboarding of investors with token issuance on Ethereum. In the iCap RE fund tokenization project, it was responsible for providing integration into secondary marketplaces specifically for token exchange.
- Cocoricos is a DeFi platform that aims to create new standards for generating passive income with the help of digital assets and to contribute to better blockchain security for all crypto holders.
- The DigiShares platform enables an issuer to manage and automate a host of processes related to fundraising and fund management. In addition, the platform makes it possible to trade tokens via the built-in OTC marketplace.
Given that the market for real estate is experiencing growth and is open to new and innovative technological developments for streamlining most of the processes, we’ll no doubt soon be witnessing a surge in service providers who offer similar or even more sophisticated solutions.
The prospects for real estate tokenization
Real estate tokenization is becoming increasingly popular and is demonstrating a huge potential for further growth. Prior to its introduction, only a small number of both accredited and institutional investors had an opportunity to participate in investment projects. Now the situation has changed, and the real estate market has become more inclusive and democratic thanks to blockchain-enabled tokenization.
Tokenization is bringing about greater liquidity and transparency. As technology advances, it’s abundantly clear that real estate, which for so long was resistant to change, will quickly catch up with other industries.
In the months and years ahead, more and more tech startups and companies will appear on the horizon to offer their unique solutions for real estate tokenization, in their turn helping the whole real estate industry to make great strides.
Of course, there’ll be some challenges and pitfalls along the way. But the crucial point is that right now barriers to a wider tokenization adoption are being removed, knowledge and experience are being enriched, and customized real estate tokenization platforms and other solutions are improving. So there’s every reason to be optimistic about what the future holds.
The real estate industry has yet to realize the remarkable potential of blockchain-enabled tokenization for tackling the existing market challenges. But even now, it’s evident that tokenization has already provided the industry with substantial benefits — most obviously, in terms of improved liquidity, transparency, security, inclusiveness, and management.
Apart from real estate, tokenization represents a go-to tool for many other industries that are in need of change and disruption. It will set them on a new path, enabling them to achieve much-desired and long-awaited improvements and efficiencies in their workflows.
We at PixelPlex have been helping an array of businesses find their individual routes to success. You too can take advantage of our elaborate STO platform and digitize any type of asset in order to build the ecosystem you need for your own security token offering campaign.
Don’t be shy — knock on our door whenever you need us, and we’ll be glad to guide you towards the brave new tokenized world.
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