The real estate asset class, including residential, office, retail, industrial and other alternative properties, represent together the largest asset class globally only behind the debt market. The real estate industry has been traditionally conservative and slow to incorporate innovations and technology developments. Visionary startups like Airbnb disrupted the sector of hospitality providing a new productivity boost to existing real estate assets for millions of owners around the globe. That was a few years ago already…. But more recently, the blockchain has started to offer new level of benefits and potential disruptions to the real estate industry as well. It might have an impact orders of magnitude potentially similar to Airbnb or bigger. Those who realize that and act now will harness the benefits and profits of this real estate disruption with blockchain technology.
The barrier to entry is and has always been high in the real estate industry due to both the technicality of the underlying assets and the minimum investment amount required. Retail investors have access mostly to the residential sector or to REITs composed of a basket of assets that these investors cannot choose or select individually. Similarly, asset owners have traditionally financed their projects through debt with banks.
Tokenization of real estate assets is a new concept enabled by the blockchain technology. There are several approaches. The idea we present here is to issue tokens that represent digitized asset backed by the real estate asset itself. Real estate assets can be a building, or an iconic landmark, while the tokens representing these assets will be issued, managed and exchanged thanks to the blockchain. In a simple analogy, think of shares of a company you trade on the stock exchange via their symbol: apply concepts similar to real estate.
Simple enough? Let’s keep reading …
Real Estate Tokenization – what does it mean practically?
The key promise of real estate tokenization is to unleash new investment strategies, opportunities, and to open the assets to retail investors by lowering considerably the barrier to entry. It is our opinion that the real estate asset owners who realize about this potential will have a significant advantage over their competitors in the coming years. For individual real estate assets, tokenization offers many benefits. Firstly, by tokenizing an asset with blockchain technology, a global pool of new investors could be accessed. Potentially it decreases the time and costs needed to raise funds and it could also help to raise larger amounts.
To describe the advantages of tokenization, we will briefly look at both Asset Owners and Investors.
For Asset Owners, a full capital and profit could be released on day one of the token sale with no sales discount or traditional sales fee (2-3%) whilst retaining full ownership of the properties. Tokens can be used to synthetically sell a portfolio of units in new/existing buildings. Units are owned, let and managed by the asset owner, still, for the term of the token. Potentially, there are unlimited upside capital appreciation potential with limited potential downside exposure. The token provides the ability to synthetically resell and capture optimum profits on the underlying assets based on strategic timelines and milestones in the developments. Additionally, when used as a debt instrument for new developments, the asset owner is not exposed to fluctuations in Libor and can lock in financing costs over a multi-year period.
For Investors, a previously inaccessible asset is now at reach. While REITs provide certain advantages and facilitate the access to real estate assets, they also have large limitations. REITs are usually composed of a basket of assets and investors are forced to invest and get exposure to the whole basket of real estate assets. With tokenization, investors chose the token that gives them access to real estate asset they most believe in. The locking period for investors would be considerably shorter than in traditional real estate investments. Investors would be connected continuously and almost instant compliant trades would be possible on the secondary market. The liquidity in real estate is a concern especially outside the most liquid cities like London for example.
Regarding the disadvantages or limiting factors, these mainly involve the fact that it is a new technology and approach. The infrastructure required is globally new at the time of writing this article. Infrastructure means both the regulatory (how to formally link a token representing a digital asset, to the real world … and make it enforceable?) and the technical side: how to ensure that digital trades of token fulfill regulatory requirements while at the same time protecting traders’ identities and assets? Detailing these points is certainly subject to a deeper discussion and will not go there today. We anticipate that the major players in the trading infrastructure space, such as SIX, Deutsche Boerse, or even Gibraltar, will be delivering solutions up to the market’s expectations.
Example Real Estate Tokenization – refinancing real estate debt
Let’s consider “Jumbo Beach Resort”, a beautiful, iconic resort with all features you expect from world-class assets of this kind. Jumbo Beach Resort is a real estate construction that is about to be released on the market. The construction company (asset owners) “DevCo” has significant debt with banks for the financing of the project. Now, The board of Directors at DevCo take the strategic decision to benefit from tokenization to refinance their debt backed by the construction through the issuance of a token (the tokenization process). From this point onwards, DevCo hires a professional services firm to take the process forward. First, the token is designed as a bond, from business perspective. The Token is then aligned with a selected regulation and its authority (in our case, let’s assume this is FINMA in Switzerland). The discussions with the regulator move on well and an investment prospectus is issued, linking the token with a newly created bond backed by the real estate asset. That’s a critically important regulated aspect of the process: the operation is recognized by an established financial authority. Now, a proper corporate and tax structuring allows DevCo (which is based outside of Europe) to benefit from a tax-friendly environment such as Luxembourg or Liechtenstein for cash repatriation and portability to an international pool of investors. This in turn provides a EU-domicile to the deal. Last but not least, as a regulated token, the next steps is to find a suitable trading venue. It allows (1) to get access to the largest possible pool of investors and (2) have the right infrastructure for delivering on compliant trades (blockchain protocol for security tokens, trading, settlement, custody). On this last point, several forward-looking EU-based exchanges are now preparing the ground for trades in 2019 already including SIX (Switzerland), Gibraltar GSX, Malta, Deutsche Boerse and a few more. An investor roadshow and awareness allows to raise sufficient subscription of the token and there you go, the token is live! After the sale to primary investors, the deal is closed and cash repatriated to DevCo.
Sounds simple? It’s actually not …. but our company strives to make it simple for our customers to focus on the business value and outcomes, while we do the heavyweight lifting for you.
Thanks to Hector Sanchez Casas who contributed to this article with his research
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