2021: The Year of Tokenised Real Estate Securities?

Advances in technology such as the world wide web have increased trading speeds and lowered costs for financial market participants. Until recently, innovation in financial products and infrastructure has mostly benefited stock and bond markets. However, the advent of tokenisation has opened new opportunities in the real estate market.

Traditionally, purchasing a property required the physical presence of the buyer and seller in order to sign the deed and file a record of the title transfer with a local land registry. By digitalising the entire process of buying or selling real estate, real estate Security Token enable this illiquid asset classes to become tradable just like stocks or bonds. However, the real breakthrough is that Security Token enable real estate properties or entire portfolios of properties to be divided into smaller trading units, each represented by a unique Security Token stored on a distributed ledger. For example, if an apartment is split up into 100 fractions and each of them is assigned to one token, then the purchase of one token entitles the token holder to 1% of the ownership of the apartment. By fractionalising ownership, tokenisation lowers the barriers, allowing more investors to trade, and more capital to flow into the asset class.

“Owning property, especially property that produces income, has long been one of the fastest paths to generational wealth. Though the barrier to entry is high, those who can afford to play the game reap substantial rewards. Tokenisation levels the playing field to some degree, allowing even those among us with less capital to leverage the concept of fractional ownership to own a portion of an expensive asset — whether that be a condominium, vehicle, business, or piece of art.”

Dan Simerman, Head of Financial Relations at the IOTA Foundation writing for NASDAQ.

Since tokenisation enables the division of large real estate assets into smaller shares, investors can have more control over their allocation and strategy. Diversification across multiple properties, countries, or segments such as commercial or residential is possible with real estate Security Token. Rebalancing strategies based on return on equity or other metrics will also be possible for the first time, as investors will easily be able to go in and out of portfolios or individual properties. This newfound ability to easily reallocate capital should increase the efficiency of the real estate market in the coming decade.

With the population surpassing 7.5 Billion, the demand for real estate and financial products linked to real estate is steadily increasing. In competition with the notional value of the derivatives market, estimated to be worth $640 trillion, real estate is often considered to be the largest asset class in the world, with over $200 trillion in value according to Savills. Prior to tokenisation, investors that wanted to gain exposure to real estate securities could choose between real estate investment funds (REITs) in the Anglo-Saxon Countries, or ETFs that track REITs such as iShares European Property Yield UCITS ETF. Instead of REITs that have a fixed number of shares, Germany has open-ended public real estate funds (GOEREF)s that enable the number of shares on the market to vary.

Tokenised real estate securities can follow either model. They can also be a type of special purpose vehicle (SPV) or a debt instrument. For example, Brickblock in Germany tokenised the participation shares of an SPV in order to sell a property worth approximately €2 million in Wiesbaden, Germany. In contrast, the Liechtenstein-based Crowdlitoken is structured as a subordinate bond (“CRT”) that has an initial term of 25 years. When traders want to go in and out of their Crowdlitoken investment, they can sell the purchased token to another interested party on secondary markets.

With the CROWDLITOKEN bond we prove the ability of the blockchain to make illiquid assets more liquid and to lower entry barriers to investing in real estate. Fully digital securities such as the CRT combine many advantages that result in the capital markets becoming available to a wider audience. The CRT, combining the advantages of both direct and indirect real estate investing, is the first of additional partner products which will be issued through the company’s platform.”

Isabella Brom, CROWDLITOKEN

The tokenised real estate investment platform Finexity also uses the bond structure. Finexity users can build real estate portfolios with a minimum of €500. They use the bond structure over direct investment, because they cannot register more than 1'000 investors in the land register. If they enabled direct investment, then this would limit trading of the shares, and thus not meet the requirement of the fungibility of an investment token in Germany. Furthermore, problems such as real estate transfer tax would also arise in the case of direct participation. However, their bond is not a subordinate loan, but rather it is classified as a Security Token or investment token according to the BaFin classification system. Effectively, this means that investors always rank directly after the bank in the rank of creditors, similar to how traditional property ownership works.

One of the most popular real estate token is called RealT. They are a French-Canadian team that focus on high yielding lower-income housing in the US. The return on RealT tokens is paid out daily over the Ethereum blockchain, and annual yields range from 10% — 12%. RealT token are structured as shares of a Delaware-based limited liability corporation (LLC). Due to the nature of RealT token being regulated securities, trading is mostly designated for professional investors, although some exceptions apply. Each RealT token can be traded by pre-approved or so-called “white-listed” Ethereum addressees on the decentralised exchange Uniswap, and the trading volume and returns can be viewed on the popular Security Token data website, STOmarket.com.

Although the business models listed below do not currently exist, real estate tokens may enable several new innovative businesses in the future. For example,

  • Rent-to-Own: As home prices become increasingly expensive, partial ownership of properties may be the future for the average household. If the property that a tenant lives in is tokenised, the tenant can slowly accrue equity in their apartment over time. For example, if a tenant purchases 10% of their home’s token off of the market, then they are effectively reducing their rent by 10% minus transaction fees. By holding the token, they are entitled to 10% of that property’s monthly rental yield. This can also make the tenant feel more motivated to maintain their property to a good standard as they now have a long-term financial interest in its value.
  • Community Project Financing: Building new hospitals, desalination plants, or other public facilities can be jointly invested in by the community with token. For example, a new hospital could finance part of their capital costs by issuing a token to local investors that personally know the key people involved in the project and can gauge their creditworthiness. Tokenisation could foster development projects ranging from the beautification of parks to historic landmark restorations.
  • Refinancing: The reverse of renting to own, a homeowner that would like to access capital could tokenise a portion of their home and sell shares to investors.
  • Smart Contract Tokenised Real Estate Fund: As properties and portfolios of properties become tokenised, a developer could build a fund of funds or a fund of properties entirely on a blockchain. Pre-approved investors could buy and sell shares of the real estate fund by interacting with smart contracts directly.

From a legal perspective, governments can choose to regulate tokenised real estate securities according to existing regulations or develop new regulations for this burgeoning ecosystem. During the last decade, many countries have relaxed their security offering regulations for crowdfunding campaigns, and some companies in the tokenised real estate market such as RealT have used security exemption laws to raise capital under less onerous compliance requirements. In 2015, Austria reformed their Alternativfinanzierungsgesetz (AltFG) to allow a maximum funding of €5 million without a prospectus, and Germany’s Kleinanlegerschutzgesetz increased the maximum to €2.5 million without a prospectus. These changes may encourage small and local tokenised real estate funds to thrive in areas where there is market demand. However, many countries have unique regulatory frameworks for real estate securities, and there may be special taxes and regulations imposed on foreign investors. Therefore, investors should always consult a professional tax accountant for guidance.

Overall, the growing market for regulated and tokenised real estate securities enables new investment opportunities, flexible time horizons, and lower subscription tickets. We are excited to be able to offer investors options within this industry on in our marketplace at area2invest.

Originally published at https://www.area2invest.com on February 23, 2021.

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Launch your own marketplace for traditional & tokenized financial products.