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Innowise is an international full-cycle software development company founded in 2007. We are a team of 1400+ IT professionals developing software for other professionals worldwide.

Tokenization of property: the future of real estate assets

The real estate industry has traditionally been associated with high entry barriers, illiquidity, and limited accessibility for small-scale investors. However, with the advent of blockchain technology, a new concept called “tokenization” is revolutionizing the way property assets are bought, sold, and traded. This article explores the tokenization of real estate and its potential as the future of real estate asset management.

What is tokenization of real estate?

Tokenization pertains to the conversion of tangible assets from the physical and digital world, like properties and land, into digital tokens on a blockchain. Each token signifies a portion of the underlying asset, granting investors partial ownership without requiring them to purchase the entire asset in its entirety. These tokens derive their value from the corresponding property, granting investors the advantages and potential returns linked to owning properties. With a market size of around $200 million, real estate tokens account for nearly 40% of the digital securities market, making them an increasingly popular investment option. The Security Token Market’s December 2020 Real Estate Report put the total market cap of real estate tokenization at over $25 million. By June 2021, that market cap had risen to over $32 million, an increase of more than 25% in six months.

How does real estate tokenization work?

Property tokenization involves several key steps. First, a property undergoes due diligence and valuation by experts to determine its market value. Next, a special purpose vehicle (SPV) is created to hold the property, ensuring legal compliance and protecting token holders. The property is then divided into fractional ownership units, represented as real estate crypto tokens on a blockchain platform.

Investors can then purchase these tokens, which provide them with proportional ownership rights, including rental income, capital appreciation, and the ability to trade their tokens on secondary markets. Smart contracts, programmed on the blockchain, automate and enforce the terms of the investment, ensuring transparency and security.

real estate token

Real estate is a tough market for new investors.

The tokenization of real estate lowers the entry barrier and democratizes investments in assets.

Benefits of real estate tokenization

Lower barrier to entry: broadening access to real estate investments

Tokenization of properties acts as a driving force in broadening investment prospects by enabling partial ownership of physical assets. This innovative method facilitates the involvement of small-scale investors in the property market, dismantling conventional entry barriers. Unlike traditional real estate investments that often require significant initial capital, tokenization offers lower minimum investment requirements, granting retail investors access to potentially lucrative returns without imposing a heavy financial burden.

Ability to create liquidity: diversify, minimize risk, and enhance market dynamics

One of the key advantages of tokenization of property is its ability to create liquidity in the market. By harnessing the capabilities of blockchain technology, tokens representing physical assets can be transferred with ease and strong security measures. This feature allows investors to enhance portfolio diversification and mitigate risk. Through investing in fractional portions of assets, individuals obtain the freedom to engage in buying and selling tokens on secondary markets, thereby unlocking assets that were previously difficult to liquidate. This newfound liquidity empowers both investors and asset owners, fostering a more dynamic and inclusive market for tangible assets.

Lower transaction costs: streamlined processes and enhanced returns

Real estate tokenization brings forth the potential for lower transaction costs through automated processes and the utilization of a permanent, tamper-proof digital ledger. By leveraging blockchain technology, investment transactions can be streamlined, reducing time-consuming paperwork and administrative burdens. The automation and efficiency of tokenization not only expedite transaction completion but also contribute to cost savings for all parties involved. Ultimately, this leads to enhanced returns for investors, as higher efficiency translates into increased profitability. Furthermore, tokenization offers additional benefits such as real-time capitalization table tracking, improved accessibility, and greater transparency for poten tial investors. With blockchain’s decentralized ledger, stakeholders can gain valuable insights into the investment landscape, empowering them to make informed decisions based on accurate and up-to-date information.

More transparent and efficient transactions: revolutionizing the buying and selling process

Tokenization revolutionizes conventional transactions involving physical properties by eliminating intermediaries like brokers or agents. This simplified process accelerates the buying and selling of assets, reducing complexities and improving transaction efficiency. The incorporation of blockchain technology guarantees transparency, as all transactions are recorded and unchangeable on a decentralized ledger. This increased transparency cultivates trust among investors, mitigates the risk of fraudulent activities, and enhances the overall integrity of transactions.

Better liquidity: fractional ownership and secondary markets

Tokenization of tangible assets breaks the liquidity barrier of traditionally difficult-to-sell assets by dividing them into tokens. This model of fractional ownership empowers investors to trade fractions of these assets on secondary markets, presenting an exit opportunity and augmenting overall liquidity. Property owners can unlock the value of their assets, while investors enjoy increased flexibility and diversification in their investment portfolios. The secondary market for these tokens further amplifies liquidity by offering a platform for seamless interaction and efficient transactions between buyers and sellers.

Opportunity for small-scale investors: democratizing real estate investments

Tokenization expands the accessibility of the property market, making it inclusive for a wider range of investors, including those with limited budgets. By reducing the minimum investment requirement, tokenization enables individuals to invest in valuable properties that were previously out of reach. This democratization of property investments empowers small-scale investors to engage in this asset class and reap the potential returns associated with real estate ventures. Through tokenization, individuals now have the opportunity to explore and capitalize on real estate prospects that were previously limited to a privileged few.

Decrease in counterparty risk: enhancing trust and security

Tokenization of assets harnesses the secure features of blockchain technology, effectively minimizing counterparty risk. Smart contracts, which are integral to tokenization, guarantee transactions only take place upon meeting predetermined conditions. This eradicates the potential for fraud or non-compliance, establishing a secure investment environment for investors. Additionally, fractional ownership made possible through tokenization disperses risk among multiple investors, rather than concentrating it solely with one owner. Through the reduction of counterparty risk, tokenization bolsters investor confidence and cultivates a more robust investment landscape.
security

Driving down transactional costs and enhancing efficiency: the power of smart contracts

Tokenization introduces the transformative potential of “smart contracts,” revolutionizing transactional processes in the real estate industry. By replacing traditional paperwork and laborious administration, smart contracts streamline and automate complex tasks, significantly reducing operational costs and enhancing overall efficiency. This innovative technology enables the frictionless transfer of digital property assets, opening new avenues for investors to navigate previously cumbersome processes swiftly and securely. Smart contracts hold the promise of reshaping the way transactions are conducted in the real estate market, paving the way for a more efficient and cost-effective investment landscape.

Regulatory clarity and institutional investors: paving the path for growth

Although the benefits of secondary markets for digital property assets are clear, attracting active participation from institutional investors hinges on regulatory clarity. As institutional investors anticipate clearer regulations, the market stands ready for substantial expansion once necessary frameworks and guidelines are established. The market’s development will be expedited by increased involvement from institutional investors, resulting in additional growth and the fulfillment of real estate tokenization’s full potential.

Auditing and transparency: adding value to investment portfolios

Digital assets incorporated into investment portfolios bring added transparency and traceability, thanks to the inherent properties of blockchain technology. The utilization of blockchain’s immutable and decentralized nature ensures that transactions are transparent and trackable, instilling investor confidence and promoting accountability. By embracing digital assets, investors benefit from an audit perspective, as the underlying technology enhances the clarity and reliability of financial records. The incorporation of blockchain-based digital assets represents a significant step forward in portfolio management, as it adds value through increased transparency and instills trust among investors.

Key considerations regarding real estate tokenization

While tokenization presents numerous benefits, it also comes with certain challenges and risks. These include regulatory uncertainties, potential market volatility, the need for robust cybersecurity measures, and the reliance on blockchain infrastructure. Addressing these challenges through regulatory frameworks, industry standards, and technological advancements will be crucial for the widespread adoption of tokenized real estate.

Ensuring regulatory compliance

To comply with local regulations, it is essential to enforce mandatory user identification before selling tokens. For instance, no state would allow token issuance unless they are confident that people from terrorist organizations cannot obtain them. To meet these requirements, we implement a smart contract-based token access blocking system by combining SoulBound NFT technology and KYC procedures. As a result, users who have not undergone KYC or do not possess the corresponding SoulBound NFTs in their wallets will be unable to engage in any token-related operations or access the platform.

Securities law implications

In general, the categorization of real estate tokenization as a security is common, but it is crucial to assess each individual token separately from the beginning. If a token is deemed a security, the issuance of said token will be governed by relevant prospectus requirements or the possibility of relying on an exemption, such as the “accredited investor” exemption. Furthermore, the issuer must also take into account the relevant registration obligations, in addition to the prospectus requirements.

Reconciliation with the land registries

To ensure distinctiveness in the tokenization of properties, it is crucial to align the transaction with the prevailing land registration systems. For instance, given that each region in Canada maintains its own land registration system, a property token issuer must take on the responsibility of harmonizing the transaction with the land registration systems in the specific regions where the physical properties are located.  

Use cases

The tokenization of property has introduced a groundbreaking approach that is transforming the conventional landscape of property ownership and investment. This innovative concept, although relatively new, has already witnessed notable success stories in the realm of digital real estate. Here are a few examples of digital real estate.

Pioneering tokenization: Elevated Returns and St. Regis Resort

In 2018, Elevated Returns, an asset management firm based in New York, made headlines by completing its first tokenization real estate deal. The company embarked on a groundbreaking initiative by tokenizing the prestigious St. Regis Resort in Aspen, Colorado, with an estimated value of $18 million, using the Ethereum blockchain. Initially planning to sell the property as a single asset, Elevated Returns opted to offer 18.9% ownership through the sale of tokens. To facilitate the token sale, Elevated Returns partnered with Templum Markets LLP and utilized the Indiegogo platform. This collaborative effort opened doors to new possibilities in tokenized real estate investment, attracting a wider range of investors keen on participating in fractional ownership.

Red Swan and the power of tokenization

Red Swan, a Texas-based commercial real estate marketplace, has also made significant strides in the field of tokenization. Leveraging the security token platform Polymath, Red Swan successfully tokenized a staggering $2.2 billion worth of real estate assets, with an additional $4 billion in properties lined up for tokenization, as reported by CoinDesk in February 2020. This impressive achievement underscores the growing recognition of tokenization as a catalyst for liquidity, efficiency, and cost reduction within the real estate market.

The future of tokenized real estate assets

The future of tokenized real estate assets holds great promise for transforming the industry and revolutionizing investment opportunities. As technology continues to advance and regulatory frameworks adapt, we can anticipate a widespread adoption of tokenized real estate on a global scale. This shift will likely be accompanied by the emergence of specialized platforms and tokenized real estate marketplaces dedicated to trading real estate tokens, which will enhance liquidity and expand investment options.

Tokenization offers a convenient and cost-effective method for investing in real estate assets. However, due to its novelty, there is still a lack of consistent regulatory frameworks governing real estate tokenization. The application of securities laws varies depending on the nature of the tokenized asset, and this lack of clarity can pose challenges for market participants.

Despite these challenges, tokenization has the potential to revolutionize real estate investment by increasing liquidity in an otherwise illiquid asset class, reducing barriers to entry for retail investors, and lowering transaction costs. However, it is crucial to address key issues such as establishing clear market regulations, reconciling tokenized assets with land title registries, and implementing centralized reporting of transactions.

For investors and real property owners looking to capitalize on the opportunities presented by real estate tokenization, seeking advice from experts is essential. By navigating these complexities and working together, stakeholders can unlock the full potential of tokenized real estate and shape a future where investing in property is more accessible and efficient than ever before.

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Andrew Nalichaev Blockchain expert

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