The real estate investment market is one of the largest financial markets worldwide, with an estimated $8.9 trillion in 2018. This is for a good reason, as building places for people to live serves a basic human need, while public and commercial buildings are a crucial element of a functioning economy.
However, real estate is also a highly illiquid market that is largely restricted to institutional investors. Construction projects are highly expensive, but lucrative undertakings, which can only be initiated with significant capital investment. This means that investment opportunities for the common man are severely limited, for example to buying stocks in publicly traded real estate companies.
With the advent of blockchain technology, this is going to change very soon through the process of tokenization. In essence, tokens are tradeable digital assets that usually represent something with a real-world value, like credit balance in a digital economy (cryptocurrencies), virtual items in games (non-fungible tokens), the rights to use a decentralized network (utility tokens), or financial instruments (security tokens).
What they all have in common is that tokens are usually issued on a decentralized public ledger, also known as a blockchain. This means that they can be held and traded completely without requiring a centralized intermediary, such as a bank or a centralized exchange.
Security Tokens can represent fractional Ownership
In this article, we will be looking at security tokens specifically. As the name suggests, these represent real-world securities and are regulated by governmental financial supervisors, such as the US-based Security Exchange Commission (SEC). While, in theory, many types of securities can be mapped onto tokens, the three most common reasons why security tokens have value is that they represent either equities, bonds, or (fractional) ownership in physical assets.
It is especially the latter type that is most interesting for real estate investments. Suppose you want to initiate a construction project (e.g. an office building in Manhattan), but you only have a fraction of the funds necessary as a capital investment. You could however split up the ownership of the property you want to build into a number of tokens, say 1 million. Now, each token represents one-millionth of the total ownership of the property.
Depending on the implementation of the token, it can grant its holder various benefits, such as a share of the revenue, or voting rights. Additionally, holding the tokens can grant the owner access to the office building, such as the right to rent office spaces, either for a limited time or permanently.
This makes various business models possible. For example, the initiators of the project can approach multiple businesses who want to rent office space directly and offer them ownership tokens, in order to collaboratively construct an office site. Granted that they hold a sufficient number of tokens, they can move in right away, after the project is complete. If they wish to move out again, they can simply sell their tokens on the secondary market.
Alternatively, the constructor can approach private investors and offer them dividend payments on the revenue the project generates by renting out office spaces. Again, investors can easily liquidate their holdings by selling them on the secondary market, or use them as collateral to instantly receive a decentralized loan.
Another potential use case is to tokenize an existing constructed building and sell fractional ownership of the property to investors. This could either be used as an exit strategy, or in order to raise funds for a new construction project, while retaining the majority share of the ownership in the finished building.
Security Token Platforms facilitate Tokenization
While this sounds very easy in theory, actually implementing a security token has some pitfalls. First of all, the token must be implemented on a public blockchain, including any smart contract logic the token needs to serve its intended function.
Then, the token sale must be registered by the regulators and it needs to be listed on a security token exchange. Ultimately, the issuers need to identify the buyers of their token as part of international Anti Money Laundering (AML) and Know Your Customer (KYC) standards. Depending on which regulations apply, some security tokens may only be sold to accredited investors.
Luckily, there are platforms that facilitate the issuance of security tokens and provide valuable services to their creators. One of these platforms is Realio. For a reasonable fee paid in the platform’s own native utility token, anyone may create a security token, thus tokenizing their assets. All assets can be tokenized, including for example exotic cars or artwork, but real estate is their primary go-to-market.
Realio operates a decentralized exchange that automatically lists all security tokens created on the platform. Decentralized means that Realio does not act as a custodial intermediary to enable trading. All trades are done in a peer to peer fashion, without traders ever giving away control over their assets.
In order to encourage this peer to peer trading, the exchange charges a small trading fee from taker-orders, which are redistributed in full to market makers. This means that there is always someone around who offers to buy and sell security tokens in order to profit from the spread and the trading fees.
While not acting as a centralized custodian, Realio identifies its traders through an automated KYC/AML process, making sure that traders are legally eligible to buy tokens. Finally, Realio provides compliance services by creating standardized security tokens that comply with national regulations, such as the various exemptions provided by the SEC.
Tokenization can provide more liquidity to the global real estate markets. On the one hand, fractional ownership and easy access to security tokens through exchanges can appeal to investors that would otherwise not invest in real estate. On the other hand, security token exchanges provide an easy way to liquidate the assets when needed.
Tokenization platforms facilitate the issuance of security tokens by providing token standards and an automated process for creating the tokens, as well as exchanges. This makes it even easier to tokenize assets and to invest in the fractional ownership of physical assets.