Will real estate tokenization change real estate investing forever? As technology moves forward at a grueling pace, investors scour and scrape for opportunities to be on the cutting edge. The democratization of finance isn’t a new concept; it’s been happening for decades. The introduction of index funds, fractional shares, and mobile-first brokerages has changed how we nurture and grow our wealth.
And the next frontier of these investment opportunities—real estate tokenization—is starting to gain steam.
As companies start to tokenize their physical assets, new investors (finally) have a chance to diversify their nest egg and make money in real estate as millionaires do. And if you’re one of those millionaires sitting on physical assets—this could change everything.
So, what is real estate tokenization? How does it work? And why should you care?
Let’s dive in.
The Current State of Real Estate Investment
The globalized real estate market is 10.5 trillion dollars—an unfathomable amount of capital. Yet, with all those trillions floating around, retail investors participate using outdated investment vehicles.
In fact, most lucrative real estate projects are reserved for high-profile investors or investable only by ownership of a property management company.
Here’s how an Average Joe makes money in real estate in 2021:
Publicly traded companies that own a swath of commercial real estate. Many have a particular area of focus, such as hospitals, business parks, or shopping malls.
Crowdfunded Real Estate Investments
When it comes to shared ownership of private real estate—think of websites like Fundrise. This is where a collective pool of investors owns one or many private real estate investments. Potentially, crowdfunded assets can carry more risk (due to lack of transparency or trajectory) than publicly traded REITS or self-owned property.
- Privately Owned Residential, Commercial, or Raw Land Assets
These are private properties owned and sold typically by one or many persons or businesses
There’s no doubt that there’s money to be made in these trades, but there’s an entirely new solution popping up on investors’ radars.
What is Tokenization in Real Estate?
Real estate tokenization takes physical real estate assets (any type of real estate) and divides them into shares that can be bought or sold. This process is called securitization, and the shares are referred to as security tokens.
Click here for a more in-depth understanding of tokenization
How Does Real Estate Tokenization Work?
Real estate tokenization allows asset owners to sell real estate through Securitized Token Offerings (STO). These STOs take the proposed value of the asset and divide it into shares that are available for purchase.
These tokens can be listed for sale using Cryptocurrency Exchanges or Alternative Trading Systems (ATS). Each of these exchanges varies from a regulatory standpoint, but their primary function is to match buyers and sellers.
Initial Coin Offerings (ICO) vs. Security Token Offerings (STO)
You may have heard about an initial coin offering before, which is similar to security token offerings. However, there’s a difference:
Initial coin offerings are “utility tokens” which only have value inside their platform.
e.g., Say Disney decided to issue “Waltcoins” that you could use to buy merchandise in their theme parks. These Waltcoins represent value at Disney and can only purchase goods and services with Disney’s permission in Disney’s ecosystem.
Security tokens are different. They’re typically connected to real-world assets (like real estate, businesses, stocks, etc.) and represent direct ownership. Investors in STOs hope for future appreciation of the asset.
What Are the Benefits of Tokenization?
STOs come with most of the benefits of owning real estate properties while enjoying the advantages of Blockchain technology. Both owners and investors stand to benefit from this process.
From an asset owner’s perspective, they can get the money they need when they need it.
From an investor’s perspective, they can participate in an offering previously not available to them.
Both can sell or purchase tokens on the open market to increase or decrease their position, much like buying or selling shares of stock. And since the tokens should live on a Blockchain that offers smart contracts, they’ll gain unparalleled security, transparency, and process automation.
What is Blockchain?
Blockchain is a ledger of transactions between peers compiled into “blocks” of data. This digital ledger is not regulated by one business or person. Rather, its upkeep relies on a network of computers or systems. The result is a large set of transactional data that’s fully transparent and nearly impossible to alter.
Blockchain technology is synonymous with Bitcoin but is used in (almost) all cryptocurrencies. When reaching for understanding, think about Blockchain like the system underneath the asset. There are many Blockchains that exist.
i.e., Think of Blockchain as the foundation, plumbing, and electrical that enables a business built on top to make and record transactions.
How Would Blockchain Work in Real Estate?
For real estate’s purposes, we can see how transparent ownership, logging, and security are critical. It theoretically eliminates bankers, mortgage brokers, real estate agents, and other third-party entities that make purchasing property more difficult and expensive.
What Are Smart Contracts (And How Do They Work in Real Estate)?
Smart contracts are a lot like contracts in the real world but digital. Smart contracts have the potential to create “if x happens, then y happens” relationships with just about anything—including real estate transactions and profits.
They’re immutable computer programs in themselves, meaning an individual cannot tamper with the predetermined contractual outcome. So, if you have a smart contract on the Blockchain whenever a condition is met, expect the outcome to trigger automatically.
How Would Smart Contracts Work in Real Estate?
Imagine if someone made an offer to buy your home on the Blockchain. You could utilize a smart contract with set conditions that oversee each step of the buying process. The smart contract could facilitate the entire transaction (and all parties involved) with unbeatable accuracy—cutting out most, if not all 3rd party service providers.
How Will These Technologies Change Real Estate Investing?
Let’s look at a real-world example of Blockchain, smart contracts, and real estate:
Say you own an apartment complex that conducts an STO on an exchange that utilizes the Ethereum Blockchain. You’ve let potential investors know you plan to use the proceeds of the STO to make building improvements and attract higher-paying tenants.
There are ten total Security Tokens offered. You decide to keep six and sell four—one each to new investors. If the tenants of the complex pay rent each month, that amount would go directly to the smart contract.
First, the smart contract collects revenue from all the tenants.
Next, it pays the property tax to the government.
Finally, it splits the remaining profit with you and the investors.
Since you own 6/10 tokens, you’ll receive 60% of the profits while other investors receive 10% each. While simple, this same concept can be applied to numerous property types to raise capital in the hopes of generating returns for investors.
The Bottom Line
Real estate tokenization is changing the way we look at real estate investments. From an owner’s perspective, raising capital is easier than ever and more efficient through Security Token Offerings on different exchanges. And retail investors can finally diversify their portfolios with real income-generating or appreciating assets that aren’t correlated to indexes like the S&P 500.
Real estate tokenization can be applied to multiple property types—each with its own investment risks and rewards. Tokenization is still in its infancy. However, there’s no doubt its effect on investment, monetization, and ownership structure can potentially change the real estate industry forever.