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A few statistics to start this story
- The size of the professionally managed global real estate investment market grew from $7.4 trillion in 2016 to $8.5 trillion in 2017.
- For most people, 2/3 of family wealth is in the family home. Home equity can be a source of capital for all your wealth-building goals, and a home can be a significant legacy for the next generation.
- 8.25% of all American households – or roughly 10,108,811 households – count as accredited investors (as of 2013, calculated using Federal Reserve SCF microdata). Furthermore, they hold about 70.28% of all private wealth in the US, or a whopping $45.5 trillion.
So what is tokenization?
- Tokenization is the process of representing fractional ownership interest in an asset (utility asset or security asset) with a blockchain-based token.
A common blockchain-based token used for representing an asset is an ERC20 (Ethereum-based) token . The same principles of encryption apply to an ERC20 as they do, broadly speaking, to Bitcoin.
- Real estate tokenization, therefore, is the process of representing an ownership interest in real estate with a token. The detail here is what the token truly represents. Tokens can represent ownership in the underlying asset, equity in a legal structure that owns the asset, an interest in debt secured by the real estate, a stream of income based on cash flows from the asset, and the list goes on.
Why would an investor or a real estate owner/manager decide to tokenize?
- This isn’t real estate specific, necessarily – it applies to all illiquid assets.
- Tokenization created liquidity – the investment pool for tokens is truly global. Anyone that meets capital requirements and has an internet connection can invest.
- Lower investor barriers – the barriers for investor entry will likely be lowered as real estate assets become more liquid. The accredited investor restrictions may view tokenized real estate in a more liquid light – that 8.25% of all US households would expand massively.
- Programmable securities – tokens can be allocated/managed through smart contracts that would automatically enact important processes, e.g. automated dividend payout through smart contracts, which would reduce costs. Even if some manual work was required, it would be less, relative to not having smart contracts involved.
- Security and immutability – cryptographic encryption protects these assets, and blockchains tracking the tokens are append-only, meaning everything that has happened in the past is public to anyone who might want to look, and that includes the regulators.
What are the considerations for tokenizing a piece of real estate, or any illiquid asset?
There are many considerations, and it is a delicate process to execute well.
For example, get the smart contract wrong and you’ll end up needing to burn the old tokens and airdrop (send) new tokens to investors (sometimes a lengthy process, not to mention the embarrassment).
Here are some other important considerations.
- What does the token truly represent – shares in a special purpose vehicle that own the real estate, a right to cash flow from a property?
- Security regulations – is this a Reg D offering, Reg S, Reg A+? Have you spoken with a relevant representative to confirm compliance, if not a traditional exemption?
- Have you conducted KYC/AML/accreditation? Does this just apply to US KYC/AML/accreditation, or is it compliant globally?
There are many other issues to consider, including, but not limited to, tokenomics, tokenization ratio, cash flow to token holders (discretionary vs. guaranteed), tax considerations and mortgage considerations.
This all begs the question…
What are the next steps?
Well, anyone who owns real estate/manages real estate, or anyone who would like to invest in a more liquid real estate opportunity should keep reading…
Tokenization represents an incredible opportunity to both real estate owners and managers for many reasons, including earlier access to capital and a broader investor group. This process also allows investors more liquid opportunities and the potential to become newly accredited.
However, tokenization is not a simple process and requires ample counsel and guidance from professionals with both legal, tax, auditing and technology experience.