04 TP

Tokenisation of real estate assets

Hafeez Azeez Jan 19, 2023

Asset tokenisation is the mechanism by which digital tokens are issued representing either digital or physical assets on a blockchain or distributed ledger system. The Blockchain guarantees that once you buy these tokens your ownership is immutable - that is, no single authority can erase or change your ownership.

There’s a lot of interest in tokenisation not only in real estate but in other assets which have traditionally been less liquid and inaccessible due to the high cost of capital required or the transaction fees associated. Art, for instance, has seen several companies testing the market and risk appetite for investors to enter via fractional ownership using the Blockchain. This ultimately allows investors to diversify at lower capital levels.

Ultimately Blockchain/tokenisation systems are similar to conventional securities but with the additional benefit of:

  • Transparency – An inherent feature, it allows visibility and traceability of transactions both to the origins and current ownership. The immutability means once transactions are recorded, they cannot be change or deleted.  This is an extremely useful feature to keep track of property titles as there is one source to rely on.
  • Liquidity & fractional ownership – While incorporation and REITs allow for fractional ownership, these have had a relatively small impact on the overall real estate market in terms of trading.  Tokenisation promises lower barriers to entry and less friction in transaction cost, both in terms of time and the costs associated with traditional middlemen fees. This can also be extended past direct ownership by using tokenisation to create securitised loans with automated default mechanism using smart contracts.
  • Lead time & transaction cost – As mentioned, reduction in the traditional middleman should reduce the cost and the length of time required to execute these transactions. The ledger nature of the Blockchain should also reduce cost associated with administrative tasks such as aggregating and compiling information and making the necessary updates to the database.
  • Smart contracts – Depending on the Blockchain architect, smart contracts can be integrated to allow for a level of automation which can include contract generation, document verification, assets in escrow, dividend payments, etc. Smart contracts can be further integrated with trusted parties/nodes to ensure trigger events are reliably entered into the system. For instance, the bank (node) acknowledges receipt of payment which triggers the release of the real estate token to its new owner.

These benefits do come challenges and learning hurdles to overcome. The level of impact will largely vary depending on the complexity and integration of parties in the tokenised ecosystem.

  • Scope - The exact scope of tokenisation can vary from the simplistic, in which it acts as a registry, to the more complex environment which includes multiple parties, smart contracts to enable automation of payments, holds assets in escrow and has external parties acting as reliable sources of information. Having this well thought out at the start will have a significant impact on usability and the success of the system.
  • Initial confidence – Several countries have already recognised the utility and potential benefit of this process although it remains a relatively small part of the mark. As with any innovation, there is an inherent risk aversion, and any negative press may lead to a loss in confidence.
  • Cyber threat – This is an inherent risk in all IT environments. However, the open-source nature and a shortage of programmers in this space translates into challenges in the software development process, exposing tokenised assets to theft, programming errors and cyber-attacks.
  • Fracture assets – Clarity over control and ownership will need to be enforceable under law. Some countries have chosen to transfer the same rights as those of incorporated entities to tokenised assets. A good example would be Wyoming (USA) which allows decentralised autonomous organisations (DAOs) to operate like a limited liability company and with control of ownership similar to voting rights attached to shares.
  • Development cost – Inevitably with a new sector, there will be unexpected costs. With Blockchain being a buzzword, the costs associated with software engineers in this space has significantly increased. Careful cost benefit analysis will need to be considered, ensuring that the time of transition or development yields sufficient benefits. A key criticism here from a technical basis is that the current ledger system does exist to support a similar process with a centralised authority.
  • Accessibility & authorisation – Currently most software access uses a form of role based controls. As it sounds, assigned privileges are based on the role of the user.  Depending on the scope and objectives of the tokenised environment, this may need to be flexible to accommodate changes, evolution, and temporary access.  As a relatively new form of technology this may represent a challenge.
  • KYC/AML – The Blockchain inherently will be globally accessible and therefore trusted intermediaries or updated processes will need to be in place to ensure operations meet regulatory requirements.
  • Regulatory changes – The local laws and regulations will need to consider all of the above, and more, to ensure that a tokenised system can efficiently and effectively operate while maintaining the ability to enforce its governance.

While there are significant hurdles to overcome, creating a more accessible real estate market (estimated globally above US $280 trillion) promises to create significant opportunities to investors and access to capital.

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Hafeez Azeez
Client Director
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