EMERGING REAL ESTATE INVESTMENT TRENDS:
The Future of Blockchain and Real Estate Tokenization
By Sohail Hassan
Have you ever taken a trip down a technology rabbit hole and wonder if you would ever come out? As a real estate developer, MarketSpace Capital has a fiduciary responsibility to find ways to enhance the overall returns for our investors. Yes, we look to find ways to enhance our property revenues, but we also search for countless ways to reduce our expenses, become more efficient and enhance our net operating income. During the past year, our leadership team has been writing about and investigating the future of blockchain technology, and how it has the potential to impact efficiency, due diligence, go-to market strategy, overall liquidity, and profitability for our investors.
While the world has gone largely digital, certain financial markets remain archaic for managing, buying, and selling assets. This is especially true in the real estate marketplace that continues to use manual and time-consuming methods for acquiring, administering, and trading assets. As such a result, the real estate sector is very illiquid and inaccessible to most of society. Yes, this represents an inefficient market, but this manually intensive infrastructure also provides for a “technology intervention.” In short, by using blockchain technology and issuing real estate assets on a distributed ledger (also commonly known as tokenization), the real estate investment market could automate middleman processes, increase liquidity, lower capital requirements for investment and improve transparency…a true democratization of real estate. This, in turn, could lower the expenses of real estate issuers and broaden the universe of potential investors. As such, real estate is an industry ripe for tokenization.
The Inefficiency of the Real Estate Industry
The development and marketing of real estate became a popular form of income and was common throughout the Middle Ages. Property ownership was a symbol of wealth and was one of the ways for the wealthy to ensure their assets were stable. As an established industry, the real estate market flourished, and came to the United States with the European colonists.
Fueled by the opportunities of a New World, and the capitalism of a free-market society, the seeds were planted for American entrepreneurs to turn the industry into a profitable machine. These seeds, and the real estate industry in the United States, started to grow in the early 1800s when the Louisiana purchase became the first major real estate acquisition made by the U.S.
The use of blockchain technology eliminates friction and allows for the real estate industry to greatly reduce high overheads and operating expenses...
As the industry grew, so did the “food chain” of those trying to make money in real estate transactions. Consequently, private sector players such as architects, engineers, surveyors, lawyers, developers, contractors, accountants, appraisers, brokers, title companies, property managers, etc. all have their hand out as part of each transaction. Then, there is the public sector with their property taxes, fees, assessments, penalties, etc. Finally, you have the capital sources complete with investment bankers, mortgage brokers, lenders, investors, Broker-Dealers, Registered Investment Advisors, as well as the ongoing cost of investor relations, governance, reporting, compliance, etc. In short, there are a myriad of participants involved in the real estate investment industry that help support our national economy.
Today, highly inefficient, manual, and repetitive acquisition, due diligence, operation, transfer, and record-keeping processes plague the real estate investment market. Lack of efficient administrative infrastructure gives rise to manual and highly cumbersome asset, property, and stakeholder management, which in turn, produces sizable expenditures. By automating administrative processes, the use of blockchain technology eliminates friction and allows for the real estate industry to greatly reduce high overheads and operating expenses.
Basic Concepts of Blockchain
If you have been following banking, investing, or cryptocurrency over the last ten years, you may have heard the term “blockchain.” In short, blockchain is the record-keeping and storage technology behind many of these financial networks like Bitcoin. But what is it … exactly? Many technologists do not fully understand the technology behind Blockchain, yet they understand what it does from an intuitive standpoint. In the same way that you may intuitively understand Microsoft Word, Venmo, Uber, SalesForce, or even the use of SAP software, you still probably do not fully understand the technology behind it.
So, in simple terms, Blockchain is a database technology that stores information. Specifically, it stores data in blocks that are then chained together … hence the name … Blockchain. As new data comes in, it is entered into a fresh block. Once the block is filled with data, it is chained onto the previous block, which makes the data chained together in chronological order.
Blockchain was invented for Bitcoin by Satoshi Nakamoto in 2008 as a shared, irreversible ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible (a house, car, cash, land) or intangible (intellectual property, patents, copyrights, branding). Virtually anything of value can be tracked and traded on a blockchain network, reducing risk, eliminating fraud, and cutting costs for all involved. But there is no intangible asset more reliant on Blockchain technology than digital, virtual and cryptocurrency.
Digital currency is a form of currency that is available only in digital or electronic form, and not in physical form. It is also called digital money, electronic money, electronic currency, or cyber cash. Digital currencies are intangible and can only be owned and transacted by using computers or electronic wallets connected to the Internet or designated networks. In contrast, physical currencies, like banknotes and minted coins, are tangible and transactions are possible only by their holders who have their physical ownership, or through a regulated banking system.
Like any standard fiat currency, digital currencies can be used to purchase goods as well as to pay for services, yet sometimes are restricted to use among certain online communities, like gaming sites, gambling portals, or social networks. Digital currencies have all intrinsic properties like physical currency, and they allow for instantaneous transactions that can be seamlessly executed for making payments across borders when connected to supported devices and networks.
A cryptocurrency is another form of digital currency which uses cryptography to secure and verify transactions and to manage and control the creation of new currency units. Bitcoin and Ethereum are the most popular cryptocurrencies, and just like any other regulated fiat currency, the holders are subject to currency valuation swings, in the same way that the US Dollar is exchanged with the EU Euro or the Mexican Peso. Therefore, many investors have been investing and holding positions in cryptocurrency in hopes that the currency valuation will grow, and they can benefit from such growth. Yet, in any currency game, there are always winners and losers on each “bet.”
As an alternative, a form of cryptocurrency, called a “stable coin,” is a currency that always maintains a stable price, as it is tied to a fiat, or government issued currency, which is not backed by a commodity. An example of this is Circle USDC, which is the largest stable coin ecosystem in the world and is a digital coin that is tied to the US Dollar. So, as the US Dollar fluctuates in value, so does the Circle USDC. However, if you are looking to use your Circle US Digital Coins to purchase US-denominated assets, i.e., real estate “security tokens,” then there is no exposure to currency risk.
Security Tokens vs. Crowd Funding
In the same way that you may hold a membership interest in an LLC, or shares of stock in a corporation, tokenization is the process of converting your ownership interest in an asset, i.e., a security, into a token that can be moved, recorded, or stored on a blockchain system. Simply put, tokenization converts the value stored in some object – a physical object, like a painting, real estate, stock, bond, or an intangible object, like a carbon credit – into a token that can be manipulated, pledged, sold, purchased, etc. along a blockchain system.
When you think of the building blocks of the blockchain, you should think of a global decentralized ledger … or in simpler terms, an excel spreadsheet … that has a separate worksheet for each type of asset. Yet within each worksheet, there is a series of “wallets” for investors running across the columns from left to right. And then within each wallet, think of every single token, i.e., currency, running down the rows from top to bottom. By way of example, if I have 30 Bitcoin tokens in my wallet, it shows up on this ledger. And every time I sell any of these tokens, there is a debit to my wallet, and a corresponding credit appears in the purchaser’s wallet. Simple right?
But now, think about the billions of asset types (each is a worksheet), such as Bitcoin, Ethereum, stocks, bonds, gold, or even a multifamily real estate asset. And, within each worksheet, you have billions of wallets (each is a personal holding). And then, within each wallet, you have billions of tokens (representing the currency). Now, as the worldwide accountant to everyone, try keeping all that information accurate, in a real time basis, and make sure that there is no cheating or errors. Yes, it seems like a daunting task, but that is the basis of blockchain technology. In effect, these debits and credits are accounted for, stored, reconciled, verified and irreversible in a matter of seconds.
From a liquidity standpoint, Digital Security Tokens are very fungible. By way of example, think about owning shares of General Electric stock on the NYSE, and if you need cash or look to sell shares, you can do so by processing a stock sale order. Like the NYSE, Security Token Exchanges, i.e., a marketplace, also exist. In fact, there are regulated and non-regulated exchanges, and although the marketplace for tokenization is still relatively nascent, perhaps the largest market share of exchanges take place on the US-based “tZero” platform. Although there are other exchanges throughout the world, it is projected that the Regulated Exchange environment and transaction volumes will grow by a factor of 10 throughout 2021.
For many years, crowd-funding platforms have offered access to invest and trade “digitized” assets, including real estate. Yet, security tokens are better than crowd-funding platforms for two primary reasons.
First, the global tokenization industry will use the exact same standards on all the tokenization platforms throughout different continents, and they will all be interoperable. This means that real estate tokens that are issued and tradeable on an exchange in the US, will also be tradable in Europe and Asia. These tokens that are issued can be kept in safe custody by most security token custodians globally. It also means that no investors or issuers will be locked into a single vendor’s ecosystem but will be able to transfer their tokens for trading or custody to any other vendor globally (only limited by regulatory restrictions). The second reason that security tokens are better is that blockchain technology is a much more modern, secure, and efficient method for implementing securities transfer, settlement, and trading, when compared to a crowd-funding proprietary digitization of securities.
Real Estate Tokenization
Real estate is the biggest single asset class ($228 trillion in total assets) where tokenization can provide value, as less than 1% of all real estate assets are traded on a national stock exchange. Although there are many, one of the biggest benefits to real estate tokenization is the ability to reduce investment ticket sizes by several orders of magnitude. This is due to the automation of issuance and post-issuance processes, and the lower ticket size, dramatically increases the universe of investors able to invest in each investment vehicle. Another significant benefit is the new liquidity of real estate by making real estate assets tradeable in a marketplace. Arguably, this single event will increase the investment capital directed to invest in real estate and will make the asset class more accessible for investors. In fact, only 7% of all commercial real estate is available to investors, yet over 80% of individuals seek to have some type of investment in real estate.
Real estate assets have several characteristics that lend themselves to Security Token Offerings (STOs). They are a relatively secure, fixed asset, they require substantial investment capital, they are well understood from most investors, they are easy to compare, are quantifiable and generally they are highly illiquid investments.
The real estate market will benefit from the “standard” blockchain characteristics, and to speed transactions, a set of rules – called a “smart contract” – is stored on the blockchain and executed automatically, to automate and reduce the operating, investment, and administrative costs, such as:
- the cost of issuance, transfer, settlement, standards and trading processes, including the verification of Accreditation Standards, Know Your Client (KYC), Anti-Money Laundering (AML), Patriot Act, Suitability Questionnaire, Subscription Agreements, etc.;
- the governance processes and SEC compliance such as cross-border transfers, cross-investor-type trading, Rule 144 lock-up periods, caps on investor counts, Blue Sky Laws, Regulation D filings, Regulation S compliance, etc., and;
- the increased ability to attract investors, including engaging with foreign investors and to significantly reduce ticket size of investors to cater to a larger pool of smaller investors, thereby increasing the universe of investors for any given project; and
- the ability to reduce intermediaries such as Central Securities Depositories (CSDs), transfer agents, broker-dealers, lawyers, accountants, etc. due to the blockchain trust layer.
As a result of blockchain technology, we should, therefore, see that good projects can raise capital easier, faster and at a reduced cost, investors can enjoy increased liquidity on their investments, good projects can get a liquidity premium, and investors can globally get access to previously inaccessible types of investments.
The real estate market will benefit from the “standard” blockchain characteristics.
Future of Real Estate Tokenization
So, what does all this latest and greatest technology mean for Marketspace Capital and our real estate investors? You can expect these tokenized sales to increase in popularity as mainstream investors continue to invest and take notice. According to NASDAQ, KPMG, for example, created a prospectus for potential investors interested in tokenized real estate as an investment vehicle in Hong Kong and Singapore. Other reputable real estate firms have billions of dollars of capital being raised through Security Token Offerings (STO), and these assets are already trading by other investors. And while KPMG is not a firm known for catering to the average, small-scale investor, the fact that it is interested in the potential of tokenization as an investment vehicle speaks volumes about its potential and opportunity for mass adoption.
MarketSpace Capital is strategically positioning itself as a market leader in the blockchain and Security Token space. We, and our co-development partners, presently hold over $1 Billion in multifamily assets, are investigating a tax-free exchange from the current ownership interest to Security Tokens, and exploring the regulatory, legal, accounting, and operating requirements for executing STOs for our future offerings. For liquidity and safeguarding against currency risk, it is our belief that by using a stable coin such as Circle USDC, and then offering exchange functions on a regulated exchange such as the tZero trading platform, we can satisfy our investor’s goals and objectives. Both today, and in the future, tokenization will democratize investment opportunities while providing liquidity for our investors. We are strategically positioned to reduce the traditional barriers to entry faced by many “would-be” investors and look forward to expanding our investor database to acquire real estate assets and build wealth.