From Brick & Mortar to Bits & Bytes: Real Estate Tokenization Explained

Published on

October 24, 2023

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Digital transformation, in the form of real estate tokenization, has the potential to revolutionize global real estate’s $317 trillion market. Using blockchain technology, tokenization will open a wealth of opportunities for property owners, investors, and real estate professionals, enabling fractionalized property ownership and driving liquidity for the real estate market.

Understanding the Basics

Tokenization allows the representation of a physical asset digitally on a blockchain network. Not only can physical assets be tokenized, with one token representing the entire asset, but they can be fractionalized, meaning a set number of digital assets constitute the value of the entire physical asset.

Fractionalization allows for part ownership of an asset, akin to owning shares in a company, and these fractionalized digital assets can be bought, sold, and traded far faster and more simply than conventional property purchases.

What is Real Estate Tokenization?

So, for real estate, tokenization allows property ownership to be fragmented or fractionalized into digitally owned shares. Property investors can acquire any proportion of these tokens, which opens up ownership of larger, expensive properties to multiple and smaller-scale investors, increasing liquidity in the real estate market.

A tokenized property's value is reflected in its tokens' value. In the simplest terms, if a property valued at $1 million is represented digitally into 100 tokens, each would be worth $10,000. If the property's value rises to $2 million, each token would become worth $20,000.

Blockchain & Real Estate: A Revolutionary Fusion

One of the first examples of real estate tokenization in the U.S. was the part-tokenization of the St Regis Resort in Aspen, Colorado, in 2018. The property was owned by New York asset management company Elevated Returns, which had initially planned a novel IPO for 49% of the hotel, selling it as a single-asset real estate investment trust.

Instead, Elevated Returns pivoted to an even more revolutionary approach, selling 18.9% of the resort as digital “Aspen Digital Security” (ASPD) tokens representing fractional ownership at $1.25 each via brokerage firm Templum Markets LLC.

Elevated Returns was one of the first companies to see the opportunity blockchain technology and tokenization presented for real estate investing. Director Jason Kirschenbaum, said at the time:

“The Aspen Digital closing not only represents a new coin on the market that is asset-backed, it also establishes a blueprint for future real estate tokenization.

The future of real estate investing is one that provides global exposure, transparency, public access, and liquidity, all of which are elements that can be delivered through blockchain technology.”

Today, the tokenized real estate market has reached around $200 million, rising from just $32 million in June 2021, with real estate tokens constituting almost 40% of the digital securities market.

Sources to Check Out:

The Technical Aspect of Tokenization

How Tokenization Transforms Physical Assets

Tokenization converts an asset into digital tokens, which can be traded relatively on exchanges or dedicated platforms, increasing liquidity in a market. Blockchain technology provides speed, security, transparency, and scalability. Investors can acquire equity in property anywhere in the world in just a few clicks. Now, numerous platforms tokenize real estate assets and provide a marketplace for investors.

Real estate tokens are similar to non-fungible tokens (NFTs) in that each is unique with its own data and cannot be simply exchanged like for like as with fungible tokens such as Bitcoin.

Real estate tokenization can not only apply to the ownership of an entire property or fractional ownership of a property, but tokens can also represent an equity interest in an entity that owns real property, an interest in debt secured to a property, or a right to a share of the profits generated by a property.

Safety First: Ensuring Security in Digital Property Tokens

A blockchain is a (usually) decentralized distributed ledger that digitally and immutably encrypts and stores transactions and related data. Such a distributed network does not have data stored in a single location, but rather it is distributed among network participants, reducing vulnerability from attack or a single point of failure. A genuinely decentralized blockchain is governed by network participants or automated mechanisms rather than a central organization, putting control back with users. Blockchain transactions are also transparent amongst participants, and this combination of features works to prevent fraud and illicit or unauthorized activity.

With real estate tokenization, there are significant benefits to using blockchain’s smart contracts, which process transactions only when criteria are fully met. Tokenization can prevent counterparty risk and influence and prevent fraud or non-compliance, creating a more secure environment for investors.

Sources to Check Out:

Benefits of Tokenized Real Estate

Speed

It’s possible to buy and sell blockchain-based tokens quickly without needing third parties like banks or brokers, which adds liquidity to the market. This fractional ownership is far faster than the process and legalities of conventional property purchasing.

Security

Blockchain technology provides a digital, immutable, and tamper-proof record of ownership and the transaction history of tokens, helping to prevent fraud. Blockchain’s smart contracts automate the execution and record of transactions, and each token can record vital ownership data.

Market liquidity and accessibility

Real estate is traditionally considered an illiquid asset class due to the costs and complexities of real estate purchases. Fractionalized real estate ownership opens up the market to new and small-scale investors, adding liquidity and increasing the ability of property owners and builders to raise capital.

Real estate tokens differ from real estate investment trusts (REITs). Tokens can be linked to specific or single property. In contrast, REITs are gateways to invest in pools of various properties.

Rewards from real estate token ownership

Not only can real estate token purchasers own a fraction of some significant, high-value properties, even the property of their dreams, but they also benefit from the property's appreciation in value over time, and part of the token ownership rewards can be any rental income.

Sources to Check Out:

EY: Tokenization – From illiquid to liquid real estate ownership

Challenges and Considerations

Roadblocks in Real Estate Tokenization

Potential for fraud

Though blockchain technology adds security to transactions, such a nascent and unregulated space has attracted many illicit actors. Unfortunately, fraudulent and otherwise risky projects and technology providers exist, and cyber attackers heavily target token platforms, crypto token wallets, and exchanges.

Risk adversity and sector uncertainty

Blockchain technologies, cryptocurrencies, and other digital tokens have yet to achieve mainstream adoption. Technologies, regulators, and consumers are evolving and adjusting to these new Web3 and investment experiences. Thus, consumers have little protection against scams and illicit actors. Tokens listed and traded as cryptocurrencies are subject to incredible volatility fed by several factors, including sudden regulatory responses and consumer sentiment.

Lack of regulation and land registry implications

The lack of appropriate regulation affects the confidence of real estate tokenization project leaders and investors. In some countries, real estate assets fall under securities regulation, but in others, they are classified as commodities.

Legal and Regulatory Landscape: Navigating New Waters

Cryptocurrencies and digital tokens have yet to be comprehensively and consistently regulated around the globe. This adds much uncertainty to the sector, slowing the adoption of innovations such as real estate tokenization. Part of the issue lies with whether tokens are securities. If they are, they fall under regulations designed for stock and bond markets.

The issue is still being widely debated, and full clarity may be some way off. Investors and those considering tokenizing real estate must devote real effort to understanding the legal and regulatory landscape to date, the possible future, tax, property and land registration, and other legalities.

Sources to Check Out:

Case Studies: Tokenization in Action

Real-life Examples of Tokenized Properties

In addition to the St Regis Resort example we began with, numerous cases of successful property tokenization can be found in our “Sources to Check Out” sections.

The most recent, significant step forward for real estate tokenization is the Moscow Stock Exchange's plan to introduce digital financial assets (DFAs) for real estate assets in 2024. Once DFA issuance is overseen by the National Settlement Depository (NSD), the DFAs can be traded on the exchange, becoming more accessible to investors.

Learning from Tokenization Trials

In the UK, Her Majesty’s Land Registry (HMLR) partnered with ConsenSys Codefi to explore the use of blockchain to increase simplicity and transparency in UK real estate. Though a research and development project for HMLR, the trial replicated real property tokenization and the fractionalization of a property. The technology trial demonstrated cost and time savings, increased liquidity and investor accessibility, and provided “trusted proof of evidence of the origin and provenance of a traded fractional property asset.”

Sources to Check Out:

The Future of Tokenized Real Estate

Real estate tokenization is a novel and nascent development that can significantly benefit property owners, real estate professionals, and property investors. That said, it must be remembered that the sector has its risks and remains widely unregulated, adding much uncertainty. Savvy early adopters could steal a march on real estate tokenization's potential but must prepare for its evolution, regulation, and risk.

Prepping for a Tokenized Tomorrow: Steps for Real Estate Professionals

Real estate tokenization is one extremely promising application of blockchain technology that could transform property investing, and that process is beginning now. Deloitte, in its first whitepaper on the topic, predicts the value of the real estate tokenization market could reach $1 trillion by 2030. It further expects the trend to accelerate in the Asia Pacific region due to an increased adoption of blockchain technology.

To stay ahead of the curve, real estate professionals may need to pivot to understanding and facilitating access for their clients. There’s no better time to start understanding real estate tokenization, its promise, and the players.

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