The Benefits of Tokenizing Real Estate Over Traditional Fundraising

Tokenizing real estate will bring forth concrete benefits for both issuers and investors. For starters, it will simplify the extremely cumbersome process of buying and selling properties. In addition, commercial real estate investments tend to be limited to well-heeled investors who have all their paperwork in order. 

Today’s traditional, tried-and-true fundraising dominates, despite being a cumbersome process consuming a lot of time, money, manpower, documents, and maintenance. Plus, venture capital deals tend to come with strings attached, requests for board seats, and notes. And angel investors rarely release all the funds at once. Developers have to reach certain goal posts to unlock them, which could be disruptive at critical milestones.

The idea of “fractional ownership” of commercial real estate is not new, but humanity needed blockchain technology to solve the problem of how to manage the operation more efficiently and to democratize access. The real estate business is ripe for disruption and innovation, and tokenization might be the next evolution of this $280 Trillion business.  

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Will blockchain technology solve the age-old traditional problems of the real estate market? 

If it does, blockchain might be an opportunity of epic proportions. While tokenizing real estate is not yet a fully regulated affair in most parts of the world, and humanity is still ironing out the technology’s kinks, the potential for this class of Security Token Offering (STO) is undeniable: owners get millimetric control over the size of the stake they want to sell. In addition, since a smart contract deployed on a blockchain controls the operation, both the issuer and the buyers get all kinds of assurances. And, the smart contract executes them in an automated way. 

Not only that, also take into account what this USC Gould’s Business Law Digest’s article has to say about the Security Tokens market:

“The traditional global real estate market is one of the largest markets on earth – valued at a whopping $280 trillion. Despite its impressive market size, traditional real estate is often critiqued as one of the most illiquid and nontransparent markets because of high investment costs, inefficient processes, expensive middlemen, and market conditions that tie investments for a long time.”

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That’s right, real estate tokenization is a potential trillion dollar market with the prospect of  addressing the most intransigent problems in fundraising. Keep reading to love the idea even more.

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Traditional Fundraising for Commercial Real Estate

Traditional fundraising requires a lot of manhours involving complex processes, and it takes a lot of time to get everything signed and ready to go. So much so, that the process can distract the owners from working on the real project. Specifically:

• Venture capital always comes with strings attached. More often than not, investors will join boards and directly influence the project, hopefully for the better. 
• In most cases, venture capital doesn’t come all at once. The owners will have to reach milestones or goals to receive the next check. This can wreak havoc on cash flow.
• In addition, the traditional system’s fees are prohibitively large. There are a lot of third parties involved, and you have to pay each one. The costs of a tokenized real estate project are considerably lower, and the fees are incredibly low. 
• In most real estate investments, realization only comes when the owner sells or refinances. 

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Traditional Investments in Commercial Real Estate 

Commercial real estate assets aim to generate current income and/or a higher resale value and can be considered a hedge against inflation driven by economic factors such as economic growth, job creation, consumption and inflation. In addition, because most commercial real estate investments employ leverage, both gains and losses get magnified.  

For investors, the primary disadvantages are the high price of entry and illiquidity risks.  Individual projects are not listed on any exchange and are typically regarded as fixed and long term. Generally, there are no liquidity provisions, no standardized mechanisms in place to sell partial interests in non-realized funds, and there are significant restrictions on transferring ownership.

These factors should be taken into consideration when evaluating commercial real estate strategies and their related suitability requirements for specific buyers.

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The benefits of tokenizing real estate

For both commercial real estate developers and investors, the main benefits of tokenization are liquidity and granting a whole new demographic access to individual development projects through STOs. It’s also important to point out that, much like the Internet, every blockchain works 24/ 7 and it’s available all around the world. These are other benefits of tokenizing real estate:

• STOs might be wildly different from each other, but every STO uses conventional blockchain transactions. This fact can do wonders for standardization. In the real world, things are much more chaotic.
• Smart contracts are deployed on the blockchain and are very hard to change. Every transaction lives on the decentralized ledger forever. This brings forth the promise of immutability, a rare ability.
• Everything is out in the open, this brings forth the promise of radical transparency.
• Generally speaking, the blockchain is as safe as your smart contract. Most of the hacks in the space come from faulty code. If your programmer does a solid job on the smart contract, the benefits on security for the whole operation cannot be exaggerated. 
• Buyers can diversify and customize their portfolios however they want. They can invest low amounts in all kinds of real estate projects. This could revitalize the industry in an enormous way.
• Blockchain technology mixed with specialized software can simplify the management of the admittedly huge group of investors. Issuers will get all kinds of ever-evolving tools to do this. Historically, managing a sizable mass of investors has always been a nightmare. Technology is here to help.
• Issuing security tokens can serve as a way to raise temporary funds as well. Smart contracts permit all kinds of buyback options that will be clear to anyone who enters the deal from the very beginning. 
• Also, those security tokens can now be exchanged in the open market for other tokens and cryptocurrency. The sky’s the limit for sought-after tokens, and the secondary market is a click away open 24/7.
• Security tokens are much closer to full regulation and all the protection that comes with it than cryptocurrencies as a whole. They are securities and the issuers are working hard to comply with authorities and get the processes fixed and in the books. It’s just a matter of time. 

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Difficulties of tokenizing real estate

Consider once again what the USC Gould’s Business Law Digest has to say about the regulatory difficulties and intricacies that the industry will have to face for real estate tokenization to become a major part of the industry:

“While some regulators view real estate tokens as securities, others categorize them as real property investments. For example, the SEC categorizes most tokens as securities, the Commodity Futures Trading Commission considers some tokens to be commodities, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network categorizes some tokens as currencies, and the Internal Revenue Service considers some tokens to be taxable property. Additionally, there is no international regulatory framework to reference.”

And that’s just in the United States. The STO issuer is targeting a global market and each country has their own securities law and are probably facing similar standardization problems as the US. Breaking the law is not an option and could turn into significant fines, so the issuer has to be mindful of all of this and navigate with caution. 

Another difficulty that tokenizing real estate brings is a diminished control of certain activities. Everything is automated and programmed early into the smart contract, and that can severely impact the amount of control the owner has. This can be a good thing, though. Another scenario is that, since people are able to trade their tokens anytime, they probably will. This could translate into a lack of investor loyalty. 

Last but not least, the general public is not aware of real estate tokenization and doesn’t fully understand what access to real estate-backed tokens could mean for their wealth and financial stability. For STOs to be as popular as NFTs will require pioneering commercial real estate developers and an immense effort by the whole industry.