One of the most common assets to invest in, has been real estate. From apartments and multi-family housing, to industrial properties and office buildings – There are numerous types of real estate that all come with their own pros and cons.
While some advantages might be the stable cash flow and smaller risk compared to other assets, such as stocks, they are not flawless. One of the biggest challenges a small company or investor has to overcome is acquiring sufficient capital.
Many investments, such as shares of a company or precious metals, allow you to only buy a fraction of the whole asset. Real estate on the other hand is only sold as the complete apartment or building. Now you might think it is impossible to cut a building into thousands of small parts – which most likely would not really support their internal structure.
Blockchain and the process of tokenization have found a way to help out with this issue and allow more people to buy into the real estate market.
What is Real Estate Tokenization?
Real Estate Tokenization is the process of dividing a building into digital shares that represent partial ownership, based on blockchain technology. After issuing these so-called “Tokens”, which hold a specific value, they can be exchanged on secondary markets and thus increase the liquidity of real estate investments.
Why do we need Real Estate Tokenization?
Some of the biggest problems with real estate investment are the illiquidity and the entry barrier.
Illiquidity means that an asset cannot be exchanged into other assets quickly or easily. Especially buildings are very illiquid and transactions can take up many months or even years from start to finish.
Another point already mentioned earlier is the high entry barrier. Even when taking a loan to finance an investment, there still needs to be sufficient capital in place in order to secure the financing. This makes it impossible for many investors to enter the market, or to keep a diversified portfolio of several properties.
Lastly, another disadvantage of owning real estate directly is that it takes lots of time and effort to manage them. This includes maintenance, collecting rent and responding to tenant problems.
All in all, these are very important issues that tokenization can possibly address and improve the investing process. But how does it work?
How does Real Estate Tokenization work?
There are 2 types of Real Estate Tokenization that are common:
- Creating a share of a property that allows investors to profit from the increasing value of the building and collect rent as a form of dividend.
- Crowdfunding the development of a building by issuing shares and then distributing the profit after it is finished.
The process of creating a tokenized real estate project consists of the following 4 phases:
- Deal Structuring
In the first phase of tokenization, the investment deal has to be structured. This means all the conditions have to be written down and discussed by the managing team. It includes the value of the building, the amount of shares distributed, the value of each share, distribution of rent, … and many more.
- Digitizing the Conditions
Next, these conditions specified in the previous step have to be brought into a digital version. Therefore a smart contract, on the basis of blockchain, will be set up and the rules will be implemented into these programmes. Smart Contracts are able to automatically execute orders such as exchanging tokens between owners and distributing rent.
- Raising Capital
Now the token has to be published and the required amount of capital will be taken from the involved investors. These shares will then be stored on digital wallets.
- Returning Profits
The last step is the distribution of profits and dividends. This means that smart contracts will pay the share of rental income to investors and also define the growth of the token’s value. In addition, these tokens can be traded on digital marketplaces, where people are able to exchange the ownership of a share of real estate.
What are successful Real Estate Tokenization Companies?
Tokenization can be seen as the future of real estate investment as it allows more people and companies to enter the market, easier diversify a portfolio, and outsource the management of properties. A 4-step process allows creating these tokens that represent the share of a building and can be traded on digital marketplaces.
If you want to learn more about PropTech, Smart Buildings and Commercial Real Estate (CRE), feel free to take a look at our other articles.