Real Estate Tokenization Basics Part 1
Updated: Sep 21, 2023
In 2019, global commercial real estate investment hit an all-time high of US $830 billion. However, real estate has historically been one of the most illiquid asset types, requiring substantial capital investments and lengthy, costly transaction procedures. As a result, real Estate Investment Trusts (REITs) have historically outperformed other main asset classes as a more liquid option to invest in real estate.
More desire for improved access from new investors and increased liquidity from current investors motivates to reshape the real estate investment market. In addition, a new wave of technology is bringing better efficiency, security, and cost savings to the financial sector, with tokenization heralding the arrival of novel real estate solutions for the digital age.
Tokenization is a fast-growing segment of the financial industry that permits investing through digital tokens backed by physical securities or assets.
In this article, I will discuss Real Estate Tokenization Basics Part I.
Definition of Terminologies?
To better understand the concept of tokenization, we will consider some common terminology often used.
Tokenization: This is moving traditional non-digital securities to a digital form using blockchain technology.
Tokenized Securities: This describes digital investment products with the characteristics and functions of securities.
Security Tokens: Term used to describe the form in which tokenized securities are issued to investors.
Blockchain Technology: At the core of tokenization is a distributed ledger that secures identical copies of data across a network of authorized stakeholders. In contrast to a centralized database, there is no single point of failure for data stored on a blockchain, and unauthorized access to or alteration of data is near impossible.
Integrating Real Estate into Blockchain Technology?
Using blockchain technology's safe, immutable properties, tokenization enables secure transaction records and rapid settlement procedures for digital fractional ownership. As a result, tokenization is gaining pace in the real estate industry, with conventional real estate institutions collaborating with technology companies to investigate the tokenization of loans or equity.
As more technology-enabled real estate initiatives come to fruition, we anticipate that enhanced investor access to high-quality property assets will revitalize real estate investment. Technology providers will benefit from high-quality asset origination and the financial acumen of an increasing network of conventional real estate players. Tokenization has the potential to usher in a new era of real estate investing, one that offers improved choice and freedom for all stakeholders, but getting there will need a collaborative effort.
For more information on Blockchain and Real Estate, check out these articles:
Benefits of Tokenization
1. Fractionalization: For assets that have historically required significantly high upfront payment, tokenization reduces investment barriers by allowing interests in the asset to be more easily distributed across a larger pool of investors, democratizing access to the asset. In addition, a secure digital register of members (ROM) on the blockchain handles fractional ownership. As a result, new financial products might be supplied to a broader pool of investors at a cheaper unit cost, with a fee structure that includes an access premium for previously unavailable investment opportunities.
2. Efficiency in Operation: Smart contracts are programmable blockchain activities that automate compliance checks, investor whitelisting, and post-issuance issues such as dividend distribution. Additionally, smart contracts enable the programming of tokens with unique features, allowing for the creation of shared class-specific attributes and customizable fee structures for tokenized assets at a minimal operating cost.
3. Time Savings on Settlement: Transactions involving tokenized goods may be completed nearly instantaneously, in contrast to the days or weeks that conventional financial transactions can often take to settle.
4. Transparency of Personal Information: The immutability and resistance to cyber-attacks of blockchain as a distributed ledger technology are attributed to data being dispersed over a network of participating nodes rather than a single centralized database. In addition, while transaction data is made trackable and accessible on the blockchain, cryptographic hashes ensure that blockchain transactions maintain data privacy.
5. Flexibility: The elements listed above enable investment flexibility: fractionalization enables flexible portfolio construction and diversification; operational efficiency and reduced settlement time allow faster transfer of investment interests. Data transparency enables investment analysis with up-to-date information. Liquidity Tokenization facilitates liquidity by allowing for the safe transfer of shares between investors, with each transaction recorded on the digital ROM. Global public market liquidity for tokenized securities is also well on its way as regulatory regimes throughout the globe embrace and build frameworks for regulating digital securities exchanges.
Life Cycle of a Tokenized Security
The lifecycle of a tokenized security has five stages.
1. Deal Structuring:
Critical choices about the security token's terms and conditions must be defined during the initial deal structuring stage. Deal structure is vital to every securities offering, regardless of the technology. Tokenization is not designed to circumvent existing legal and regulatory restrictions; instead, the intention is to enhance operational procedures to allow novel financial solutions fundamentally. The phases outlined in blue on the figure represent areas where technology can substantially impact.
2. Digitization Stage:
The second stage, digitization, is when data previously saved on paper or in documents are uploaded to the blockchain and programmed in smart contracts and the issuance of security tokens.
3. Initial distribution:
The primary distribution procedure involves the issuance of tokens to investors in return for investment cash, with the investors' information stored on the digital ROM.
4. Post-tokenization administration:
During the post-tokenization administration, corporate action management operations such as dividend distribution and shareholder voting, the majority automated via smart contracts embedded in the token, begin. Post-tokenization administration will continue until it matures or is redeemed for the token's existence.
5. The concluding stage:
Secondary trading is when the benefit of tokenization in terms of increased liquidity is realized. At this stage, a token holder may swap their tokens with another investor directly or via an exchange.
Summary
Traditional real estate investing entails substantial financial commitments, extensive procedures, paperwork, and walled information. Tokenization tackles these issues by introducing operational efficiency and more transparency to real estate transactions and the added advantages of fractional ownership and liquidity to real estate investing. Technology adoption can benefit and provide value to all players in the real estate sector.
Fractionalization enables issuers to access a broader investor base with a greater pool of investment capital, while simplified procedures and automation minimize operating expenses throughout the tokenized security's lifespan. In addition, settlement supported by blockchain technology speeds up. It secures the transfer of ownership rights in an asset since an immutable record of ownership is always maintained on the blockchain.
In part two of this article, I will discuss the challenges and opportunities with real estate tokenization and the future of real estate tokenization.
By Edith Lagunas
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