Analyzing the Cost-Effectiveness of Real Estate Tokenization

Real Estate Tokenization
Real Estate Tokenization

The growing real estate industry which was under the control of a few organizations and influential individuals has democratized itself by being made more open towards investment through tokenization. This has boosted its liquidity. 

What is Tokenization?

It refers to the digitization of physical assets on a secure and transparent distributed ledger based on blockchain technology. It enables the frictionless transaction of money and the exchange of assets. By promoting the concept of fractional ownership, an individual can buy small pieces of property instead of investing in the whole property at one shot. The tokens can also be traded on the leading international secondary markets just like shares on the stock market. This ensures more participation and higher returns. The tokens are supported by smart contracts and the sales will be recorded on the immutable blockchain ledger. Hence, tokenization creates diversification for investors as they can make investments in multiple properties located in different parts of the globe. It promotes more inclusiveness. 

Advantages rendered by Real Estate tokenization

  • Eliminates the role of intermediaries in the system – Different kinds of intermediaries such as brokers, agents, banks, and lawyers are removed from the equation. It enables developers and investors to directly interact on a common platform without any restrictions. Hence, settlement of real estate transactions will take only a few minutes at an affordable cost. 
  • Promotes higher levels of transparency – With no chances for fraud and corruption to take place in the system, blockchain technology adds a great deal of transparency via secure recordkeeping to the entire process of real estate. This is not prevalent in conventional real estate. 
  • Ensures high immutability – All the data and documents will be recorded on the immutable distributed ledger publicly accessible to everyone on the blockchain network. This ensures the healthy transfer of assets, information, and transactions without any chances of tampering. 
  • Facilitates automation – Through self-executing programs in the form of smart contracts, processes such as compliance, document verification, trading, and escrow management can be automated sans human intervention. 
  • Higher liquidity – By increasing the pool of potential investors accessing the real estate sector for undertaking investments, additional liquidity is created through secondary markets. This leads to the assets commanding a premium price in the market and a consequent rise in its value. 

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Limitations of Real Estate tokenization

  • Not all authorities recognize the concept of security tokens uniformly across the world. A clear-cut regulatory structure is needed for optimizing the performance of tokenization. 
  • More licensed platforms are needed to manage the rising number of Security token offerings. Multiple trial and error methods need to be undertaken before developing a fully-functional working model. 
  • Custody solutions and security aspects regarding security tokens need to be worked out. In case the tokens happen to be stolen or hacked, investors will lose a large number of funds without any chances of recovery. 
  • The tax laws regarding cryptocurrencies are not consistent in all countries. Some nations have not recognized the need to tax cryptocurrency. Certain countries impose taxes on crypto-only when it has been converted into fiat. This leads to complexity as each investor would face a different tax structure according to his location. 
  • The prices of security tokens would fluctuate frequently and this will affect the confidence of investors. It also put off those investors who prefer stability and certainty. 

Use cases of tokenization

  • Formation of a Special Purpose vehicle – A special purpose vehicle (SPV) can be formed for all the token holders. Transactions will be validated by trusted third parties such as a public notary or the company registry. Tokens will be issued on the Ethereum blockchain network and a smart contract will contain the terms and conditions regarding the token. The repayment of the principal amount would be done during the expiration of the token. 
  • Issuance of debt instruments – Instruments like corporate bonds or commercial papers can be issued by the firm. There is no need for third-party validation since it is a debt instrument. The tokens will directly represent a share of the debt. It can be used more in on-chain tokenization for single buyers. 
  • Off-chain tokenization – To strongly believe that the issued token to an investor is tied to a real-world asset, it needs to be backed up by appropriate collaterals such as a mortgage or a pledge. With just a contractual promise, there exist a lot of enforceability issues affecting the practical application. This will lead to disputes occurring during the execution of transactions. Hence, there is an urgent need for a proper dispute resolution mechanism. 

The more applications and use-cases that are built on the top of the base protocol layer of a tokenization platform, the more network effects can be realized and a higher amount of value can be derived from participation in the platform.

Obstacles to the growth of Real Estate tokenization

Though it sounds good in theory, it faces a lot of challenges regarding practical implementation. Not many investors currently are aware of the concept of tokenization of an asset. Regulatory hurdles will be involved as a common framework that needs to be adopted regarding the rules of tokenization and custody solutions all over the world. Investors also need to equip themselves with concepts such as fractional ownership before deciding to invest. Market participants have to be comfortable with the use of blockchain technology. It can completely transform the entire real estate sector and move it forward as it promotes transparency, increases liquidity, and facilitates financial inclusion. Many companies such as Deloitte and PwC want to explore the business of property search, due diligence, leasing, and title management by integrating tokenization. Mass adoption by the people will take considerable time.

Summing up

The secondary market where tokens will be traded needs sufficient liquidity. Assets can be tokenized either on-chain or off-chain after satisfying regulatory and security concerns. On-chain tokenization is preferable when assets can be freely transferred without the statutory need of a third party. It will also depend on the jurisdiction where it is taking place. Standardization in the different protocols and better coordination between the various market participants would enable faster adoption of tokenization. Incentives need to be distributed for transitioning into a blockchain-enabled financial market infrastructure.