Tokenization: From Brick to Blockchain

The real estate industry is swiftly adopting tokenization, and conventional real estate institutions are working with technology suppliers to investigate the tokenization of loan or equity. Increasing investor access to high-quality real estate assets is anticipated to revitalize real estate investment as more technology-driven real estate initiatives come to fruition.

Investment Revolution: The Innovation of Real Estate Tokenization

In the financial industry, tokenization is experiencing rapid growth, allowing investment through digital tokens backed by physical securities or assets. Blockchain technology is at the core of tokenization, a distributed ledger that secures identical data copies across an authorized stakeholder network.

Tokenization leverages the immutable security features inherent in blockchain technology, facilitating digital fractional ownership with secure transaction records and expeditious settlement procedures. Traditionally, real estate has been characterized by low liquidity due to substantial capital requirements and protracted, costly transaction processes.

Real Estate Investment Trusts (REITs) have proven to outperform other major asset classes over the long term, serving as a more liquid avenue to access the real estate market. Through the process of real estate tokenization, a real estate asset is divided into manageable pieces or tokens. Each of these tokens is represented as a digital token on a blockchain. This innovation facilitates investors to engage in the buying and selling of fractional ownership in real estate assets more seamlessly and profitably than was previously possible.

How Real Estate Tokenization Works?

Tokenization is an act of dividing a real estate property into digital tokens, each representing a portion of the original property. Tokenization makes real estate investing more affordable to a wider variety of potential buyers by dividing pricey properties into smaller, more inexpensive pieces.

The foundation of the procedure is blockchain, which offers a transparent and safe medium for token transfers and storage. Additionally, smart contracts, which are self-executing agreements, define the terms of the transaction and initiate transfers on their own when predetermined criteria are satisfied. By streamlining transactions and removing the need for intermediaries, this mix of technologies improves overall process efficiency.

Lifecycle of a Tokenized Security 

Source: Aranca Research

The lifecycle of a tokenized security can broadly be divided into five stages:

• Deal Structuring: In the initial phase, the crucial factors include shareholder and asset categories, relevant jurisdiction, and applicable legislation. Before securing capital for a new venture, issuers often opt to tokenize previous transactions to enhance liquidity for existing investors.
• Digitization: Information traditionally in paper form is uploaded to the blockchain and encoded into smart contracts to issue security tokens.
• Investor Management: In the primary distribution phase, tokens are allocated to investors in exchange for capital, and investor details are recorded digitally.
• Corporate Action Management: Post-tokenization involves managing corporate actions like dividends and shareholder voting, which can often be automated using token-based smart contracts. This management persists until the token matures or is redeemed.
• Secondary Market Trading: The final stage, enhancing liquidity through tokenization, occurs in secondary trading, where token holders trade on exchanges or over-the-counter with other investors.

Source: Aranca Research

Returns from Real Estate Tokenization

Investing $10 in a real estate token represents a one-millionth share in the underlying apartment building's value. Upon property sale, a proportional one-millionth (0.0001%) of the proceeds would be achieved. Potential earnings from tokenizing real estate can vary substantially and rely on multiple factors such as:

• Rental Income: The revenue from real estate asset tokenization depends on rental income. Discrepancies in investment contracts, dictating the distribution of rental proceeds and property expenses, vary among tokenization platforms. After deducting expenses, token holders receive rental income proportional to their ownership stakes.
• Capital Gains: The ROI resulting from real estate tokenization is contingent upon factors such as jurisdictional regulations and the extent of capital gain tax deductions applicable.
• Dividend Payments: The determination of the profit-sharing payment schedule between the company and its investors constitutes an additional factor for consideration. The pricing per share is established by the board of directors of the real estate company, with variations evident across different companies.
• Platform Fees: The trading or processing fees associated with the real estate tokenization platform significantly influences return on investment. Specifically, RealT retains just 2% of the gross rental income, with the remaining 98% being disbursed to RealToken holders in USDC.
• Financing Costs: The financial arrangements associated with the property, particularly when secured through a mortgage, exert a consequential influence on the investment's net income, with interest rates and loan terms playing pivotal roles in shaping this outcome.

Implication of Real Estate Tokenization

In recent years, blockchain-based tokenized property, whether real or otherwise, has garnered significant attention. Tokenization brings clear benefits, reducing paperwork in property transactions through smart contracts, saving time, effort, and execution costs, while streamlining verification processes for enhanced efficiency.

• Liquidity: Tokenization facilitates the safe exchange of shares among investors, allowing each transaction to be recorded on the digital record of ownership. The imminent globalization of liquidity in tokenized securities arises as regulatory frameworks worldwide increasingly embrace and establish guidelines for the oversight of digital securities exchanges.
• Data Transparency: Blockchain's distributed ledger ensures data immutability and resistance to cyber-attacks. While transaction information remains trackable and visible, blockchain transactions maintain data anonymity through cryptographic hashes.
• Taxation: In traditional real estate transactions, buyers receive a deed and physically inspect the property. In the tokenized realm, caution is crucial due to prevalent scams; investors must verify the token's legitimacy and its underlying real estate asset.
• Tokenized Real Property Different from REITs: REITs were a way to democratize commercial real estate ownership. Tokenization is an extension to what REITs are and inclusive of any real estate, and not just commercial. Through tokenization, each property can be divided into fractional shares, enabling individuals to become fractional owners of any real estate asset. This innovation widens the investor base, fostering a more inclusive and democratic form of ownership.
• Legal Implications: In traditional real estate transactions, a tangible deed verifies property ownership. Conversely, the tokenized realm harbors scams, necessitating vigilant investor scrutiny to ensure tokens authentically represent tangible real estate assets.

Conclusion: The Road Ahead

The real estate market is currently experiencing a significant transformation through the emergence of tokenization. Currently valued at approximately $200 million, real estate tokens constitute nearly 40% of the digital securities market, establishing themselves as an increasingly popular investment avenue. The potential trajectory of tokenized real estate holds promise, with the potential to revolutionize investment practices and trading dynamics in the real estate sector. Enhanced liquidity stands out as a primary benefit of tokenized real estate, as these tokens are transactable on a digital marketplace, enabling investors to seamlessly trade ownership stakes devoid of traditional intermediaries such as real estate agents or banks. This facet not only facilitates easier transactions but also broadens accessibility to real estate investment by allowing investors to acquire smaller ownership shares in a property.

Tokenization of diverse real estate assets is expected to surge in future, encompassing residential and commercial properties, as well as real estate funds and REITs. However, it is imperative to acknowledge the existence of regulatory and legal challenges that necessitate resolution to ensure the execution of tokenization in a compliant and transparent manner.