This case study practically shows a use case in which tokens are making a market more liquid, accessible and liberate. Specifically, how everybody can access real estate investments with the help of security tokens.
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This case study practically shows a use case in which tokens are making a market more liquid, accessible and liberate. The focus completely lies on the tokenization itself, not on the actual Initial Offering like a STO.
Lisa is a passionate mother of two lovely children aging six and eight years. She wants to enable her children pursuing their dreams and saved 10,000 US-Dollar for each child that they are supposed to be given once they finish high school.
Lisa is not familiar with stocks but has a decent knowledge about properties since she is an architect. After doing some research, Lisa quickly realizes that with 10,000 US-Dollar she will neither be able to buy a property nor is it enough money to finance a property with a loan from the bank. Simply speaking, she is excluded from the whole asset class of real estate The cheapest property she found in her area had a price tag of 160,000 US-Dollar.
Real Estate is an asset class that is well-known and easy to understand for everybody. It is an investment that everybody knows about and the specifics are quite easy to understand: A property such as a house is bought and the owner profits of monthly rental payments. Apart from speculation that this real estate object might increase in value due to external factors.
The issue whatsoever is that the access to real-estate investments is quite limited. Buying a property usually requires a large sum of money that needs to be paid upfront. Other options are loans from the bank and mortgages. In any case, you at least need savings that, calculating with an average salary, would take a couple of months or years for an individual to save. Most probably, the individual would not invest that money into other assets classes while saving for the property payment. Hence, the capital is bound without generating returns – which is, especially during low interest rate times, also a pity for the individual.
Lisa comes up with the idea that she can gather a few friends and buy the property together. Sharing the property with five persons is possible when everybody invests 10,000 US-Dollar. Now Lisa can afford to invest into the chosen property.
What if this market could be made more liquid in order to leverage more capital and earlier invest in real estate as an individual?
She must be able to liquidate her share of the property in order to obtain the cash and give it to her child at a specific point. She also realizes that she would need to sell it to another person and have a meeting with the notary that signs this transaction. This will cost her a lot of money and time and it will be difficult to find an investor for this specific property with the specific share of it.
Breaking this question down, the following requirements would need to be met in order to enable such investments:
- The required minimum amount of invested money needs to be small (low monetary barrier)
- The costs associated with an investment need to be low so that smaller investments are worth to accept (cheap process)
- The effort to keep track of the owners or shareholders of the property shall be associated only with small costs
- The asset shall be flexible and liquid
Lisa heard of so-called tokens, small calculatory units on a Blockchain that represent her share of the property. Everybody who holds one unit of this token has is entitled to receive one portion of the revenues earned with that property. There are exchanges where she can sell those tokens at any time. In order to liquidate her share as soon as her daughter graduates, Lisa decides to buy a token that is or will be listed on a public exchange. People can buy a small fraction there as well and do not have to trust her directly, which makes selling the share a lot easier with the existing liquidity of the exchange.
Can a token make real estate investments more accessible?
Read my book “Assets on Blockchain” – the world’s standard piece for tokenized assets and STOs
Instead of rephrasing the general advantages of tokens as an asset representation, we can now outline the defined requirements with the knowledge obtained.
- The required amount of money to be able to invest needs to be small (low monetary barrier)
By fulfilling step B: having small costs, it is possible to accept smaller investments as well without having a big delusion.
- The costs associated with an investment need to be low so that smaller investments are worth to accept (cheap process)
Implementing a token is a very lightweight process and the token itself is not very complex in terms of the functionality. Once a token is developed, this implementation can be replicated for many different properties.
The more it is standardized and automatized, the more notary costs can be eliminated that would otherwise occur. This make the process fast, lightweight and cheap.
- The effort to keep track of the owners or shareholders of the property shall be associated only with small costs
Instead of managing the list of owners or shareholders manually, a token would replace this ownership management.
Not only can the token be used to manage the ownership, it can also be programmed so that revenues (in this case rental payments) are distributed between the owners. The extent of automation can lead so far that the rental payment only needs to be send to a Smart Contract. This Smart Contract is not just defining the contract specifics but can also execute them. Hence, if the rental payment is collected, the smart contract can distribute it between the shareholders without a need of manual intervention.
- The asset shall be flexible and liquid
Tokens can be divided into fractional units by nature and the issuer can limit the how fractionable an asset it. Having an asset that can be divided into small pieces, both investors and issuers are profiting of a more liberal market:
An investor might buy one percent of a property, enabling him to e.g. invest in real estate starting with an amount as low as 500 US-Dollar.
After the property has been financed and sold to many different investors, they can easier manage their portfolio. While they previously would have needed to sell the complete property or a large portion of it in order to liquidate their assets, they can now sell very small fractions. What has been possible for stocks and financial products or real estate funds is now possible for a single property.
If you hold a portfolio of different real estate properties or an asset manager manages many different assets including real estate, rebalancing the portfolio is a matter of seconds.
After doing further research, Lisa stumbles upon a specific offer in her area. It is the first offering of the company and hence limited to 16 investors. The investment is split up into 16 tokens, hence each token costs 10.000 US-Dollar. Together, all 16 people that do not even need to know each other can fully finance the property with the 160,000 US-Dollar of costs.
Lisa decides to buy a share. Finally, she is able to invest a sum of 10,000 solely into one, self-selected property in her area.
Is the tokenization of real estate already possible?
Some people might argue that investing into real estate with smaller amounts of money or sharing a property with different investors is already possible. Indeed, both of it is possible, however to a very different extent.
Sharing a property could for example be done by having a company as a vehicle in between that hold the properties. For example, you would have an own company that fully owns a specific building. Now, the investors own shares of the company. Any revenues made with the property would apparently flow into the company which then distributes it between the shareholders. Hence, ownership of a property with other investors is possible, however a very complicated process. Usually, a notary has to be included whenever a transaction is made. This also makes it almost impossible to have many different stakeholders involved at a reasonable cost level. These companies are called Special Purpose Vehicles (SPV).
Crowdfunding for properties does exist, however buying very small fractions is usually not possible and a secondary market liquidity is not given.
Indeed, buying portions of real estate or crowdfunding properties is possible, but at a very basic level.
What are the challenges of tokenizing real estate?
In order to represent the ownership of real estate with a token, a specific Regulationwould significantly enhance the process. When a SPV is needed that can then be tokenized, the intermediary element makes the process a bit more costly. As soon as real estate can directly be tokenized, efficiency gains can be realized drastically.
Lisa just leaves her own house in the morning and gets to know about a pipe break in the neighbor’s house – the property she invested in and bought the token of. In the investors group, she sees that people are already discussing the issue – nevertheless, none of the 500 investors of the property actually feels responsible to fix it or get it fixed by a specialist. Lisa decides to call the specialist and pay him out of her pocket.
Apart from Regulation, the internal Governanceis a challenge to be solved. There must be a responsible party that is responsible for daily operations and the maintenance of properties. Practically speaking, someone has to roll up his sleeves to fix the water pipe quickly when problems occur. In a company, the CEO has the responsibility. It has to be defined how the responsible persons for property maintenance can be selected and if voting rights shall be attached to the tokens.
Paying the bill for the water pipe fixing specialist was frustrating for Lisa since she cannot easily get the money back in portions from 500 different investors. Doing some research, she now gets to know about another company that offers a new, different token type for real estate with voting rights: A clear role structure is defined in terms of who has which responsibilities and just leaves her own house without having further responsibilities.
Summary: Tokenizing real estate
Tokenizing real estate is technically possible in an easy way for a single property. What is expected to be built within the next months and years is the infrastructure to tokenize real estate objects with a few clicks that allows to attach it to the legal documents – as well as Regulations keeping up and establishing a solid framework for tokenized real estate.
This was an excerpt of my book ASSETS ON BLOCKCHAIN. If you want to learn more about how tokenization works, how security token offerings are conducted and what Regulators worldwide think of tokenized securities, make sure to get your copy:
