Tokenization of the Real Estate Market

This week’s article focuses on the Real Estate Market and innovation idea of combining it with Blockchain technology. Real Estate Market is considered to be one of many sources of investments, but it is still believed to be an inefficient and non-liquid market. In this article, we attempted to describe the main drawbacks of the Real Estate Market as a source for investments and show how modern technologies as Blockchain could dramatically affect the situation and investment decisions. 

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Drawbacks of Real Estate Market

To begin with, we have started to analyse why exactly some investors have doubts about investing in the Real Estate Market.

 Firstly, let us draw your attention that the average price in Europe of residential property in EU-28 as of September 2019 is in the range from 1,633€ (Bulgaria) to 21,179€ (United Kingdom) per square meter. So, for example, if one wants to buy a 45 m2 apartment in Italy (where the average price is 6,589 €/m2)he should have 296,505 €. Giving these numbers, we can clearly state that this market is closed to the average investor.  Consequently, the average investor would rather invest in the equity market.

Another concern of investors would be the lack of data. Compared to the equity market where we can talk about high-frequency data, where there are many agencies/experts who provide their statics and opinion on any particular investments you consider, of course, the real estate market would seem insufficient and not-transparent. If we talk about the real estate market, there is no such word as an exchange and no global database with all available options to invest. 

As a matter of fact, investors are also concerned with timing. All of us have a smartphone in the hands can buy shares within seconds. Meanwhile, the real estate market is lacking transparency in this matter. Generally speaking, all involved actors (investor, owner, tenant and etc) need to perform several actions which are linked to each other and couldn’t be done automatically or at the same time.

 Here comes another issue, usually the actors encounter each other only once and therefore there must be no trust between them. Having this in mind we should also mention the great number of scums in the real estate market which again puts in not in favour of investors.

 

Tokenization of Real Estate Market

How does it work?

Tokenization is a process of splitting an asset into parts (tokens), while each token represents the value of the share of the asset. The owners of the property can create as many tokens as they want. Here, of course, knowing the real price of the property the price of each token will vary. It is as we say that cutting a cake in 10 or 50 pieces would create a different price for each piece. Now, let us walk you through the process of tokenization on the real estate market. Once the owner of the property has decided to tokenize it, the first thing would be to create tokens (security tokens in fact) and sell them to the investors. This process is called STO (Security Token Offering).

A security token is an investment contract written on the underlying asset. So in the case of STO, all the security tokens are linked to a real tangible asset. Advantage of STO over ICO (Initial Coin Offering) is that investing in STO the person also gets ownership on the share of the asset. Compared to ICO it reduces the risk of fraud and illegal activity (in case of STO each individual is obliged to be identified). After completing the STO, the tokens should be listed on the exchange so that the participants can trade it. For the particular exchange to be valid, it should compile with certain regulations. It is worth to mention that once the token is created, nothing prevents it from being traded on different exchanges.

Advantages of Tokenization

The tokens can be traded in secondary markets which will bring more liquidity to the real estate market. Everyone can buy or sell these tokens as a fraction of the ownership, this lowers the investment entry-level and will bring a larger number of investors into real estate. With the use of blockchain, the transactions are completed with digital contracts that are automatized so the transactions are cheaper and faster. Additionally, tokenizations allow investors to have a digital history of the transactions that allow them to prove ownership and makes impossible for someone to falsify transactions or try to sell the tokens more than once.

Room for improvement

Any token needs to be approved by the regulators. This is reducing the risk for the investors, but, on the other hand, it makes the procedure more complicated. In addition, all existing STOs are now registered under D exemption by a Securities and Exchange Commission (SEC) [1]. That means that if one wishes to invest in STO he should have a special authorization to do so, which creates a barrier for the pull of investors. Another important issue with tokenization of real estate is a lack of exchanges offering security token trading. This situation could be mainly explained by two factors. Firstly, it was estimated that 4/5 ICOs in 2017 were scams. Reasonably, investors are concerns about the security of STO and for now, are reluctant to make massive investments. Secondly, there is a number of countries where STO is banned (an example would be China). 

 As you can see, the tokenization of the Real Estate Market has a lot to offer. And though this method has a number of drawbacks, there is a chance that in the nearest future it will revolutionize the Real Estate Market and transform it beyond recognition

Stay tuned for other articles from The Finance Association of EPFL! Don’t hesitate to send us any suggestions at tfa@epfl.ch or on our Facebook and Instagram pages.

Anna Valiullina

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[1] Regulation D (Reg D) is a Securities and Exchange Commission (SEC) regulation governing private placement exemptions. Usually used by smaller companies, the regulation allows capital to be raised through the sale of equity or debt securities without the need to register those securities with the SEC. //Source: https://www.investopedia.com/terms/r/regulationd.asp

 

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