Author : Vlad Estoup
Blockchain technology is revolutionizing the way people keep records and transfer value. Distributed ledgers provide accurate, immutable record-keeping capabilities, as well as the ability to seamlessly transfer assets without counter-party risk. In this piece, we explore the current state of the tokenized real estate market, and how to successfully issue real estate-backed digital securities.
To date, over $250 million worth of real estate has been tokenized. About 74% of these deals took place in the United States, and almost 80% were issued on the Ethereum blockchain as ERC-20 tokens. Aspencoin alone — the world’s largest real estate digital security — represents over 10% of the entire digitized real estate market.
Most offerings of tokenized real estate consist of equity (about 63%) — meaning the investor is a legitimate owner of the property they are investing in. They can receive dividends based on the cash flow of the property, which are often paid through the blockchain.
The rest of the market is broken down equally into three main categories: debt, investment funds and revenue sharing.
Debt offerings are like typical fixed-income instruments, allowing issuers to borrow capital at a predetermined interest rate. This means that unless the issuer defaults on their debt, investors are guaranteed a certain return until they decide to liquidate their investment.
Investment funds are usually composed of a diversified portfolio of real estate properties. In certain cases, the properties are related to each other. For example, certain funds focus on renovating distressed properties (providing investors with capital appreciation opportunities), while others focus on renting out multi-family properties (offering investors a fixed monthly dividend). Depending on the risk-appetite of the buyer, investment funds can provide a more diversified approach to real estate investing.
Revenue sharing structures are a way for issuers to offer investors a fraction of a property’s cash flow. This means the issuer is in full control of the property’s management and costs, but the property’s net income gets distributed amongst tokenholders. Under this structure, issuers do not share capital appreciation with their investors.
Below is a breakdown of the different types of securities in the real estate digital securities market vs the digital securities market as a whole:
Source: Atlas One Research
We can see that equity is by far the most dominant security type — both in real estate and in the entire market.
Revenue sharing, on the other hand, is seen more than twice as often in the tokenized real estate market than in the digital securities market as a whole. This is largely due to issuers’ willingness to distribute the cash flow from their properties while reaping the benefits of capital appreciation.
But what is the key to a successful tokenized real estate offering?
Four-Step Distribution Life-Cycle
To gain a better understanding of how real estate tokenization works, and how to do it successfully, we have broken down this process into four major steps:
1. Deal Identification
Sourcing a quality deal is often the most important step. The real challenge with tokenizing real estate lies in finding an issuer that would benefit from the value proposition of digital securities.
With RE digital security offerings, the ideal candidate is usually a property that needs an immediate cash injection in order to finance its operations, or an investor/sponsor looking to create liquidity to use for for other projects. They would also be looking to raise capital from a wide pool of investors (as opposed to a concentrated few). In this setting, digital securities can be valuable because of their increased transferability, higher liquidity and low intermediary costs (compared to private placements and public REITs). More information about the benefits of digital security offerings versus traditional investment vehicles can be found here.
2. Smart Contract Creation and Token Issuance
This is the most technical aspect of the digital security distribution lifecycle. First, stakeholders must decide which blockchain to issue tokens on. This can be a complex process, but most are currently using the Ethereum blockchain. The main element to consider when selecting a blockchain is the ability to tailor smart contracts to the issuer’s needs. The issuer must be able to easily issue dividends, whitelist investors in a scalable fashion and transfer tokens to and between approved wallets.
Some issuers, such as REITBZ, have successfully issued digital securities on the Tezos blockchain. The main difference between the two is that Ethereum was originally developed with a proof-of-work mechanism, while Tezos was built with proof-of-stake in mind from the ground up. The jury is still out as to which is better.
Which blockchain is right for whom will depend on the issuers’ specific needs (such as secondary trading on decentralized exchanges), but also on their appetite for adopting new disruptive technologies. Many market players, like Atlas One, try to be agnostic and build that ability to manage multiple blockchains to enable issuers to switch at a later date if issuer needs change.
Once that is decided, however, issuers must find the most efficient way to fractionalize their capital structure. Some issuers create many more tokens than shares (for example 1 token could represent 10 shares of the property), while some will choose to go with a 1-to-1 structure where 1 token represents 1 share. Combined with minimum investment requirements, this aspect controls how sparsely distributed the digital security will be in the future.
Finally, the smart contract can (and generally does) include a Know-Your-Client element. Some protocols, such as ERC-1400, ensure that only whitelisted wallets can receive the digital securities, which streamlines and facilitates the investor accreditation process.
3. Marketing & Distribution
This is arguably the most important aspect of the tokenization lifecycle. How an issuer decides to market their offering will determine both the amount of capital that flows in, as well as the type of investors that participate.
Creating distribution partnerships is a crucial element of the tokenization process. By partnering with key crowdfunding and broker-dealer platforms, issuers have the ability to reach a larger pool of investors while spreading the message to a large audience. When the digital security is backed by a solid investment property, the issuer’s ability to raise capital is directly proportional to their capacity to reach a wide pool of investors.
It is also important to offer perks in order to attract investors. For example, Aspencoin tokenholders benefit from discounted rates at the hotel. While this may not be possible in certain cases, finding creative ways to offer perks is a great way to ensure investors will be happy to participate in the offering.
4. Post-Transaction Management
After the security is issued and investors are subscribed to the deal, dividend payments are issued on the blockchain. The issuer must decide whether these will be issued in the form of additional tokens or fiat (either through cash or stablecoins).
Creating liquidity post-transaction is also critical. Many funds offer redemption options though there may be redemption fees. Some use decentralized exchanges like Uniswap in order to repurchase their investors’ tokens, while others choose to do so directly through their platforms.
Token issuance platforms increasingly need to provide dividend, redemption, and liquidity functionality for issuers and investors.
Once the required lockup periods are over, digital securities can be traded freely on secondary markets, as long as there is a whitelisting process taking place in the secondary trading venue. Providing issuers with access to secondary exchanges is a key element in ensuring the offering’s success. The total yearly volume on these secondary markets is about $25 million — small but growing.
While the real estate tokenization market is growing, there are some clear leaders in the space. In order to successfully raise capital through a real estate-backed digital security offering, issuers have to be in a strategic position to benefit from the technology.
Furthermore, selecting the right blockchain and token structure is key to ensuring the issuer has control over the distribution of their offering. Once this is decided, the marketing and distribution process determines how much traction a digital security offering will ultimately receive.
With a sound distribution strategy in place, both issuers and investors are set to benefit from the numerous advantages of digital securities.
Disclaimer: The information provided on Atlas One’s research, social media channels, website, webinars, blog, emails and accompanying material (collectively, the “Information”) is for informational purposes only. It does not constitute or form any part of any offer or invitation or other solicitation or recommendation to purchase any securities. The Information should not be considered financial or professional advice. You should consult with a professional to determine what may be best for your individual needs. The Information is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it does Atlas One assume any liability. Atlas One assumes no obligation to update the information or advise on further developments relating to these areas.