Tokenization advantages for real estate owners

Tokenization can benefit real estate owners, sponsors, and investors alike.

‍These are some of the principal advantages for sponsors and owners:

• Additional capital sources: Tokenization provides exposure for real estate projects to a large number of investors. Many investors might never even hear about a real estate project except if it is tokenized. Real estate tokenization platforms naturally provide additional marketing and raise awareness, improving sponsors’ access to capital
• Efficiency through automation: Smart contracts that underlay real estate tokens can automate compliance with securities regulations, plus automate investor communications, distributions, purchases and sales, tax accounting, and (when appropriate) investor voting. Automation enables real estate sponsors to manage large numbers of investors and provide a strong audit trail for all property activities
• Improved investor liquidity: Tokenization allows sponsors to provide greater liquidity to their investors, which may improve investor returns and allow investors to reallocate capital to the sponsor’s next deal. Sponsors can directly benefit from investors having greater liquidity
• Resolve ownership issues: Tokenizing an asset can be a way for a real estate owner to address thorny issues such as how to dissolve a partnership or divide an estate among heirs. Token-holding owners of real estate can make their own decisions about buying, selling, or exiting. Tokenization doesn’t resolve every property-related conflict, to be sure, but can help with many problems that may arise
• Equity activation: Tokenization opens up many new options for activating and managing the equity in a property. Owners who tokenize their real estate can sell a portion of the equity (potentially with a buyback option), raise temporary funds, obtain debt secured by their tokens (not the real estate), and trade real estate tokens for other tokens. 

Real estate tokenization example

Imagine an apartment building in your favorite city that’s worth $10 million. The building is owned by a company that’s structured as an LLC, with the only purpose of the LLC being to own the apartment building. Ownership of the LLC is tokenized into 1 million tokens, with every token—worth $10—representing one-millionth of the LLC. 

Now imagine that you paid $10 to own one of these real estate tokens. You would own one-millionth of the value of the underlying apartment building. If the property is sold, you would receive one-millionth (0.0001%) of the sale price. When rents from the apartment building are received, you would earn one-millionth of the net cash flow. If the real estate asset depreciated in value, you could claim one-millionth of that depreciation value on your taxes. 

If the apartment building gains value over time, perhaps because of a rental price increase, the token price would rise above $10 commensurately. After a the initial holding period, you could sell or trade that token to other eligible investors.

Real estate tokenization vs. fractional ownership

Blockchain-based tokenization compares favorably to existing methods of fractional ownership. It inherits the best of properties of typical syndications while adding some of the advantages of REITS and crowdfunding. 

• Real estate investment trusts: REITs are publicly available as investment funds but are difficult, expensive, and time consuming for sponsors to create. REIT investors only gain exposure to entire portfolios of real estate, not specific properties. For these reasons, returns from REITs are generally lower than returns from other forms of fractional real estate investing 
• Timeshares: Timeshares are generally only available for small residential properties and have a long history of being a poor investment. They are best suited for vacationers who actually use the property regularly
• Private placements: investing in private real estate deals is usually the best approach for accredited investors. They typically provide the best returns, best property specificity, and overall best investments. However, most private placement deals are, well, private. Private placement real estate offerings aren’t generally accessible to most investors. And they almost always require the investor to commit funds for the long term (3-10 years)
• Crowdfunding: Real estate crowdfunding platforms can also offer attractive investment opportunities. The quality of crowdfunding sites varies widely, with many platforms supporting very limited portfolios of real estate assets. Crowdfunding opportunities also require investing for the long term, just like private placements 

The history of fractionalized real estate ownership has dramatically limited the ability to invest. Until the JOBS Act in 2012 it was illegal to advertise any kind of private placement; now, advertising is allowed in certain circumstances.

It was historically also challenging to manage large numbers of investors – but with the creation of blockchain, automation of compliance, distributions, and communications is well within reach. It is only now that the technological and regulatory environments have evolved so that true fractional ownership is feasible. And only via real estate tokenization.

When these advantages are combined with the ability for liquidity of real estate investments, real estate tokenization becomes a huge advance for real estate investors and sponsors alike.

Security token offerings vs. non-fungible tokens

Tokenized real estate uses security token offerings (STOs), which are explicitly securities in accordance with the U.S. Securities and Exchange Commission (SEC). Security token offerings are fungible tokens, meaning that one STO for a given real estate property is just like any other for that asset. 

Non-fungible tokens (NFTs) can also digitally represent real estate ownership, but are not the same as STOs. The non-fungibility of NFTs means that every NFT (i.e., every property) has only one owner, and no NFT is exactly the same.

NFTs may or may not be securities in compliance with the SEC and investors should be cautious as NFTs are sometimes also described as tokenized real estate and might be confused with tokenized fractional real estate platforms such as HoneyBricks.

Disadvantages of tokenizing real estate

Tokenization does require sponsors to think about real estate differently.

‍Here are some potential drawbacks for sponsors of tokenized real estate:

• Reduced control through automation: Tokenization automates many processes, which may be disconcerting for sponsors who prefer total privacy and control 
• Less investor loyalty: With investors more easily able to swap tokens, sponsors may worry about losing a stable investor base. But good sponsors can still maintain a relationship with investors and their track record may attract even more capital. There are also mechanisms for rewarding loyal investors (early purchase, for example) that support sponsors’ ability to create and grow their own investor base
• More investors to manage: Some sponsors may be daunted by managing larger numbers of investors, which requires different approaches to communication. Sponsors can leverage the support of a tokenization platform to maintain investor communications at scale 
• Need for stricter privacy controls: Sponsors need to define and maintain strict controls over what information is released to investors and the secondary market. Primary investors require detailed information, which may not be appropriate for a larger audience. A good tokenization platform can facilitate and automate these controls to help sponsors strike the right balance between privacy and transparency.