One of the industries where tokenization will soon be a game-changer is the real estate industry. By using blockchain, it is possible to tokenize houses, apartments and properties and represent them on the blockchain. This will shake up the real estate market and inevitably change this rather traditional industry. Blockchain has great potential, as it is creating trust and helps to shape a world of transactions without friction. Tokenization will, among other things, solve the problems of liquidity in the commercial real estate sector. It offers numerous forms of application and pioneers in the industry are already leading the way by developing promising projects. In this article, we will take a closer look at how tokenization of real estate works, what the advantages are, and what use cases there are. Tokenization will be a large trend in 2021 as the possibilities of fragmented ownership enables investors to build a risk optimized portfolio. The future is digital and blockchain is now bringing this development to one of the oldest industries. It was about time. — Author: Nicolas Weber
Tokenization and real estate — a perfect match
The concept of tokenization is gaining more attention again and is picking up momentum. Not only since this year the economy has been aware of tokenization and its countless possible use cases. Ideas and projects are being worked on everywhere. One of these use cases is the tokenization of real estate. The underlying technology is blockchain. In simplified terms, a blockchain is a distributed, decentralized database stored on a large number of servers. A one-time update on one server results in the simultaneous update of data on all servers. Transactions on blockchain-based platforms can never be altered or changed. This unalterable storage creates trust among all participants. Everything that has been stored on the blockchain can never be changed or deleted. Tokens can now be linked to these transactions, mostly as digital representations of assets, money, or securities.
The Token Container Model was introduced in 2020 in Liechtenstein and is one of the most innovation-friendly legal frameworks for blockchain. The “Tokenomy” (Token Economy) has been very unregulated up to now and there only have been rather rough legal guidelines, if at all, which hardly provided investors with the necessary security. The TVTG offers the perfect legal framework for the tokenization, administration, and disposition of assets in Liechtenstein. Now tokenization can be fully implemented in the real estate industry.
Tokenization solves many known problems of the industry
Especially during the COVID-19 pandemic, problems of the industry such as the dependence on physical meetings for contract conclusions once more become apparent. Procedural difficulties and inefficiencies are jeopardizing the success of this industry.
Furthermore, a large number of intermediaries (lawyers, brokers, financial institutions, etc.) still causes avoidable friction. In order to establish the necessary trust between these intermediaries and to guarantee compliance a high amount of paperwork is required. These cumbersome circumstances lead to increased costs and time expenditure. If real estate is tokenized, however, intermediaries become obsolete, as the blockchain relies on the “peer to peer” principle (person to person transaction). Blockchain technology, therefore, creates trust between two contractual partners and guarantees safe processing through its technical basis. It increases transparency and automation while enabling the international transfer of the tokens (shares of real estate) in seconds.
Real estate in itself is not mobile and sales/acquisition processes are very complex. In addition, unforeseeable events, such as construction errors and natural disasters, can have a negative impact on liquidity. Although blockchain cannot counteract physical risks, it does make it possible to design solution processes efficiently and cost-effectively. This significantly increases liquidity and mitigates the negative impact. Above all, however, an enormous liquidity boost is generated by the possibility of fragmenting real estate investments through tokenization, i.e. offering smaller shares effectively and at any desired price and the associated “partial tokenization”. This allows to effectively use the intangible assets of the property by selling certain shares. Until now, this has not been possible, which transforms the static process of selling into a dynamic one and offers owners much more flexibility.
This grants investors the opportunity to diversify their portfolios. For institutional investors as well as for retail investors. An example of how tokenization could be applied could look like this: Normally you have to pay rent or buy a property completely. With tokenization a mixture of these two options is possible. You could own 60% of the property and tokenize 40%. This 40% can be offered on a secondary market and can work as a mortgage. For this, you will not need a financial service provider or a bank. Necessary capital can thus be obtained at any time through assets that are already owned and not yet fungible. In general, it can be said that smart contracts make the entire investment process faster and safer. Without the need for a middleman, these processes can take place in a matter of seconds, again saving time and money.
Potential of tokenized real estate
Equipped with register features, real estate tokens can map the corresponding ownership and liquidity relationships in the digital world. This enables efficient and above all daily liquidity management of real estate. It is possible to have the entire spectrum of properties converted into digital assets by means of a blockchain (i.e. without a deed or analog land register entry). Another option is payments to the owners, which are mapped in this way. The alimentation of real estate is a suitable instrument for asset managers to create liquidity efficiently and cost-effectively. In addition, a door is now opening for institutional investors to previously tied-up capital.
The new model reduces direct and indirect marginal costs due to the tradability of part-ownership and the increased liquidity of the asset itself. In addition, the land transfer tax is avoided, as it was previously significantly reduced by high liquidity premiums. This makes it possible to liquidate properties efficiently without deducting costs. It is now possible to trade actively on the secondary market without liquidity discounts. This offers simple and cost-saving possibilities to invest in real estate at any time. Location or friction costs caused by superfluous intermediaries would also not play a role. Furthermore, it also offers an adjusted user interface for asset managers and their institutional investors. This gives investors and financial institutions access to traditional and completely new asset classes (e.g. equity tokens). Compliance and technical security are guaranteed. The important activity of safekeeping includes the storage of private keys, which are necessary for the transmission, storage and, above all, secure safekeeping of tokens. Here, startups such as Amazing Blocks offer a secure, customer-oriented alternative to existing systems.
The decentralized concept of blockchain enables property owners and investors to come together without the involvement of an intermediary. Although notaries are still needed for the process, the new legislation in Liechtenstein offers a very efficient way in this respect as well. One can either tokenize the real estate itself as an AG in Liechtenstein and then trade and sell the shares, which will then be in the form of tokens. Or one proceeds via a holding structure in such a way that one tokenizes his company which owns the real estate and then trades the tokenized shares. The first solution implies that the individual property itself has the status of a legal entity of which one then holds shares. The second option is particularly suitable in the case when you want to tokenize a larger real estate portfolio.
This affects the purchase and sale of real estate since the costs of e.g. legal structuring and brokerage fees account for a considerable proportion of the total transaction sum. Especially in the case of partial sales, this is the basic requirement for their realization on a wide scale.
Tokenization of real estate with Amazing Blocks
Amazing Blocks was founded in August 2020 in Liechtenstein and offers business consulting and software development. According to the Liechtenstein Token Act various assets can be tokenized, such as real estate. In order to do so, one has to establish a legal entity in Liechtenstein. This is essential for the tokenization of real estate, as the real estate must be transferred to the newly founded umbrella in order to create a digital identity for the property. An alternative would be to transfer the real estate to an already existing AG in Liechtenstein, which in turn would carry out the tokenization process. Here it should again be noted that this can save costs compared with the traditional processes. In the event of legal hurdles or any questions or problems that may arise, Amazing Blocks has partnerships with renowned law firms in Liechtenstein such as Annerton and Nägele. The company will always remain the owner of Its token unless it is sold of course. The shareholder accordingly owns part of the company, which is why the company can also encumber and sell the property. The board of directors of the AG decides by statute whether it wants to grant the shareholders owner-like rights or whether partial tokenization should take place. For example, the sale can be determined by digital shareholder resolution. This would be similar to a German AG, but it is much more expensive to maintain. Furthermore, shares or real estate cannot be tokenized here.
The simple concept of tokenization, converting rights to an asset into a digital token will have a significant effect on the real estate industry. Enabling the trading of digital assets, including tokenized shares of real estate, on secondary markets, blockchain technology will fundamentally change the way of financing and processing in this sector. It is time that the real estate industry gets ready for Web 3.0 and starts to truly participate in the digital transformation. Aspects of the tokenization such as the fragmentation of ownership will be of great value to institutional as well as retail investors. With tokenization a true diversification of portfolios is achievable. If investors can mitigate their risks better by not having to buy 100% of one asset and instead can now partially participate, we will witness an increase in capital inflow. For retail investors, this development will provide a much bigger number of opportunities to invest, even with small amounts of capital. The minimum investment size will be smaller. Tokenization will reduce the high barriers to entry and contribute to changing an industry plagued by high entry barriers and a lack of liquidity. In some way, tokenization will by opening this illiquid market, help to democratize this sector, while at the same time allowing new great amounts of capital to enter it. Another important aspect is that the underlying blockchain technology will enable to trade tokenized assets every day, 24/7, increasing the liquidity as well.
If we look at the transaction volume of the real estate investment market in Germany in the years 2004 to 2020, we see a rapid, relatively even (except of course for the crash around 2008) increase from 21 billion euros to 80 billion euros. This perfectly underlines the importance and positive future prospects of this industry. It is now much easier to participate in this growth through tokenization via software providers such as Amazing Blocks. Above all, the fragmentation of the shares and the partial tokenization that has been made possible are models that were not available before. The real estate sector is finally ready for the disruptive digital age.
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Amazing Blocks offers a tokenization solution that enables its clients to tokenize various assets according to the Liechtenstein Token Act (software-as-a-service). The software covers both the issuance of tokens and investing in tokens. It suits the needs for tokenizing all kinds of assets (e.g. machines, cash flow generating contracts, trademarks, real estate, cars). Imagine that some asset should be tokenized. For this asset various tokens would make sense: Equity tokens, debt tokens, participation rights as tokens, ownership tokens, or any mixture of these tokens. The software of Amazing Blocks helps issuers to handle multiple assets and to issue multiple tokens for these assets. This is possible by integrating blockchain technology with the law (that is, the Liechtenstein Token Act). At the core, there is the “digital legal entity in Liechtenstein” based on “tokenized shares” which allows a very efficient foundation, a very efficient operation of the company and, thus, an efficient and flexible possibility to tokenize assets. This should now make a wide variety of tokenization projects possible, because the costs for tokenization are significantly reduced.
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