This is the second article in a special Forkast series, Real Estate Tokenization: Ownership Realized. Learn more about this series here.
As the aftershocks of the FTX cryptocurrency exchange collapse continue to rock the digital asset industry, some familiar accusations about the sector have been quick to resurface.
New York Congressman Ritchie Torres told the U.S. House of Representatives this week that the crypto tokens issued by FTX were “not very different from Monopoly money.”
Last week, JPMorgan & Chase Chief Executive Jamie Dimon, a long-standing and high-profile crypto-skeptic, said cryptocurrencies were as valuable as “pet rocks.”
So far, so familiar. Digital assets have long attracted criticism over their supposed lack of real-world asset backing. What, then, to make of digital assets backed by arguably the most real-world asset class of all — real estate?
Real estate, according to conventional wisdom, is one of the surest bets in the investment universe. It’s also one of the most difficult investments to make, requiring all sorts of legal and administrative procedures, large capital commitments, and long time horizons due to its lack of liquidity.
Tokenization, which is increasingly used to enable fractionalized ownership of everything from sports teams to artworks using blockchain technology, seeks to change all that.
Access and asset choices
“Tokenization of real estate makes property investment very accessible to everybody, and the entry barriers are super-low,” Lawrence Peh, an independent director at Hong Leong Bank Vietnam and an adviser to the board at Hoa Binh Construction Group, told Forkast.
“You can be very specific in the property that you want to invest in, and the liquidity and trading are 24/7 — those are very obvious benefits over traditional real estate investing. And you also reduce a lot of intermediary costs,” he said, referring to the fees charged by lawyers, brokers and real estate agents for traditional property transactions.
See related article: DeFi’s real estate revolution: The rise of tokenization
The idea of fractionalized ownership of real estate is not a new one. Real estate investment trust (REIT) structures, which allow investors to buy shares in their operators’ real estate portfolios and to trade them like stock, have been around since 1960, and have brought liquidity to the inherently illiquid property sector. Tokenizing real estate takes the REIT model several steps further.
“REITs are not easily accessible to all investors globally without an exchange or a brokerage account, but blockchains are universal, which makes tokenized real estate accessible to all,” Christine Li, head of research for Asia-Pacific at international real estate agency and management company Knight Frank, told Forkast. “In addition, REIT and property fund investors typically invest in a portfolio, where the quality of the assets may vary. Real estate tokens, on the other hand, allow investing in more specific assets with a small quantum.”
Peh also emphasized the flexibility of tokenized real estate compared to REITs, saying: “REITs are very controlled. They’re controlled by brokerages, they have to be underwritten by particular companies, and they have to set up a portfolio. If you buy into a REIT, you buy into the portfolio — the good, the bad, the ugly, whatever the REIT puts into it.
“But if I have a very specific idea of my own. For example, if I only want to invest in office buildings and I like a particular office building in London that’s put on-chain, or something in Vietnam, with which I’m familiar — I can buy in. Real estate is a very personalized thing. Everybody has an opinion and everybody knows what they want.”
The liquidity that tokenizing real estate unlocks in the sector can benefit both investors and the owners of property assets by offering the former an expanded range of investment opportunities, and the latter access to a larger pool of potential purchasers, many of whom may have been previously unable to participate in the property market due to its capital requirements and other entry barriers.
“The potential market is huge,” Li said. “Even very senior real estate investors can probably buy only 10 different properties in their lifetimes, but with tokenization, investors can easily do that without having to cough up a huge sum. If there are 100 investors, they each might pay 1% of the total value of the real estate. The risk can be shared.”
Andy Yiu, head of corporate finance at Hong Kong-headquartered investment holding company BOA Financial Group and a cofounding vice president of the non-profit PropTech Institute, said: “Tokenization’s value proposition to landlords is to generate appeal for your properties among a new group of buyers. It helps asset owners to reach a group of investors that they had no way of approaching before.”
Xian Yang Wong, head of research for Singapore at global real estate services firm Cushman & Wakefield, said that in addition to allowing landlords to tap a larger pool of investors, tokenization also offered flexibility that was lacking in traditional real estate.
“It offers property owners an alternative route to raise funds, especially smaller quantum asset owners that may wish to raise capital via a divestment of a minority stake in a property while still maintaining control of that property,” he said.
“But the key value propositions of tokenization are better cost efficiencies and higher liquidity for real estate, which is traditionally an illiquid asset class,” Wong said. “Higher liquidity can potentially boost asset values.”
All four sources that Forkast interviewed for this story said tokenizing real estate would increase its value, and Yiu identified three factors he said would drive values higher.
“If the assets are more transparent — in the case of tokenization thanks to blockchain technology — the market tends to give them a higher premium. We think that because they’re more transparent, the corporate governance is better and they’re less risky,” he said.
“No. 2 is what we call the liquidity premium. With such a fractionalized financial instrument, the assets are more liquid, and because they’re more liquid, the market tends to price them at a premium compared with very illiquid assets such as antiques or other exotic assets.”
“No. 3 is active value creation,” Yiu said. “People nowadays love talking about environmental, social and governance (ESG) investing, and tokenization can potentially help allow ESG factors to be embedded into assets. So, for example, also using blockchain, we could document the supply chain of buildings’ bricks and mortar, and the measurement data on carbon emissions and electricity utilization. Investment managers tend to place a premium on assets with high ESG ratings, so tokenization can create further additional value in this way.”
As real estate tokenization’s potential for investors and landlords becomes clearer, the question arises of how it could affect intermediaries such as property lawyers, brokers and agents, and the extent to which it may emerge as a disruptive development in the industry. These issues will be examined in the last article in this three-part series, due out in January.