In recent years, real estate tokenization has emerged as an unconventional investment vehicle with advantages for both issuers and investors. The real estate sector now makes up about 40% of the digital securities market, amounting to approximately $200 million, as reported by Canadian-based digital securities company, Atlas One.
Real estate tokenization converts the value of real estate into a token stored on a blockchain, enabling digital ownership and transfer. These divisible tokens each present a fractional share of ownership stake in that real estate. This article explores the emerging trend of real estate tokenization, as well as its primary benefits and the potential for it to revolutionize the real estate investment market.
Real estate tokenization is the process of fractionalizing real property into tokens stored on a decentralized database. This decentralized database stores information like a digital ledger and is commonly referred to as blockchain. The distributed ledgers on which real estate tokens are captured are validated by the blockchain network, synchronized and shared with all network participants almost instantaneously, permanently recording an accurate ledger of transactions generally accessible to the public.
Real estate tokens are similar to non-fungible tokens (NFTs), which are non-interchangeable units of data stored on a blockchain that can be sold and traded, with the exception that real estate tokens are generally tied to the value of a physical asset. A real estate token can represent, among other things:
Real estate tokens can also be differentiated from real estate investment trusts (REITs) since they allow for a specific investment linked to a particular real property, whereas REITs typically facilitate investment into pools of various real estate assets.
The digital tokens are created and issued on a blockchain during a security token offering (STO), also referred to as a tokenized security offering or a tokenized asset offering. Each fraction of ownership is converted into a token and then encrypted to grant ownership. Ownership can then be transferred directly from investor to investor on digital securities marketplaces using alternative trading systems (ATSs) almost instantly for a relatively low fee.
One of the first successful commercial real estate STOs raised approximately US$18 million in 2018 through the issuance of Aspen Coins, where digital tokens represented fractional ownership of the luxury St. Regis Aspen Resort in Colorado, USA.
There are a number of other examples, such as a project in the United States that is aiming to raise US$100 million by offering 100 million tokens at US$1 each for a 24-story, 374 unit multifamily residential project in downtown San Jose, which is being developed by Alterra Worldwide.
By facilitating investment in fractional portions of real property, real estate tokenization enables small-scale investor participation and lowers barriers to entry for retail investors. Lower minimums and smaller investment amounts can thus be leveraged to benefit from the potential high returns available to traditional real estate investments – which typically require significantly more upfront capital.
Real estate tokens are easily and securely transferable by way of blockchain technology, allowing investors to diversify their portfolios, minimize risk and create liquidity in the real estate market. Conversely, issuers are provided access to a wider pool of investors.
Through automated processes and a permanent unchangeable digital ledger, blockchain technology has the potential to streamline investment transactions and lower transaction costs. As a result, investment transactions are generally completed faster and at a lower cost to the parties involved, facilitating higher returns for the investor. Tokenization also provides a host of other benefits, such as real time capitalization table tracking, improved accessibility and greater transparency for potential investors.
Generally, the tokenization of real estate will be considered a security but an analysis on each specific token should be considered at the outset. If the token is a security, the issuance of such a token will be subject to the applicable prospectus requirements or reliance on an exemption, such as the “accredited investor” exemption.
In addition to the prospectus requirements, the issuer must consider the applicable registration requirements.
Real estate tokenization requires reconciling the applicable transaction with the current systems of land registration.
As each jurisdiction in Canada has its own land registration system, an issuer of a real estate token will be required to reconcile the transaction with the land registration systems of the jurisdictions where the underlying real estate is located.
Tokenization provides a convenient and economical method of investing in real estate assets, but as a relatively new investment vehicle, regulators have yet to establish a consistent framework of rules that govern real estate tokenization.
The nature of the asset being tokenized impacts which regulatory frameworks will apply. Generally, as securities, tokens are subject to securities laws in Canada. Further, market confusion and knowledge gaps present challenges that must be overcome before real estate tokenization can be widely adopted.
Real estate tokenization has the potential to transform real estate investment by increasing liquidity in a largely illiquid asset class, lowering barriers to entry for retail investors and reducing transaction costs, but issues such as clear market regulation, reconciliation with land titles registries and the need for centralized reporting of transactions currently present issues for market participants.
Investors and real property owners interested in capitalizing on the trend of real estate tokenization should seek advice from experts including, legal, financial and real estate professionals.
We wish to thank Cindy Qi, articling student in Toronto, for her assistance with this article.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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