TABLE OF CONTENTS I. INT RODUCTION 3 II. THE PROBLEM (AND PROOF) 4 A. Real Estate is Highly Illiquid 4 B. Investing In Real Estate Requires Significant Amounts of Upfront Capital 5 C. Real Estate Investment Trusts Are Not the Answer 6 D. Special Purpose Vehicles Are Not the Answer 7 Ill. THE SOLUTION 8 A. Tokenization and Fractionalization of Real Estate Via Blockchain Technology 8 i. What is Blockchain Technology? 8 (a) Blockchain is a Distributed Database 8 (b) Shared Among the Nodes of a Computer Network 9 (c) Simplified Explanation of Blockchain Technology and Its Benefits 9 ii. What is Real Estate Tokenization and Fractionalization? 10 (a) Real Estate Tokenization 10 (b) Real Estate Fractionalization 10 iii. Benefits of Real Estate Tokenization and Fractionalization 10 (a) Lower Barrier to Entry 10 (b) Increased Liquidity 11 B. Challenges to Tokenization 12 i. Lack of Regulatory Clarity 12 IV. PROPOSED REG ULATORY SOLUTION-T OKENS: CONTAINERS FOR RIGHT S 13 A. T he Liechtenstein Approach 13 B. Liechtenstein Application to Tokenized Real Estate in the US 14 C. T he Blocksquare approach 15
Tokenization of Real Estate - and its Potential to Increase
Investment Accessibilitywas produced and published by
T he Tokenizer.
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I. INTRODUCTION Real estate has long been a favored investment
where investors of all levels can participate and
choice for many individuals seeking to diversify
benefit from the advantages of real estate
their portfolio and build long-term wealth.
investment. This white paper will explore the
However, traditional real estate investing often
concept of tokenization of real estate, its potential
requires a large amount of upfront capital and
to increase investment accessibility, and the
involve complex and time-consuming
potential legal implications that come with this
transactions, limiting accessibility for the average
innovative approach to real estate investing.
investor. With the emergence of blockchain technology, real estate investment opportunities are becoming more accessible and streamlined
We would like to thank Blocksquare for
through the process of tokenization.
sponsoring this report
Tokenization, relating to real estate, is the process of representing a fractional ownership interest in a parcel of real estate or some other derivative in which real estate is the underlying asset c1J. Simply put, tokenization allows real estate assets to be divided into digital "tokens," which can then be sold to investors, providing fractional ownership of the asset. The result is a more democratized and liquid real estate market,
1. Josh Morton, Blockchain Holds Potential for Commercial Real Estate, Law360, 1 (2021 ).
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II. THE PROBLEM {AND PROOF)
A. Real Estate is Highly Illiquid
Real estate is the single biggest asset class in
The single biggest negative attribute of real
the world, with the global real estate market
estate investing is illiquidity (4). Unlike stocks and
worth around an estimated $228 trillion c2).
other investment vehicles, real estate
However, just 3% of the global population have
transactions can take months, sometimes even
invested in real estate, while over 80% view real
years to complete, making it difficult for investors
estate as a good investment (3).
to quickly access their capital. This lack of liquidity can be a significant issue for investors
So, we have the largest source of wealth in the
who need access to cash quickly, such as in the
world, with a miniscule portion of the population
case of an unexpected financial emergency or
able to access it. Why might this be? The
new investment opportunity.
problem with real estate investing as it is today boils down to essentially two problems: (I) real
The average time to close on a real estate
estate is highly illiquid; and, as a direct result of
transaction is roughly 30-45 days from the date of
real estate's illiquid nature, (11) real estate
acceptance of an offer to the day the new owner
investing requires a significant amount of upfront
receives the keys cs). Of course, this number can
capital.
vary greatly depending on a number of factors such as location, market conditions, and property type. Regardless, when compared to the ease and efficiency of which users can buy and sell shares of companies on the stock market, the real estate transaction process is lengthy and complex, involves multiple parties and rigorous legal requirements. All of which make it challenging for investors to liquidate their assets easily, efficiently, and cheaply, further limiting their ability to take advantage of new investment opportunities or respond to changing market conditions. 2. Id. 3. Id.
4. Max Dilendorf, Rika Khurdayan, and Gleb Zaslavsky, Tokenization of
Real Estate: What, Why, and How, Dilendorf Law Firm, 2, (Sept. 1, 2020). 5. What is the Average T ime to Sell a House?, ZILLOW, (Mar. 13, 2023), https://www.zillow.com/sellers-guide/average-time-to-sell-a-house/.
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B. Investing In Real Estate Requires Significant Amounts of Upfront Capital
Clearly, the average US investor is going to have a tough time coming up with all that cash for an investment property, while likely still paying the mortgage on the home they live in. This is no easy task, and the proof is reflected in the numbers. As mentioned before, just 3% of the global population have invested in real estate.
Another challenge with traditional real estate
However, real estate has nearly always been
investing is the significant amount of upfront
considered a relatively safe investment, and for
capital required to purchase an investment
good reason.
property. For example, in the United States ("US"), to qualify for a mortgage for a one-unit
Going back just five years to April of 2018, the
investment property, most lenders require at
average home price in the US was $212,313(9).
least a 15% down payment with a 680-credit
Using the above-mentioned average home price
score csJ.
in April of 2023 of $327,514, that's an appreciation of roughly $115,000, or an increase
To get an idea of what kind of cash we are really
in home value of approximately 54.2%. Compare
talking about, consider the average home value
that number to the 5-year average return on the
in the US, $327,514 (7). At this price, an investor
US Stock Market from 2017 - 2021 of 17 .04% c10J.
would need to come up with a minimum of
Take that, Warren Buffet!
$49,127 for a down payment. In addition to the down payment cost, there are many other
Sadly though, 97% of the population does not get
significant costs associated with purchasing a
to enjoy these returns since they are essentially
property. Consider the following, non-exhaustive list of some of the closing costs associated with buying a property cs>:
locked out of the real estate investment market due to the significant
- Loan origination or broker fee (0-1% of loan amount); - Processing or Underwriting Fee ($300 - $900 each); - Title search fee and Title insurance ($300 $2,500+);
- Home appraisal fee ($500 - $1,000+); - Prepaid taxes and insurance ($1,000 $4,500+);
- County recording fees ($20 - $250);
6. Victoria Araj, Buying an Investment Property. 3 Signs You're Ready and What You Need to Know, Rocket Mortgage, (Mar. 31, 2023). 7.United States Home Values, Zillow Home Value Index, Zillow, (2023). 8. Gina Freeman, Average Closing Costs in 2023: Complete List of Closing Costs, THE MORTGAGE REPORTS (Oct. 17, 2022), https://themortgagereports.com/35800/guide-to-mortgage-closing-co sts-what-average-mortgage-costs-are-and-how-to-keep-yours-low#aver age 9. United States Home Values, Zillow Home Value Index, Zillow, (2023). 1 0. Rebecca Lake, What is the Average Stock Market Return?, SOFI FINANCE, INC. (Mar. l 3, 2023), https://www.sofi.com/learn/content/average-stock-market-return/.
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Compared to REITs or SPVs, tokenized real
Overall, tokenization and fractionalization offer a
estate would offer investors more direct
more efficient and accessible way for investors to
ownership and control over their investments.
participate in the real estate market, while also
Investors can buy and sell their "shares" in the
increasing the liquidity and potentially the value of
property without having to rely on a third party or
the underlying real estate assets. By increasing
middleman, such as a REIT manager. This can
liquidity and providing greater transparency and
reduce the fees and expenses associated with
control to investors, these innovative technologies
REITs and other real estate investment vehicles,
can help create a more equitable and sustainable
while also providing greater transparency and
real estate market for all stakeholders involved.
control to the investor.
B. Challenges to Tokenization iv. Lack of Regulatory Clarity
Despite the many potential benefits of real
estate tokenization and fractionalization,
there are still plenty of persisting issues that hinder the growth and adoption of these
technologies. One major issue is the lack of
regulatory clarity surrounding tokenized
assets. Security regulations vary significantly
from jurisdiction to jurisdiction and may
potentially apply to not only the creation and offering of the tokens, but also to the trading
of the tokens on secondary markets (5oJ. It is
still unclear how tokenized assets will be
treated under existing law. The SEC
considers most, but not all tokens to be
securities, while the Commodity Futures
Trading Commission (the "CFTC") considers
some tokens to be commodities (51).
Generally, tokenized real estate will likely be
considered a security (52). However, a
case-by-case analysis of each specific token
should be considered (53). What this means is
that the issuance of tokenized real estate will be subject to SEC registration and reporting
requirements. Issuers of real estate tokens who do not wish to register with the SEC must rely on one
of the several available exemptions, including
Regulation CF, Regulation D, Regulation S, and
Regulation A+ (54). Each regulation imposes different
requirement on the offering, limiting who can invest, the limits on amounts to be raised, and the
restrictions on the resale of the tokens (55). However, as previously mentioned, the uniform
status of tokens, including tokenized real estate, is
unclear. Whether they are securities, commodities,
or some other type of investment instrument is not
yet fully defined, leading to legal uncertainty and
potential compliance risks for investors and issuers
alike, creating significant barriers to entry and
limiting the growth and adoption of this technology.
Without a clear and consistent regulatory
framework, the potential benefits of tokenization and fractionalization will not be fully realized.
50. Josh Morton, Blockchain Holds Potential for Commercial Real Estate, Law360, 2 {2021). 51.ld. at 2 52. Id. at 2 53. Michael C. DeCosimo and Colton Riley, The Tokenization of Real Estate: An Introduction to Fractional Real Estate Investment, Dentons, 2 {Sept. 26, 2022). 54. Max Dilendorf et al., Tokenization of Real Estate: What, Why, and How, Dilendorf Law Firm, 10 {Sept. 1, 2020). 55. Id.
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Ultimately, the Act is designed to be flexible and
This approach enables the Act to accommodate
easily adaptable to existing laws. Instead of
current and future technological advancements in the
creating an entirely new framework specifically for
blockchain and tokenization space, without the need
tokenized assets, the Act integrates tokens within
for constant revisions or amendments. The Act's
the current legal system. By defining tokens as
flexibility ensures that the legal landscape can
containers for rights, it allows for the
effectively respond to the evolving token ecosystem
representation of various types of assets, rights, or
and provide regulatory clarity tor all stakeholders.
claims under existing laws.
B. Liechtenstein Application to Tokenized Real Estate in the US
Applying the Liechtenstein Token Act's token
This approach could revolutionize the real estate
container model to the tokenization and
industry, making it more inclusive, efficient, and
fractionalization of real estate in the US would
responsive to the evolving needs of investors and
involve creating a legal framework that integrates
property owners alike.
tokens with the existing property and real estate laws. This framework would define tokens as representations of various property rights, allowing for the seamless transfer and trade of these rights on blockchain networks. To facilitate this, lawmakers could introduce provisions that outline the responsibilities and obligations of token issuers, service providers, and investors, ensuring legal clarity tor all parties involved in tokenized real estate transactions. Additionally, the US could adopt the concept of a Physical Validator, who would be responsible for enforcing the rightful transfer of ownership in the physical world when tokenized property rights are traded or transferred. By implementing a flexible legal framework that accommodates tokenized real estate within existing laws, the US could foster innovation and open up new opportunities in the property market. Fractional ownership, enabled by tokenization, would allow investors to buy and sell portions of real estate assets, increasing liquidity and accessibility for a broader range of individuals.
C. The Blocksquare Approach Another innovative approach to tokenizing real
This layered approach was demonstrated through a
estate, distinct from the Liechtenstein model, has
pilot project tokenizing a parking space in Ljubljana,
been developed by the blockchain company
Slovenia. The notarized loan agreement was
Blocksquare. Specifically, Blocksquare has
successfully registered in the national land registry,
developed a unique protocol for tokenizing real
marking the first instance of a tokenized real estate
estate assets that bridges the blockchain world
asset being recorded by a European land registry (70).
with traditional legal protections. At the core of their approach is the creation of a digital token called
By bridging on-chain and off-chain elements,
the Blocksquare Property Token ("BSPT") which
Blocksquare delivers robust legal protections to token
represents fractional ownership in a real property
holders. The corporate resolution confers clear
asset (64).
property rights, while the loan agreement offers recourse if those rights are violated. Blocksquare's
To initiate the process, the real estate asset is
hybrid model provides a template tor effectively
valued and a smart contract is created to represent
tokenizing real estate in a legally compliant manner.
the BSPTs. This ERC-20 compliant contract contains identifying details about the property and
With $74.4 million of tokenized property across 18
encodes the transactional rules of Blocksquare's
countries, Blocksquare demonstrates the viability of
protocol (65).
fractionalizing real estate on the blockchain (71). Their novel approach merits consideration as jurisdictions
To legally link the BSPT to the underlying real
around the globe develop regulations for digital assets
esta te, Blocksquare first establishes a Public
and tokenization.
Corporate Resolution, a formal document signed by the legal representative of the property owner (66). This resolution delineates the rights conferred
to BSPT holders, such as revenue sharing, and the obligations owed to them by the owner (67). The resolution is published on-chain, creating an immutable record that binds the token to the real estate asset. Blocksquare then implements a loan agreement, with the property owner as the borrower and Blocksquare as the lender of the BSPTs (68). The property itself serves as the collateral. This agreement is notarized and registered with the land registry, preventing the owner from transacting with the property until the loan is repaid in BSPTs (69).
64. Peter Mere, Real-World Asset Tokenization 2.0, Blocksquare, (Sept. 27, 2023), https://blog.blocksquare.io/article/real-world-asset-tokeniz a tion-2-0-€stablished-bridge-between-blockchain-and-land-reg istry-1/. 65. Id. 66. Id. 67. Id. 68. Id. 69. Id. 70. First tokenized real estate in Slovenia registered land registry, Slovenian Press Agency, (Sept. 28, 2023), https://english.sta.si/3218800/first-tokenized-real-€state-in slovenia-registered-in-land-registry. 71. Blocksquare [@blocksquare_10]. Another week, Another Tokenized Property, (Sept. 25, 2023),.
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Disclaimer The information contained in this report is intended for general information purposes only. It does not constitute legal, financial, or other professional advice, and should not be used as a substitute for professional advice. The application and impact of relevant laws can vary widely based on specific facts involved. Given the changing nature of laws, rules, and regulations, and the inherent risks of electronic communication, there may be delays, omissions, or inaccuracies in the information contained herein. While we have made every effort to ensure that the information contained herein is accurate, we are not responsible for any errors or omissions, or for the results obtained from the use of this information, and without warranty of any kind, expressed or implied, including, but not limited to warranties of performance, merchantability, and fitness for a particular purpose. In no event will we, our related partnerships or corporations, or other partners, agents, or employees thereof be liable to you or anyone else for any decision made or action taken in reliance on the information contained in this report or for any consequential, special or similar damages, even if advised of the possibility of such damages. This report is not intended and does not create any contractual or other legal rights in or on behalf of any party. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Before making any decision or taking any action, you should consult with a professional advisor who has been provided with all pertinent facts relevant to your particular situation. The opinions expressed here are those of the individual author and may not reflect the opinions of the firm.
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