Real Estate Tokenization: Reshaping the Real Estate Industry

For years, the real estate sector across the globe has been slowly ramping up its efforts to innovate. There has been little disruption and innovation in the sector over the past two decades. However, the tide is about to turn. And it is expected to turn rapidly. The pressure to innovate is coming from all parts of the value chain: users demand it; regulators are expecting it; investors are rewarding it; operators need it; property managers and brokers depend on it. One such revolutionary breakthrough, although at nascent stages, is the idea of real estate tokenization through the incorporation of blockchain technology. This unique concept offers a myriad of avenues for all potential real estate stakeholders.

Real estate tokenization is the process of fragmenting a real estate asset's value into digital tokens that can be sold to investors to raise money. To "tokenize" a physical asset simply means to divide it into digital shares or blockchain-based securities that each represent a specific underlying asset or a share of different underlying assets with all of its rights and duties.

To get a better grasp over it, consider that an individual possesses $100,000 worth of property and urgently needs money. However, the investors who approach him lack the necessary funds, and the property owner is unwilling to sell his property for a lower price. Tokenization is useful in such situations. His asset can be divided and each unit will represent, say $1,000 worth of digital tokens. In this manner, investing in the asset over time is made simple and the decentralized nature of the network used in these transactions is completely transparent.

Both commercial and residential real estate can be tokenized. Pricey commercial assets like malls and shopping centres can be broken into fractional pieces to make investments more accessible. Similarly, apartments in residential towers with multiple stories can be tokenized, facilitating rapid sales and purchases.

Figure: How real estate tokenization works

Tokenizing fractionalized shares can resolve one of the biggest problems of the real estate industry, liquidity. Rather than selling the entire property in a single go, the owners of tokenized pieces can sell their tokens quickly, leading to a swift change of ownership. The transactions are executed on Smart contracts that are automatically generated without any involvement of humans, thus reducing the possibility of unfair practices.

Like any upcoming technology, real estate tokenized assets remain elusive due to their inherent complexity. Though the blockchain network is considered safe, some gaps regarding security and regulation need to be bridged. Tokens are not properly regulated and many nations lack an established or regulated tax framework. This uncertainty undermines the confidence of the investors, hindering growth. Further, this produces a complex global tax network, which makes it difficult to understand legal frameworks. Another major issue is complex licensing requirements. The tokenization of real estate assets requires authorized platforms where the management and operation of STOs (security token offerings) can be regulated. This is a tedious process, requiring a lot of "trial and error" before becoming fully licensed.

The real estate sector in India is poised to touch $1 trillion by 2030 from $1.72 billion in 2019 and is expected to report a 19% CAGR over the next decade, despite rising property prices and interest rates according to the Indian Real Estate Outlook 2022 by CIRIL. This increase can be attributed to rapid urbanization, growing population, proliferation of nuclear families, easy availability of finance, repatriation of NRIs and HNIs and rise in disposable income in the residential segment and rapid growth of the service sector, rising popularity of coworking spaces and increased number of multinational corporations in the commercial segment. However, spurring investments in this area is fraught with multiple risks, scams, absence of unique ownership records, and cumbersome paperwork. Double selling properties, selling non-existent pieces of land, and tampering with records are only some of the numerous frauds that dissuade potential real estate investors. This is where real estate tokenization by using blockchain technology makes a difference. All transactions are systematically recorded in the immutable digital ledger and require approval from the parties who were part of that chain from the beginning, it is impossible to clandestinely add, or permit access to new players, stemming the risk of fraud. By eliminating middlemen, smart contracts generated through blockchain technology provide an efficient alternative to paper contracts and reduce the cost and transaction time.

Figure: Market size of real estate in India (US$ billion)

The real estate industry is still considered to be a safe haven. If invested after thorough analysis, both the quantum of investment and prospective yields remain unparalleled when it comes to these pricey and luxurious investments. However, the potentially excellent investment instrument requires one to incur an enormous capital expenditure and high input costs, thus preserving it to only a fragment of investors. Real estate tokenization, which is essentially the fractional ownership of properties, real estate becomes a viable investment alternative for all investors. It provides scope for liquidity, as buyers can purchase a property in part, represented through tokens.

Though a shift towards blockchain technology can be disruptive, the Government's vision of making India a leader in blockchain technology seems far-fetched. The Central government has given a regulatory push to accommodate blockchain through its National Strategy on Blockchain but integrating it into mainstream operations poses formidable challenges. There is a lack of awareness about technology among the common man and many regions in the country are still devoid of an internet connection and experience frequent electricity failures. Focusing specifically on the real estate sector, we must recognize that it is a state subject and not a central subject. States implement their laws and guidelines which impact real estate transactions. Clearly, if the state and local governments fail to cooperate with the central government's National Strategy, real estate tokenization cannot be implemented on a large scale.

The adoption of blockchain in the real estate sector cannot happen in isolation. Central Government by giving the required regulatory push, state governments by easing unviable rules, real estate developers by spreading awareness about the technology's benefits, and early adopters by appraising lawmakers of peculiar legal challenges encountered - all stakeholders must work in tandem to succeed.

By Sanaa Chawla & Bhoomi Singhal