Real Estate Tokenization: Pros, Cons, and Challenges

Technology is paving its way through everything and how can the real estate sector be left behind! Smart homes equipped with IoT devices in each and every corner of a house is a concept that is increasingly becoming common.

Now, another technology that has made an impact in the real estate sector is blockchain. Although at a relatively nascent stage, blockchain is currently being explored for a number of applications in the real estate industry. One of them includes tokenization. So what is real estate tokenization and how does it bring value in the industry?

Real Estate Tokenization – An Emerging Trend

Tokenization involves converting a physical asset into its digital counterpart- which represents and acquires its value from the underlying asset. These are known as security tokens and are stored on a decentralized blockchain ledger. The security tokens, raised on the blockchain, can represent art pieces, precious metals, commodities, company shares, and real estate property.

In our case, real estate tokenization refers to recording and transacting all the interaction of the property via security tokens. Each token represents the underlying property. Tokenizing a property and further storing its data on the blockchain adds flexibility in the conventional model of real estate.

How Does It Work?

Blockchain is essentially a decentralized digital ledger used for recording data, transactions, and documents. The data is permanently stored on the ledger along with a time-stamp attached to it. Additionally, the authority for data is distributed among various members in a transparent fashion.

Tokenization involves distributing property shares into its equivalent tokens. This token can then be used for representing the ownership and each transaction made on the property is recorded on the blockchain. Moreover, digital tokens can be used for signifying proof of ownership, transferring fractional rights of the land, receive interest or pay debt on the structure or to hold equity or share of a physical property. Any interaction or transaction made on the token is then permanently stored on the blockchain ledger.

Converging real estate and blockchain through tokenization entails multiple benefits. This includes

Fractional Ownership- Tokenization allows a property or land to be split into multiple fractions- the parts of which are then denoted by security tokens.
Eliminating Access Barrier- Any individual can own shares or fractions of the property through tokens. This ensures that it eliminates the access barrier present in the expensive real estate industry.
High Liquidity- A physical property can easily be traded, bought or sold on the blockchain without the restriction of time or location. This enables high liquidity to flow in a sector that has been largely illiquid.

Pros of Asset Tokenization

The innovative strategy has been noticed by real estate investors, stakeholders, and regulators.

This is indeed due to a number of factors that facilitate unique trends in the traditional sector.

Diversification- The fractional ownership factor enables a unique approach to optimize the use of real estate property. It also allows investors to diversify their portfolio by investing equity into multiple properties across the globe.
Inclusion- This directly removes the need for á ‘bulky cheque’ needed for investment in real estate. Moreover, it allows inclusion for everyone to gain returns from real estate investment.
Transparent Records- Each detail along with validating documents are stored on a safe and secure ledger. Moreover, each interaction such as transaction of property is permanently recorded and stored on the blockchain. This eliminates the possibility of corruption and further induces transparency into the entire process.
Compliance- Smart contracts are codes developed on the blockchain that executes automatically when pre-defined conditions are met. They can be used to enable automated security and compliance checks like KYC. This removes the need for manual processes which are time-consuming and expensive.

Cons of Asset Tokenization

Blockchain is yet at a developing stage. While the concept of security tokens has gained considerable attention, it needs to resolve complex issues before it can be manifested on the ground.

Regulatory Structure- The biggest drawback is that the concept of security tokens is not clearly regulated across the globe. Although blockchain removes the middlemen, a regulatory compliance structure is needed for optimization.
Licensed Platforms- In order for the tokenization model to work, there is a need for licensed platforms that would operate and manage STO’s. This is a complex procedure that would need to run through multiple ‘trial and error’ before growing fully-functional.
Security- Although the blockchain platform is completely secure, details of custody solutions and security for digital tokens need to be worked out. In case if the tokens are stolen or hacked, consequences could be dire.
Tax Implications- Tokenization promotes global real estate markets with a wider inclusion. However, tax regimes pertaining to cryptocurrencies are not even defined in all countries. This creates a complex web as the tax structure would differ across different countries.

The Road Ahead

Theoretically, the concept of tokenization can be truly revolutionary for the real estate sector. But it has some major tests to face before it can operate at an industry-grade level. One of the main challenges remains the awareness of blockchain and security tokens. For the concept to be completely optimized, it needs to work at a much larger scale. This will indeed take a long time as the industry is on such a primary scale. Additionally, the technology also faces concerns about scalability.

All said and done, one also cannot deny that tokenization indeed holds an innovative promise to transform the real estate sector.