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Will Tokenisation Disrupt the REIT Industry? (Magazine)

Will Tokenisation Disrupt the REIT Industry?

Tokenisation is maturing with some ventures succeeding in the most challenging aspect — compliance. But what are the hurdles preventing its full-scale adoption?

By Bernie Devine, Regional Director (Asia), Yardi Systems

 

Tokenisation is the most radical innovation in the real estate industry since the introduction of REITs in 1960. Tokenisation is a way of using Blockchain to represent ownership. Let me break that down:

  • A blockchain is a form of cryptography – distributed ledgers allowing the practice and study of techniques for secure communication in the presence of third parties called adversaries.
  • It is a register of transactions and allows you to verify the current owner of a token on the chain. It is much like Torrens title in which a state creates and maintains a register of land holdings, which serves as the conclusive evidence of title of the person recorded on the register as the proprietor, and of all other interests recorded on the register.
  • As tokens can represent the ownership of the asset, many tokens can be used to break down the size of ownership parcels, allowing fractional ownership.
  • How tokens are tied to the asset could vary – it could be through a fund so that tokens are owners of the fund that in turn owns the asset, or it could be direct to the asset on a per share basis, a per area basis, a per unit basis or some other pro rata representation. So, you might be able to buy 1% of an apartment building or one square meter of an apartment. Any scenario where the portion of ownership differs from occupiable spaces would require some intricate management model that would be challenging and costly.

Tokenisation is now maturing with a number of ventures succeeding in the most difficult aspect, which is compliance. We have seen several tokens listed on various exchanges and a small number of exchanges capable of trading in real estate tokens.

Physical Real Estate Is Slow To Transact And Illiquid

Two critical challenges of the real estate market for the last 400 years, when compared to other investment asset classes, are the slow pace of transactions (it takes a relatively long time for ownership to be transferred) and liquidity (the purchase price is so large that only a limited market of buyers exists). There have been many innovations over the years (such as Private Equity Funds and REITs) that have sought to address these issues, but the Proptech community thinks it has a better solution.

To understand the subject – tokenisation of real estate investments is about changing the way ownership of an asset is represented. It’s proposed that this change in ownership model will open up how the purchase of the asset is funded and how ownership is transferred. If ownership can be broken down into smaller portions, then more people can afford to buy a portion which means that those smaller portions will be easier to sell, creating a more liquid market. Similarly, if those smaller portions can be transferred safely from one owner to another faster and more reliably then this creates greater access and liquidity. This is essentially the value proposition for tokenising real estate investments.

Laws for Tokenisation

From a legal perspective, the transfer of real estate titles is controlled by a specific regulation in each market and typically uses a title registration/transfer process that involves a government department as the host of the register. Replacing this central registry with a token representing ownership would need new laws to recognise the new form of ownership and transfer. When a dispute arises, a court will be needed to settle it, and that court will look for laws that provide direction. There is also the issue of the applicability of laws specific to real estate and their applicability if a token represents ownership. The specific laws could relate to, for example, obtaining court orders for eviction and the concept of vacant possession. Much of the law around this area relies on a reference to land titles and lease registries managed by government departments. Those laws offer protection for stakeholders in the real estate industry, and unless they are in place, the adoption of tokenisation is hard.

Similarly, investing in any form is regulated in most markets. Unlisted vehicles are subject to limits of the number of members and sometimes on the minimum investment size. Listed vehicles are very expensive to set up and have many regulations to control risk – as they accept investments from the general public. REITs are a special class of listed vehicle – and as they usually have tax benefits associated with their structure, this means even stricter rules on what they can do. Replicating a REIT structure with a token would not necessarily make the set-up any cheaper.

REITs Have a Tax Benefit Advantage

Replacing these investment models by allowing people to buy a token – the closest representation is to have a corporate title on the asset and for people to buy shares in that corporate title. This corporate title if unlisted is currently limited to a small number of members – usually 50, depending on local regulations. However, to get the tax benefits of a REIT, you still need to set up a REIT.

If these tokens were listed on an exchange where they are traded, then you’re getting into trading securities, and that also gets caught in legislation around exchange licenses in most places. What this means is not only would the tokens be subject to investment regulation but the exchanges they are traded on would also be regulated like any other stock exchange. For example, in Hong Kong digital tokens are considered virtual commodities, not currency and in some cases are regarded as securities, meaning they are subject to securities law and any exchange they are traded on is a securities exchange.

So this then creates some challenges to be overcome for tokenisation to become a reality. When comparing these models to existing solutions, there are a number of points to compare:

Attribute REIT Private Equity Tokens
Low minimum investment Yes, can be less than $1,000 Typically, millions. Crowdfunding has reduced this to $100k in some cases less than that Tokens can reduce the minimum investment size but the regulator will still require qualified investors. Token may assist intermediaries to play a part in aggregating investment
Public able to invest Yes, open to anyone who can invest in the stock market No. Limited to qualified investors only Tokens may create the opportunity for intermediate aggregation of funds
Liquidity Very high. A large number of shares, assets and potential buyers Limited due to minimum investment size and investor qualification requirements Subject to market size and regulation
Professional management Definitely. Subject to public scrutiny and regulation Up to the investor to determine the skills of the manager. Limited regulation in this area Up to the investor to determine the skills of the manager. Limited regulation in this area
Risk diversification Regulation often restricts what type of assets can be included. Setup costs demand a large portfolio. Diversification is often achieved by different asset classes and markets Fund size is often limited and single assets often the focus. Investors need to diversify with multiple investments Fund size is often limited and single assets often the focus. Investors need to diversify with multiple investments
Impacted by stock market volatility Low correlation to similar-sized stocks – typically REIT values are more impacted by the nature of the underlying asset The value and use of the underlying asset typically determines price The value and use of the underlying asset typically determines the price
Listing cost Regulatory requirements for a public listing a quite high. It’s a trade-off for access to a public register Setting up a compliant, tax effective structure is not cheap but much less than the listing cost of a REIT Setting up a compliant, tax effective structure is not cheap but much less than the listing cost of a REIT. Remains to be seen if it’s any cheaper than a PE Fund
Private Equity style returns Not possible given the risk constraints that a publicly listed entity must work within Yes Should be possible
Instant transaction settlement Depends on the market – Singapore 3 days, Hong Kong 1-2 days. Australia 2 days Weeks TBA. But should be faster than Private Equity. Maybe faster than REITS
Low transaction fee structure Many intermediaries take a fee in this process No Possibly
Able to undertake development projects Depends on regulation. Can be done in some markets Always Subject to the final regulation, who the investors are and the investment mandate
Tax benefits Significant. Typically, no tax is paid Tax effective structures help but taxes typically payable TBA – it’s doubtful regulators would view this any different to a PE investment at best
Protection of real property law Yes Yes Unclear. Needs to be addressed

In summary, I think that the tokenisation of real estate will yield benefits and should be progressed. Much of the success that is proposed relied on changes to legislation that will be hard-won, and requires the investment of time, energy and resources to turn into reality.

 

About the author:

Bernie Devine has over 30 years of experience in real estate and technology, specialising in digital transformations in real estate, and using data to create a more competitive and collaborative environment. He supports real estate clients with Retail, Commercial, Industrial, Residential and Mixed-Use assets, helping them to grow their operations, create efficiencies, and gain better insight into their business. His expertise includes asset and investment management, private equity, operations improvement, program and project management, finance, technology implementation and compliance. Bernie has led large-scale technology projects, as well as led and supported Proptech start-ups, across Australia, the USA, Middle East, Asia and Europe. Currently responsible for the growth of Yardi Systems in Asia, Bernie lives in Hong Kong and is a qualified accountant and economist. He has over 60 publications to his name and extensive public speaking experience.