Comprehensive Guide on Tokenized Real Estate Investment

Real estate has always had a reputation for being one of the safer assets. Regardless of the current happenings in the stock market, people will always require a roof under their heads and a stable job. Nevertheless, real estate transactions can become some of the most overly expensive and complicated, making the real estate market comparatively illiquid.

That can all be done, thanks to tokenization.

The process behind tokenization involves the ownership of an interest in real estate through the usage of digital tokens existing on a blockchain. The emergence of blockchain and tokenization offers several advantages over traditional methods when it comes to making deals on the real estate market. Some of these include enhanced security, streamlined management, better liquidity, and transparency.

As beneficial as tokenization can be, it does come with a complex process on the legal and technical side of things. Let’s dive deeper into the world of tokenized real estate investing.

What is Real Estate Tokenization?

The process behind real estate tokenization involves creating virtual tokens on the blockchain and assigning them to a real estate property that already exists or is under construction. These tokens can represent an interest in real estate and be utilized to raise capital towards development investment, allowing a broader range of investors and developers to participate in the real estate market.

In short, tokenization is a method that allows organizations to raise capital through crowd sales, which is essentially similar to crowdfunding, but with tokens available on blockchain technology.

The goal for this feat is far more doable if funding becomes available in such a manner. The role of tokens for this industry would be to act as the equivalent of stocks, except without requiring any overly expensive intermediaries to be involved. These tokens can then be used as a loan, shares for a development company, or ownership of a property.

The Advantages of Real Estate Tokenization

Tokenization has the potential to reshape the glocal real estate market. It enables issuers and inventors some significant advantages of existing investment options and serves as a way to introduce a massive number of new investors into the market. Tokenization comes with several benefits that shall be discussed below.

Liquidity

One of the primary advantages of tokenization would have to be liquidity. For clarification, liquidity refers to how easy it is for investors to acquire or sell or asset. At the moment, real estate investment is considered illiquid. Due to that illiquidity, some people regard it as one of the more significant negative aspects of real estate investing. It impacts the price of investments command, imposing an illiquidity discount on the underlying asset’s actual value.

With tokenization, it’s possible to regain some of the lost value to the illiquidity discount. That is possible by making real estate investment easier to buy and sell. Even a tiny improvement in the sales prices of these investments could lead to a rise in new value for issuers and resellers. Some features of real estate tokens merge to make these improvements a reality.

Lower Cost of Entry

What’s become known as sufficient capital will be changed when real estate becomes tokenized. A virtual token isn’t required to be sold as a whole unit. Instead, the code underlying the token grants permission for its subdivision, enabling the issuer or subsequent holders to sell fractional tokens at much lower prices because of the fractionalization. That paves the way for small investors to enter into the market, who were previously unable to participate, and allows for better opportunities for diversification for weather investors.

Standardized Transactions

With blockchain technology making tokenization a reality, the ability to buy and sell real estate tokens is implemented through standardized smart contracts. These smart contracts can’t be negotiated separately, and the terms are fulfilled automatically. That reduces the transaction costs considerably.

Worldwide Investment Pool

Through the power of tokenization, the pool of potential investors becomes a global phenomenon. Anyone with enough capital and internet connection can seamlessly participate in buying, holding, and selling real estate located in any location in the world.

Transparency

Blockchains can record all transactions that take place on their network. Whenever a token goes through a transaction process, all the participants become aware of it. For that reason, investors can search through a token’s history, pricing, and any other details concerning it’ transaction whenever they wish to do so.

Security

Since blockchain is a distributed ledger, no individual or organization can control the network and impose its own policies. Furthermore, the distributed ledger technology (DLT) uses advanced cryptography techniques that offer users excellent security. Each user is provided with a personal key that grants them access to their blockchain assets. That key is generally represented with a line of random characters (such as numbers and letters), making it very hard for outsiders to guess it.

Immutability

Once the transaction has been recorded and confirmed on the blockchain, it cannot be changed in any way. That provides investors with a much-needed assurance that no one can counterfeit transactions after it’s execution.

Searching for Property

One of the many issues encountered with investing in real estate comes from having to search for a property to invest in. There are plenty of marketplaces where they assess up for sale. If the assets are tokenized, they become listable for a centralized marketplace. The makes the investor’s job much smoother since they now have a seamless way to search for potential investments in one location. With this opportunity, investors gain access to search for potential investments found in other geographical areas and enable sellers to gain access to a massive pool of potential buyers.

What Should the Tokenization Strategy Include?

It’s essential to understand the tokenization strategy and familiarize yourself with some of its vital parts.

Type of Interest

The developers of a virtual token have the opportunity to choose what they should tokenize. That can include such things as the real estate property itself, equity interest within a legal entity that has ownership of a property, the mortgage for a property, and the rights to share in the profits generated by the property. There are more options, but these are just some of the many possibilities.

To put it in another way, the range of opportunities is massive and diverse. Even so, keep in mind that it’s all dependent on the interest that is tokenized. That means you will face varying levels of regulations. For that reason, before an asset is tokenized, it’s crucial to know which of the ordinances are likely to affect you.

Legal Entity

Traditionally speaking, securitization of real estate relies on the establishment of a special-purpose vehicle (SPV), and there is a good chance of tokenization doing that. An SPV is a legal entity created for a single purpose, such as holding and managing real estate.

An SPV can be a trust, corporation, limited liability company, limited partnership, or other entity. However, each of them has its pros and cons. If suitably structured, the SPV’s assets and liabilities are regarded separately from those of the developer for accounting, tax, and bankruptcy purposes. That grants the token permission to stand by its own merit as an investment without requiring the creditworthiness of any of the developers involved.

Establishing the SPV, its ownership, and transaction between it and the developer is a complex process that requires the assistance of an experienced advisor.

Smart Contracts

Smart contracts are computer codes made on a blockchain that can automatically implement and execute agreements between users without requiring an intermediary. Since smart contracts are eternally attached to the blockchain, it’s impossible to alter them once published. As a result, these smart contracts are used to establish the characteristics and sales process for the token. It’s one reason why the creation of these tokens needs to be done carefully. If it launches with some issues, it could lead to total failure on the developer’s end and unforeseen consequences for the issuer and investors.

The development of a smart contract needs to trigger the characteristic the issuer wants for its token. For example, if a token holder is expected to receive dividends or a share in profits, the smart contracts need to provide it.

One thing you need to keep in mind is that smart contracts are not there to replace lawyers. There are substantial gaps between the requirements of law and the limitation of smart contracts. It’s crucial to be aware of the function that smart contracts can and cannot handle effectively. In some cases, a legal override may need to happen, while in other cases, the smart contract has to be altered to accommodate a legal requirement.

Securities Regulations

Since real estate tokens are certified as securities under various countries’ laws, they will be required to register with the regulators. In many cases, it’s possible to acquire an exemption from registration. Failure to register with the regulators could result in civil penalties and other severe issues.

Tax Requirements

While the Internal Revenue Service has published a general guideline regarding the taxation of digital assets such as bitcoins, several aspects of how U.S. tax handles the purchasing and holding of digital tokens remain uncertain. Issuers and investors need to take some time to consult a tax professional for assistance in creating a comprehensive tax strategy. Additionally, issuers need to be aware of any reporting requirements they could have, tax-related or otherwise.

Property Location

Of course, the location of the real estate property matters the most. The parameters of the location need to be considered not only from a practical standpoint but also from a legal one. For example, not every country out there permits protection for private property rights. As a result, minimal amounts of investors will become interested in purchasing property in those geographical locations. Consider whether or not the location of the property can satisfy all involved parties.

Mortgage Issues

If the property selected to undergo the tokenization process is subject to a mortgage, the issuer is either required to get the mortgagee’s consent or pay off the mortgage. However, if the tokenization of the property is considered a mortgage itself, then the appropriate laws will need to be observed.

Anti-money Laundering and Know-Your-Customer

It becomes necessary for issues behind digital tokens to comply with the Anti-Money Laundering and Know-Your-Customer laws in places they decide to offer their tokens. If relying on the securities-law exemption that only sanctions accredited investors, issuers must take appropriate steps to accredit their purchasers. That can also include actively verifying that investors are accredited investors instead of taking their words for it.

International Sales

Plenty of countries have established securities laws and AML/KYC regulations. That means the issues need to be mindful of the various regulatory requirements when it comes to launching their tokens in specific regions. For example, a security token offering that is legal in Europe could be considered illegal in the United States. Plus, it may be possible that one country could treat a token as security while another may not.

Overall, depending on the token’s feature, it may be subjected to several other regulated money services laws and potentially commodity regulations. Before tokenizing a real estate property, you need to take the time to methodically plan a strategy. That way, you can ensure the smooth execution of the tokenization process.

Conclusion

Tokenization can become one of the most significant game changes in the real estate market. It can change the way people are investing in real estate all over the world. However, realizing that potential will all come down to how well blockchain developers managed to structure the whole thing. Tokenization has some hurdles to overcome, but it has the massive potential to reach new heights.

The real estate industry still hasn’t entirely realized the immense potential behind blockchain-enabled tokenization for dealing with existing market issues. Still, tokenization has managed to provide the industry with some benefits. Here at CitaDAO, we are one of the many platforms unlocking real-world assets to DeFi and introducing this innovation into real estate. Take the plunge and check us out for more information.

About CitaDAO

CitaDAO.io is a Decentralized Finance (DeFi) platform for Real Estate to be tokenized on-chain, built on the Ethereum ecosystem. CitaDAO aims to solve the lack of liquidity, access limitation, and lack of composability in existing real estate investments by creating interoperability with other DeFi applications/primitives that operate on the Ethereum protocol. Real estate token allows the community to diversify their portfolio on-chain to generate stable yield through real-world assets that have constant liquidity through AMM. Interested in building the future with us?

Disclaimer: The information contained in this communication is based on sources considered to be reliable, but not guaranteed, to be accurate or complete. This communication should not be relied upon or the basis for making any investment decision or be construed as a recommendation to engage in any transaction or be construed as a recommendation of any investment strategy.