Real estate tokenization refers to converting properties into tradable securities to enhance their liquidity and boost the return on investment. The holders of the securities will receive their income in the form of interest and cash flow.
The Procedure Involved in Tokenizing Real Estate
- Asset allocation – The asset can be divided into several small units or shares. If the asset has been pledged on a loan, then the loan must also be transferred along with the asset. If the asset has been sold to a company, debt securities will be issued to the investors.
- Initialization – The asset’s originator will assign a company to perform the task successfully. He will arrange the deal to take place. An SPV (Special Purpose Vehicle) will be created which will act as a custodian for the asset.
- Establishing an SPV – SPV will acquire an asset or a group of assets and refinance it by issuing securities in the capital market for sale to the prospective investors. Whoever buys the securities will gain control over the use of the asset. Till then, the originator of the asset will have control over it through an equity stake. The Cayman Islands located in the British overseas territory is a favourable location for real estate tokenization and crypto-related transactions due to its tax neutrality and tailormade regulations.
- Sale of the asset – The originator of the asset will sell it to the newly formed SPV. All the physical and legal terms and conditions must be satisfied to recognize it as a true sale. This will ensure the credibility of the securities.
- Issuance of the securities or tokens – The tokens or securities will be issued according to the value of the asset. It can be in the form of bonds, stocks, participatory notes, or shares in a trust. The issuer will bear the full responsibility regarding the issue of the tokens. He has to take care of all the legal aspects, technical administration, ensure the smooth processing of transactions, and prepare the relevant documents related to digital tokenization.
- Credit enhancement – Since the securities will be offered to the potential investors in the capital market, it will undergo a credit assessment by reputed credit rating agencies. Documents such as loan agreements, guarantee letters of the originator of the asset, amount of cash in the reserve fund within the SPV, and insurance protection will have to be submitted. If a credit enhancement has been carried out, Real estate tokenization will attract more institutional and professional investors.
- Credit rating evaluation – An investment-grade credit rating would be desirable in Commercial Real estate tokenization to grab the attention of investors to put their money in asset-backed securities. It will also attract a large group of retail investors.
- Management of the asset – The asset will be managed by an appointed trustee according to the interests of the investors. He will maintain and handle the administration of the asset properly. He will hold the title of the asset, manage the trust accounts, and collect the money from the prospective investors on a timely basis.
- Sale of the securities or tokens – An initial placement strategy will have to be formulated to sell the securities to the targeted group of investors. Legal restrictions in a jurisdiction can affect the sale. The property owner can opt for either private placement, public placement or reverse solicitation for the retail investors. Tokens can be sold by the issuer either by a financial company or through an authorized marketplace.
Reasons Why Commercial Real Estate Tokenization Has a Strong Future Ahead
- It is a new way to raise capital without depending on financial institutions and banks.
- The loan to value ratio (LTV) will be higher when compared to loans and advances availed from banks.
- The entry barriers are low and all categories of investors can put in their money without facing any minimum capital requirement norms. It improves accessibility and uplifts the returns earned on the assets.
- Wealthy investors can use real estate tokenization to diversify their portfolio and manage their risks in a better way.
- Transparency is ensured for the investors as they can track all the activities of the property using a distributed and immutable public ledger and robust smart contracts.
- Investors can easily buy the tokens directly from the leading exchanges in the market.
- The settlement process can be speeded up as peer to peer transactions can be executed without the presence of third parties and investors can experience cost savings.
- Fractionalization will increase the pool of potential investors and can increase the value of the asset if there is a liquidity premium.
Obstacles to the Tokenization of Real Estate
- A maintenance fund may be needed to be created if the property has not been sold for a long time for tax payments and repairs.
- The concept of security tokens is not uniformly regulated across the globe. Well-defined regulatory compliance will be needed for tokenizing real estate.
- In case the securities or tokens of the investors get stolen or hacked, the consequences would be huge. Hence, an appropriate custody solution for securing the digital tokens would be required.
- Licenced platforms need to be established for managing security token offerings. This is a complex process and has to undergo numerous trial and error methods before growing fully operational.
- Many countries across the world have not formed laws related to taxation of cryptocurrency. Hence, this contributes to ambiguity as the tax structure will vary from one nation to another leading to different situations for each investor.
Despite some limitations, real estate tokenization can transform the entire industry for the better. It needs to sort out the above-mentioned challenges effectively and also ensure that the technology is scalable enough for worldwide application.