There is a crisis in real estate across the northern hemisphere – but tokenization could provide the key to unlocking unprecedented liquidity through fractionalization of ownership, which will lower barriers to property investment.
However, opening up the real estate markets depends on the ability of tokenization innovators to navigate the extensive web of regulations surrounding property transactions. Blocksquare’s recent success in registering a tokenized property sale in the EU represents a significant leap forward, while operators in the US are also finding ways to ensure compliance with the SEC’s strict rules around the sale of securities.
Blockchain proponents have long pointed to the potential of asset tokenization to bring about transformative change in the real estate markets. Tokenizing real estate assets enables fractional ownership of property, making it easier for anyone to invest, and potentially making it as easily transferable as cash. A 2022 report from Boston Consulting Group projects that there could be a market of around $16 trillion of tokenized illiquid assets by 2030.
It’s a development that’s sorely needed, given that many countries are in the grip of a housing crisis caused by wages that can’t keep pace with inflation, combined with the increasing urbanization of large cities and a failure to develop sufficient affordable new housing.
While tokenization won’t necessarily directly generate more housing and real estate development, an exponentially larger investment pool will undoubtedly fuel growth by providing sources of alternative financing for developers and addressing inequality in the property ownership dynamic.
Breaking Down the Practical Barriers
In technological terms, the opportunity has long been there for the taking, since blockchain technology is no longer anything new. However, in practical terms, there’s a need to marry the on-chain transactions with the off-chain web of laws and regulations that govern real estate transactions in the real world. A combination of land registries, local governments, notaries, mortgage lenders, and insurers ensure that adequate protections are in place to ensure property purchases can’t be used as a front for scams or criminal activity.
The risk for token issuers is that if they attempt to tokenize real estate and sell it without engaging with these laws, the transaction is likely to be deemed unlawful. Reconciling these challenges has so far been a practical barrier to real estate tokenization. However, there are now promising signs that things are changing.
The First Legal Blueprint for Property Tokenization in the EU
Earlier this year, Blocksquare became the first to successfully execute a notarized tokenization of a piece of real estate, which is now included in the land registry of Slovenia, an EU country. Blocksquare underwent an extensive process based on several years of legal and technical research, which comprised two key elements – a corporate resolution, establishing the rules of engagement between the property owner and the token holders, and a loan collateral agreement. In the latter, the owner of the property pledges it as collateral on a loan agreement, which is notarized and registered with the land registry in the same way as a mortgage.
The loan is issued in native tokens, which ensures that the owner has to buy back all tokens from token holders to effect a repayment and claim ownership of the property. These two instruments combined act as a comprehensive on-chain and off-chain agreement that the Slovenian authorities have accepted as fit for purpose in a real estate transaction. The Blocksquare team successfully tokenized a parking space with the execution of a mortgage agreement between Blocksquare as the lender and token issuer and the property owner as the borrower.
Given that mortgages are recognized legal instruments in most jurisdictions, Blocksquare believes that this legal framework for real estate tokenization could be universally applied, with relevant adjustments to accommodate specific local legislative requirements. The firm recently appointed seasoned executive Fergus Murphy as its new Head of Global Institutional Banking to support its growth plans following the successful tokenization milestone.
Navigating Evolving Regulations in the US
In the US, real estate tokenization has become caught up in the evolving regulatory situation regarding the status of digital assets as securities. Issuers such as Honeybricks now treat tokenized real estate assets in the same way as shares in a traditional private placement offering, meaning that the compliance rules for the sale of securities apply.
Effectively, sales need to be registered with the SEC unless they can claim an exemption, meaning tokens are sold only to those who meet the accredited investor status. Potentially, either option may be possible for the sale of tokenized real estate. However, there are trade-offs in terms of the amount of time and administration involved against the opportunity of accessing a wider pool of investors.
The regulatory hurdles involved have made the process of achieving real estate tokenization in practice relatively slow and arduous. However, thanks to a relentless focus on long-term opportunities, the efforts of early movers are now finally bearing fruit with practical, sustainable solutions that can bring about generational change in property ownership.
