Making Real Estate Liquid: The Role of Security Tokens

Photo credit: iStockphoto/Tzido

Real estate is a notoriously illiquid asset class due to its relatively high value and cumbersome registration system. As asset owners eye liquidity and investors search for opportunities in the aftermath of COVID-19, this may be the moment we see the market press the reset button and digitise real estate with security tokenization.

Security tokenization is the representation of fractional interests in an asset using blockchain. A security token derives its value from an underlying asset, such as a piece of real estate. This is different to a cryptocurrency such as Bitcoin, which has its own value as a currency. There are many benefits for asset owners and investors but navigating tokenization will be a learning curve for many companies used to dealing in bricks and mortar.

What are the advantages for asset owners?

If traditional funding sources dry up, security tokenization could allow asset owners to raise capital quickly and cheaply, meaning that this could be the catalyst for a transformation of the real estate sector as we know it.

Security tokenization unlocks liquidity for asset owners by giving them access to a larger potential pool of investors. This is particularly valuable for high-value real estate because security tokenization broadens the class of potential purchasers to include small investors that are only seeking a fractional interest in an asset. This, in turn, allows for the spreading of risk and adds a liquidity premium to the value of the asset. In this risk-averse climate where the pool of potential purchasers is smaller than usual, we could see the creation of a whole new asset class.

An important feature of security tokenization is the flexibility of tokenomics. The self-executing smart contract embedded in a token can be drafted so the token represents anything from equity in a legal structure owning real property, to an interest in debt secured by real property, to an interest in an income stream based on cash flows from real property. This gives owners optionality to suit their needs and the ability to devise investment propositions to attract potential investors.

What are the advantages for investors?

Investors can gain exposure to real estate with security tokenization that they might not ordinarily be able to acquire outright. Although they could acquire an interest in a real estate investment trust, such opportunities usually involve more than one piece of real estate. Security tokenization facilitates single-asset exposure, giving investors much greater direct control over their investment portfolio allocations.

The fast digital nature of security tokenization is its chief advantage. Due to information disclosures facilitated by smart contracts, investors can be provided with information 24 hours a day. They can then trade tokens based on that information at any time, because a token exchange is not tied to the trading hours of a traditional securities exchange. This is especially attractive in a volatile market.

What does this mean in the near term?

Security tokenization could result in investors trading tokens on an exchange, but as potential token issuers our clients are more interested in the potential to raise funds in the first instance. This might be a reflection of current market dynamics and we predict that there will be an increased focus on secondary market liquidity as circumstances improve.

Clients are also interested in increasingly sophisticated tokenomics specifications, including how to disclose, or equally limit the disclosure, of information to investors.

Governments are also showing more interest in blockchain and tokenization, which will lead to increased promotion and opportunities but also more regulatory scrutiny.

For example, China has formed a national blockchain committee comprised of representatives from academia and the public and private sectors to devise standards for the usage of this technology.

There are few certainties in a post-COVID-19 world, but one is that the market will need to do more with less.  With its speed, efficiency and flexibility, security tokenization could be the catalyst for the transformation of real estate ownership and investment.

Scott Thiel, who leads DLA Piper’s Asia Technology group, and Jonathan Gill, a lawyer in DLA Piper’s Hong Kong Real Estate group, wrote this article. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of CDOTrends. Photo credit: iStockphoto/Tzido