Could tokenization make investing in commercial real estate assets easier and cheaper for retail investors? Andri Rabetanety, Senior Lecturer in Real Estate Finance at Glion, explores the blockchain-powered digital ‘shares’ which have the potential to tackle some of the market’s historical inefficiencies.
As a $280 trillion global industry, no-one could accuse commercial real estate investment and development as being anything other than a success story. Transaction volumes are at record highs ($1.75 trillion in 2018), equity fundraising keeps hitting new heights (including a record-breaking $20.5 bn fund by Blackstone) and cap rates are falling.
But no market is perfect and, after all, it’s during the good times when it makes most sense to deal with inherent inefficiencies. Today’s successful industry players cannot afford to get complacent, because the competition won’t.
And this is why the market is becoming so excited about tokenization. Another technology from the blockchain-powered stable, tokenization hit the headlines last year when a 19% share (worth $18 million) of the iconic St. Regis Resort in Aspen, USA, was offered to investors by the asset management firm Elevated Returns.
Given the high profile nature of the property and this ground-breaking financing method, the issue got the investment community talking. It was followed by more ‘first-mover’ tokenized issues in the US, while this year we have seen tokenization arrive in Europe, with a string of issues throughout the summer (see panel below).
Europe’s tokenization first movers
June 2019 – 18 apartments and one restaurant in Zug, Switzerland (CHF 3 million raised – 20% of total asset value)
June 2019 – AnnA Villa in France (€6.5 million raised – 100% of asset value)
July 2019 – Luxury development in Belval, Luxembourg
August 2019 – Student accommodation, Nottingham, UK (£1 million raised – 30% of value)
So what is tokenization and how might it provide greater opportunities to ‘democratize’ commercial real estate?
The first thing to note is an obvious one: unless you happen to have millions of euros sitting around you’re not likely to be in the market for a typical commercial real estate asset. Buildings are lumpy, localized and unique. Transacting them takes months, is often very complex and comes at a high cost: in the UK up to 8% of the purchase price.
For retail investors, the standard path for acquiring real estate-related holdings is through indirect investment. This usually takes the form of purchasing shares in listed real estate companies (REITs), buying into private equity real estate funds or via crowdfunding platforms.
None of these methods adequately solve the three main challenges facing real estate investors, namely:
- Access – how to gain real estate exposure with limited equity and asymmetrical information?
- Liquidity – how to exit a real estate project in a timely manner without diluting returns?
- Transparency – how to align the interests of intermediaries and share profits in a transparent way?
Tokenization is no silver bullet for these challenges. But by offering the opportunity for fractional real estate ownership at a low cost to the issuer, with the security of a blockchain ‘paper trail’ and – ultimately – a liquid secondary market for trading, it is a very intriguing prospect.
Don’t just take my word for this, either. Francesco Abbate, Managing Partners of Swiss Crypto Advisors, who accompanies investors in their tokenization journey, recently commented, “Asset tokenization will be a huge trend in the coming years, and this has already sparked a lot of interest among institutional investors worldwide.”
Upsides… and downsides
For asset owners, since tokenization makes use of existing blockchain platforms and technologies (Ethereum, EquiSafe, Tokeny, etc.) the issuer costs are an order of magnitude lower than with ‘traditional’ transactions – literally hundreds of dollars/euros compared with millions. There are no lawyers, financial intermediaries or real estate agents taking a piece of the pie.
For investors, tokens can be bought in denominations as low as $1, bringing the retail market fully into play. The early US examples also indicate attractive dividend yields (5%-6.5%) for what are high quality underlying assets.
Sounds too good to be true? Right now that’s probably the case; certainly if we’re talking about tokenization being the catalyst for a ‘big bang’ change in the real estate market. There are question marks around the regulatory treatment of tokenization, while the lack of an established secondary trading market (although this is under development) will also hold back the all-important liquidity.
While these wrinkles are being ironed out, the immediate success of tokenization projects will very much depend on elements like the quality – and profile – of the asset being tokenized. With this in mind, it was very interesting to me that the first high profile property to be tokenized was an iconic hotel.
Interesting, but perhaps not that surprising. Investor appetite for hotel real estate has been one of the biggest market stories of recent years. It has also been one of the driving forces behind Glion’s creation of a new Master’s in Finance, Real Estate and Hotel Development. As one of the co-creators of that program, I see internationally-famous hotels as being perfectly-placed to be at the forefront of any tokenization take-off.
From a country perspective, Switzerland has some of the most obvious attractions as a place to embed tokenization. The country has a crypto-friendly stance and it also possesses a fast-developing blockchain hub in the form of ‘Crypto Valley’ in the city of Zug. In addition, there are many crypto-friendly banks, while the Swiss authorities continue to pursue a principle-based and technology-neutral legislative and regulatory approach.
As this graphic shows, we’re very much at the Early Adopter stage of the tokenization innovation cycle. These first movers have proven that the technology can be used to securitize iconic properties and other alternative asset classes (luxury residential and student accommodation, for example). Issuers have experimented with securitizing partial or total asset values (my view is that the latter will become the norm), as well as utilizing different blockchain technologies and platforms.
Now it’s time for the real estate ‘pragmatists’ to build on the output of the first movers and take advantage of this opportunity. Because while tokenization will not come to dominate the market any time soon, change is inevitable. The real estate investment market is simply too inefficient and expensive to resist it.