By Nadine Loepfe
The real estate market has always played - and will always play - a major role in the investment economy, but it’s traditionally been difficult to access. High capital requirements, long transaction cycles, and a general lack of liquidity have always kept real estate investments out of reach for many. But imagine if you could invest in property without requiring large amounts of investment capital, in just a few clicks, no matter where you are in the world?
That’s the potential that Web3 and blockchain technologies bring to the table. Tokenization - the process of creating digital representation of real-world assets - holds the key to making real estate investment more accessible, efficient, and transparent for everyone.
Let’s explore how a modern Real Estate Investment Trust (REIT) could be built today using Web3 technologies. It’s more than just theory; this model could fundamentally reshape how we think about property ownership and investment, democratizing access to one of the world’s most lucrative markets.
Real-World Assets (RWAs): A brief Introduction
First, it should be explained what exactly is meant by the term ‘“real world asset’”; Real world assets are assets - both tangible and intangible - that hold inherent value in the real world in some form. Tangible examples include real estate, infrastructure, and commodities; intangible examples include bonds, stocks, and intellectual property.
If one talks about tokenizing real estate as a real-world asset - as we will expand upon in this article - it refers to creating a digital representation of a property on a distributed ledger which can then be traded, tracked, fractionalized, and more.
Why Tokenize Real Estate?
The real estate investment market is full of inefficiencies. Participation in the market is increasingly inaccessible due to high capital requirements, the asset itself is traditionally considered highly illiquid, and the transactions involved - not to mention the legacy systems that facilitate them - can be slow, expensive, and complex. Through tokenization, these long-standing and systemic issues with the market can be addressed.
First, we have lower entry costs. One does not need to be a millionaire to invest in real estate - as is the case in most real estate markets today. Such tokenization allows owning and enjoying the equity of a fraction of a property, allowing a larger number of investors to participate.
Then, there's increased liquidity. Whereas traditionally - due a huge number of factors - selling out a real estate investment could take months or even years, tokenized assets can be traded on digital exchanges and platforms seamlessly and in a relatively short period, making the process far more dynamic, and the market far more liquid.
And finally, there's global reach. Tokenized real estate allows investors to transcend regional markets. With tokenized properties listed on decentralized exchanges and marketplace platforms, you can reach properties anywhere in other countries and thereby create a diversified portfolio without the traditional geographic constraints of a REIT.
Tokenization and the potential benefits it brings enables us to envision the future of real estate investment; a digital, democratized, and decentralized system built upon distributed infrastructure that creates equity for the economically marginalized and unprecedented efficiency in a market that has been plagued by inefficiencies for decades, if not, centuries.
At the forefront of the emerging revolution is Hedera - bringing enterprise-grade governance, speed, cost efficiency, regulatory compliance, sustainability, and proven use cases that cement itself as a leader not only in the tokenization of real estate, but the tokenization of everything.
So How Would We Build a REIT on Web3 Today?
Now that we understand the basics of RWA, let’s dive into how we would use Web3 technologies to build a decentralized REIT.
ERC Standards and Tokenization
We begin our discussion by providing implementation related to the Web3 token standards - ERC-20 and ERC-3643 - to tokenize real estate. ERC-20 enables the functionality of fractional ownership, which means the ability to split up ownership of a property into tradable shares as explained earlier. Another active area of tokenizing real estate involves taking steps towards compliance with industry regulations.
We can extend ERC-3643 to implement laws related to KYC (Know-Your-Customer) requirements, ensuring that participants are verified investors. This is in high demand for keeping fraud cases at a minimum and, not insignificantly, for meeting a lot of the legal requirements that come into play when high-value assets are involved. Moreover, this geo-blocking can go all the way to blocking certain properties in respect of a user's location to ensure that local and international laws are being followed. This level of control sustains security for the system while at the same time ensuring that compliance is adhered to, therefore allowing for flexibility that is expected to come with decentralized ownership and trade.
Finally, ERC-721 can be used for individual, non-fungible attributes of real estate, such as particular property units, with fractional ownership still made possible.
Governance via DAOs
Next, we introduce distributed governance through DAOs: Decentralised Autonomous Organisations. DAOs give investors a vote on the operation of the fund on everything from property management to new acquisitions and distributions. This model is decentralized, hence ensuring transparency and giving investors greater control over their assets.
Also relevant is the concept of Blockchain Organised Restricted Governance, BORGs in short. A BORG adds a further level of flexibility that can enable different parts of the real estate portfolio to have their own specific form of governance. Some assets can require more centralized control while others are fully decentralized, depending on regulations or investor preferences. By using both DAOs and BORGs, we give investors more power over decisions, making real estate management more transparent and flexible.
Managing Treasury and Revenue
Smarter management of inflow funds is a key component in any REIT. Our Web3 REIT will utilize a treasury and smart contract-mediated distribution of revenue created by the properties to token holders. We can easily ensure appropriate reserves for unexpected expenses and distribute excess profits to investors simultaneously through what's called a “high/low water” system.
Pricing and Liquidity: Solving two Key Challenges
Among the biggest problems that one faces while dealing with real estate investment are pricing and liquidity. In a tokenized REIT, one may have what is called Decentralized Exchanges for price discovery, which include Liquidity Pools (LPs) and Automated Market Makers (AMMs). Investors contribute liquidity, and the AMM adjusts prices based on market demand, offering a more dynamic and transparent pricing model.
Initially, we’ll offer a one-sided marketplace where investors can buy into properties. Over time, this can evolve into a two-sided market, allowing easier buying and selling of property tokens.
Tokenizing a Building: A Step-by-Step Guide
How do we apply these concepts to a single building on a high level? Here’s a simple walkthrough:
First, we’ll model the building: It is tokenized into regulated ERC-20 tokens for fractional ownership. Here each token represents a share in the building. Additionally, we can use a NFT (ERC-721) for the name, address, and visual depiction of the building.
Then funds are raised through a token sale or auction, giving investors a way to determine the building’s initial price.
Then, as the building generates revenue (rent or otherwise), the funds flow into the treasury, where they’re distributed proportionally to token holders.
A Glimpse of What’s Next
Does this sound interesting? This is just the beginning. By integrating more advanced DeFi (decentralized finance) mechanisms, we can create a “fund of buildings”, and combine some of the composability that this technology offers to allow more flexibility.
In further posts, we will discuss each one of those advanced topics in greater detail. We'll cover tokenomics, list some of the active vaults and auto-compounders for managing the funds, and talk about a few challenges like price discovery and regulatory compliance. By examining each of these subjects, we will continue demonstrating exactly how Web3 technologies are impacting real estate investment.
Follow along to learn more!
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