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Real Estate Tokenization: Types and Models Explained

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Real Estate Tokenization
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Investing in real estate has always been popular. The managed real estate market reached $10.5 trillion in 2020. Many investors want to make money on commercial or residential properties, but not everyone has such an opportunity. Property investments require significant capital, and the return on such investment is quite long. Asset tokenization is already used in many areas, and it can be the best solution to simplify and democratize real estate investments. Do you want to know how real estate tokenization works? Read the explanation from Stobox below.

What is real estate tokenization?

Real estate tokenization involves the issuance of tokens with information about objects and placing them on the blockchain. A property is divided into fractions, which opens the way for private investors. Any property can be tokenized. For example, it can be an office building, an apartment, or a luxury resort.

Stobox analysts expect that in 10-15 years, most real estate will be tokenized and transferred to the blockchain. So far, this process is developing at rather slow steps since not all developers understand how real estate tokenization and fractional ownership work. However, it is clear that tokenization will gradually gain momentum as market participants get used to innovative technologies.

What are real estate investment trusts?

A real estate investment trust (REIT) is a legal entity that allows you to make fractional investments in real estate. REITs operate under a special taxation scheme compared to other companies, so investing through such companies is profitable. REITs pay dividends of up to 90%. However, this payment scheme limits the possibility of acquiring new real estate.

REITs also have a certain risk limit. For example, such organizations cannot take on too much leverage. Stobox recommends tokenizing real estate not through REITs since real estate tokens will also provide liquidity due to decentralized finances while having fewer restrictions, so you can get higher returns.

Why should you tokenize your property?

There are many benefits of digital asset tokenization, but two key ones are worth considering today. The first is that the minimum threshold for investment is significantly reduced. An investor may not buy the whole property but only a certain part of it. For example, tokenization allows to divide an object worth $1,000,000 into shares (tokens). The price of each will be $10,000. Each investor can purchase a certain piece of real estate and receive the corresponding profit.

The second key advantage is better liquidity and secondary trading as a result. If an investor is not interested in further receiving dividends and the property’s value has increased, they can simply get rid of their tokens by selling them. There are two options for selling tokens right now:

  • P2P transactions. These are private transactions between two parties, a buyer and a seller. They can find each other through bulletin boards and conclude a deal.
  • Decentralized secondary trading. This is a safer way possible with liquidity pools. In this case, transactions are regulated by smart contracts, that is, the level of fraud is minimal. One of such solutions is DS Swap by Stobox.

From the point of view of a property owner who wants to tokenize a property, the main advantage is that more investors will be interested in the offer. The threshold is lower, the conditions are easier, which means that more investors will be ready to invest in your property. Accordingly, you will receive the necessary funds faster.

Basic real estate tokenization model

Let’s first explore the basic real estate tokenization model. By itself, the token does not give ownership of an asset. If this were the case, investors would need to obtain the appropriate documents for real estate. Because of this, flexibility and the ability to easily exchange can be lost. Every transaction in any state requires entry into the real estate register, so direct real estate ownership is inefficient.

Asset tokenization is not carried out directly. In fact, you get tokenized shares in the company that owns this or that property (it is called a Special Purpose Vehicle). This option is more flexible, as some countries allow securities to be stored on the blockchain. In this case, you do not need to report every transaction to the regulators, which makes it possible for thousands of investors to participate, and an active secondary market opens.

It is important to understand that not only property that is located in jurisdictions that allow the storage of securities on the blockchain can be tokenized. In Switzerland, Liechtenstein, or any other progressive country, you can create a holding company that owns real estate in the desired country or own a company that owns real estate in the desired country. There may be different forms depending on local laws and regulations. Stobox helps to choose the optimal model and jurisdiction during consultations for businesses that are considering real estate tokenization.

What protection is provided for investors?

Security tokens are legally considered securities. Accordingly, they are subject to all legislative norms in force in a particular state concerning securities. In addition, when buying tokens, a special token purchase agreement is concluded. Please note that the Stobox tokenization infrastructure includes the stage of signing an agreement to purchase a token. This document provides additional legal protection.

The owner of the property is always a legal entity. And this also provides additional protection. If the company has all the documents in order, there are no legal problems, then the investors’ rights are also protected. Such companies are required to distribute real estate profits among token holders. If the organization fails to fulfill its obligations, investors can apply to the court.

Advanced real estate tokenization models

In addition to standard tokenization models, there are also advanced ones that can be even more interesting for investors. Of these, the following can be distinguished.

Raise-then-purchase model

One of the major issues reported by Stobox customers is the transfer of real estate from an individual to the company’s balance sheet. This is quite an expensive procedure, and the price can reach 30,000 euros which makes tokenization a more complicated task. One of the solutions is to pass these costs on to investors. However, you first need to raise funds and then buy real estate using income from the sale of digital assets.

It is important to focus on two aspects – obtaining guarantees for real estate purchase and financial attractiveness. The first aspect is solved by concluding a special reservation agreement. The second nuance depends on the value of the property. If it is relatively low, then the premium of 30,000 dollars will be tangible for investors in terms of their profits. However, if we are talking about very expensive projects worth several million dollars, the amount of re-registration will have practically no effect on profitability.

Segregated portfolio company model

A segregated portfolio avoids the need to create multiple companies for each asset. Only one legal entity is enough. As a result, costs can be significantly reduced. However, there are also certain risks like inefficiencies of any objects. If one of the properties does not make a profit, the company will have to pay dividends from efficient real estate objects owned by other investors.

However, this problem can be solved by splitting the balance sheet. The balance, in this case, must be maintained separately for each type of property. Using tokenization, it is possible to issue separate securities for each individual real estate segment.

Summary

Real estate tokenization is one of the best options for attracting investment in real estate. Property owners can attract investments faster and expand the pool of investors by lowering the entry threshold. There are several tokenization models, and each company can choose the one that suits them best. All approaches have their advantages and disadvantages. It is important to study them in detail to choose the best option. An experienced consulting company with successful tokenization cases can help you with that.

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