Tokenisation of real estate: an untapped opportunity?

The tokenisation of real estate has been discussed for some time, including by large investors. So far, it has not come to fruition on a large scale, even though the technology is available. The Land Registry ran a successful ‘proof of concept’ as part of its Digital Street research and development project a few years ago. In this series, we will first explore the significant potential benefits offered by tokenisation. In subsequent articles, we will consider some of the legal and regulatory considerations that may be hampering adoption, and propose a way forward to realising those gains. Tokenisation, in this context, involves representing ownership or investment in a real estate asset in the form of a blockchain-based “token”. The token is issued by a blockchain system, and every action taken in relation to that token, including transfers, is recorded on the same system. For real estate, tokenisation offers a way to fractionalise ownership of these typically large, high value assets, and to introduce efficiency and automation into aspects of transfer and sale. The democratisation of real estate and the creation of more accessible investment opportunities for individuals are also often touted as potential benefits of tokenisation. Moreover, increased liquidity would reduce a perceived drawback of this asset class compared to others also competing for available capital. Blockchain technology Blockchain systems have the benefit of being transparent (anyone with appropriate authorisation can see the records) and very secure (it is difficult to tamper with or change the records). The system can, therefore, offer a reliable register of token ownership, while enabling visibility of its past ownership. In the Land Registry’s Digital Street project, two types of token were issued. A “title token” was issued to the registered owner of a property, mirroring the traditional title deed registered on the Land Registry. The holder was then able to issue security tokens linked to their title token and representing a share of the property. The title token holder could decide on the terms of issue of the security tokens, including the price and how many to issue. The related security tokens were issued, traded and managed on a blockchain. Blockchain systems can also support so-called “smart contracts”. These are automated processes embedded into the blockchain system and are triggered by events or actions logged on it. Tokenisation can, therefore, offer a new way to record ownership and transfer, and can be combined with automation of processes to deliver greater efficiency. Although tokenisation uses technology originally devised for the creation of cryptocurrency, tokenisation of real estate would be a very different proposition. The value of real estate tokens would be very clearly pegged to a real-world asset. Unlike some crypto-assets, the drivers of value of the underlying asset would not fundamentally change and real estate tokens should not be subject to the extreme volatility of many cryptocurrencies. Flexibility of structuring These systems can be built from scratch or on one of the existing blockchain systems using existing protocols – for example, the Ethereum system was conceived as a form of infrastructure for third party blockchain projects and can carry both tokens and smart contracts. The functionality of blockchain applications is not predetermined but can be shaped as needed for the project in question. An asset owner can decide on how private or public to make the token register for that asset, what processes to automate, whether to add additional information to the blockchain for the benefit of token holders, how to structure the trading of tokens, whether to allow further sub-division of issued tokens, the rights and obligations attaching to token ownership, and so on. While in future, standardisation of tokens might emerge, pioneers in this early innovative phase can shape tokens to match their commercial objectives and priorities. The combination of transparency, security, automation and flexibility is a powerful proposition. A recent French project to test using blockchain infrastructure for land transactions delivered faster transfers with reduced paperwork and much greater efficiency of process. On the flip side, potential purchasers of tokens will need to be clear about the rights and obligations that a particular token carries – we have seen buyers fall foul of this issue in relation to “non-fungible tokens”, for example. Democratisation of real estate Real estate assets are typically high value and, therefore, out of reach for private retail investors. They are also relatively illiquid, partly because of the scale of investment needed, and partly because of the complexity, cost and slow pace of real estate transactions. Equally, real estate is seen as a reliable investment – both as a safe place to invest capital and because of an expectation of reasonable growth over time. As a result, it is typically a key part of the asset mix in any investment strategy. There is a strong perception of untapped demand and funds, particularly from retail investors, that could be accessed by offering investment opportunities on a much smaller scale. Tokenisation could deliver democratisation of real estate investment by opening up these opportunities to those who would otherwise be unable to afford or consider this asset class. It could also address the affordability challenges of real estate for younger people, giving them a way to invest in land and enjoy the potential capital gains, on a smaller scale. A single source of truth Tokenisation could also reduce transactional administration and paperwork. Real estate transfers are known for being due diligence heavy and subject to extensive formalities. Due diligence could be simplified by logging key information about the underlying asset onto a blockchain. Past attempts to simplify property information searches (for example, residential home information packs) failed in part because of a lack of trust by purchasers in the information they were being given. Blockchain structures were originally conceived to do away with the need for a trusted counterparty or intermediary: the extreme difficulty of tampering with information recorded on the blockchain means that it can be relied on, whether counterparties are known or not (subject, of course, to having robust procedures in place to ensure that information to be logged is true and complete). It would be possible, therefore, to simplify purchaser due diligence by ensuring that key information about the asset is lodged on the blockchain and kept up to date (ideally by the issuing organisation, not the token issuer). The blockchain could also carry regular updates on the performance of the asset, including environmental performance, energy efficiency and asset condition, enabling token holders to manage their investment. As management of real estate digitalises, so the opportunities to share data increase, provided that a collaborative approach is taken. In this way, the blockchain could pull together a range of key information about the underlying asset and become a “single source of truth” for investors and potential token holders. Automation of transactions Transaction processes could be simplified using automation, for example through self-executing smart contracts. These typically operate on a simple “if then” basis. For example, if a fee of £x is received, then the potential purchaser will be given access to due diligence information. If payment is received, the transaction will complete. If the transaction completes, notification will be sent to the Land Registry. Moreover, automation can remove or reduce risks flowing from human error – misspelling a surname, missing a registration deadline, or errors creeping into a plan that has been copied many times. Switching to a more automated asset management process and creating a single source of truth would reduce errors and deliver important mitigation of business risk. Potential gains For all of the above reasons, there are significant potential gains to be delivered by the tokenisation of real estate. However, while blockchain technology may not currently be regulated in itself (in the UK at least), certain blockchain applications are indeed regulated. In the next article in this series, we will explore how financial regulation applies to security tokens, and how land law formalities can combine to deter potential tokenisation innovators. Ian Wilkinson is international sector leader for the built environment; Ian McKenzie is head of blockchain and tech in the built environment; Xavier Pican is international blockchain chair; and Catherine Hammon is digital transformation knowledge lawyer at Osborne Clarke Photo © Jonathan Raa/NurPhoto/Shutterstock