Commercial Real Estate Asset Tokenization: How It Works and How to Build

Tokenization of commercial real estate transactions will reduce transaction costs from 30% to 2%, entry barriers for investors from $200,000 to $100 and reduce the time for conducting operations from 1 month to 1 click. In this article, we will look at...

Table of Contents

#1. What is tokenization
#2. How to carry on tokenization
#3. Case 1: Residential sales
#4. Case 2: Real estate investment
#5. Case 3: Early Construction Financing
#6. What are the benefits of tokenization
#7. Liquidity
#8. Programmability
#9. Immutability
#10. What you need to remember when conducting tokenization
#11. Lack of legal infrastructure
#12. Tokenization does not mean instant liquidity
#13. Always remember about KYC & AML

Tokenization of commercial real estate transactions will reduce transaction costs from 30% to 2%, entry barriers for investors from $200,000 to $100 and reduce the time for conducting operations from 1 month to 1 click. In this article, we will look at examples of how tokenization works and how to do it yourself.

What is tokenization

This is the transfer of accounting and asset management (individual buildings, premises and directly related cash flows) into a digital format, where tokens symbolize the digital certificates of these assets.

Now for tokenization is used blocking technology, because it increases the reliability and security of data, and also makes it possible to automate certain processes. But some restrictions are imposed on tokenization:

  1. Rights can be recorded in digital form. If it is necessary to tokenize an apartment, its owner must be able to assign the ownership of real estate and the cash flows generated by it to a digital marker. This requires laws and infrastructure that allow you to work with digital certificates of ownership.
  2. Rights can be transferred via the blockchain. This means that transactions conducted through the blockchain must have legal force, and immediately after the sale of tokens, without the "paper" procedures.
  3. Tokens can be easily exchanged for a real asset. The owner of the tokens must be able to exchange them for an asset that they symbolize.

How to carry on tokenization

Essentially, tokenization is the same securitization (a form of attracting investment by issuing securities), but tokens are used instead of stocks and bonds. The process of tokenization of commercial real estate can be presented in the form of three steps:
  1. The property owner creates a digital certificate of ownership of the object or a cash flow directly related to it (for example, a mortgage loan or rent). This is done using specialized platforms such as Securrency, Harbor, Atlant, Polymath, Alt.Estate, Jointer, Securitize and Swarm.
  2. The intermediary structure produces limited emission of tokens, each of which is a digital share of ownership of the tokenized object.
  3. After the emission tokens are sold to investors.
Let us consider this process on the example of three cases, each of which represents a typical real estate transaction.

Case 1: Residential sales

Suppose you own a property worth $ 250,000 and you need to sell it through tokenization. We will do this on the example of cooperation with the Alt.Estate platform (this is not the best platform, the authors chose it by chance).

The tokenization process on Alt.Estate is as follows:

  1. The owner or his representative submits an application to Alt.Estate. In the application you need to specify the main characteristics of the property and the details of the owner.
  2. The object is being tested and estimated cost. This is done by an independent contractor who is chosen by agreement of both parties.
  3. The platform tokenizes real estate, dividing it, for example, into 1,000 virtual parts. 1,000 tokens out, each worth $ 25.
  4. Tokens put up for sale. Trading takes place on the Alt.Estate marketplace. The starting price is $ 25 per token. Then it will be formed on the basis of the balance of supply and demand.
  5. Investors buy tokens, becoming co-owners of the property being sold. If they want to sell tokens, they simply need to put them on sale again.

Case 2: Real estate investment

Now imagine that you are the owner of a building with office space that is leased. The building you have is old and has not been repaired for a long time, because of which the rent brings little profit, while the competitor in the neighborhood shovels up money. To increase the rates, you need a major overhaul, but, alas, there is no money for it.

To finance the repair, you decide to perform tokenization. This process proceeds according to the same scenario as in the case of a sale, except for the following points:

  1. Tokens do not give ownership of an asset. They give the right to part of the rental income or fixed dividend payments.
  2. The right to dispose of the building remains with the owner.
For buyers, tokens are an investment asset, and a risky one. The problem is that the owner can raise money, make repairs and then sell the building, leaving investors with nothing. You can also set low rates, which will lead to a decrease in the yield of tokens and, consequently, to a decrease in their prices. This will allow the owner to buy tokens at the lowest prices, after which the rates can be raised to the market level.

The issuer can raise the attractiveness of such investments by undertaking not to sell real estate or act against the benefits of investors. You can also enter limited asset management, for example, in the question of the choice of rates and tenants. Or delegate control to a third party.

Case 3: Early Construction Financing

The most difficult thing in construction is to get the first 20% of financing. Because of this starting threshold, many developers are forced to conduct lengthy, tedious negotiations, pay large commissions, mortgage personal property - do everything in order to convince investors of their honesty and prospects of construction.

Commercial Real Estate Asset Tokenization Investment scheme

Investment scheme for early construction of a BitRent startup

If you use the experience of tokenization and the initial offer of coins, it will be much easier to collect money. Developers will simply launch for each new construction a separate ICO with their tokens and sell them on the financial markets. This will reduce the entry threshold, which will increase the number of investors.

You can conduct such a crowdsale at the BlackSquare.io site. Their experts recommend doing it in three stages:

Stage 1. Private pre-sale

As in the case of traditional ICOs, the initial offer during real estate tokenization is better to start with closed sales for large investors. This approach will help to understand whether the project has prospects: if investors are interested, the crowdsale can be continued, if not - it’s better to close it.

At this stage, 5–10% of all token emissions are sold. Investors are either invited privately or they written in the whitelist. In the latter case, those wishing to, as a rule, are screened out according to certain criteria: passing KYC&AML procedures, accredited investor status, a significant minimum threshold for entry, and so on.

Stage 2. Pre-sale

Upon successful completion of a private pre-sale, the project is presented to more investors. More public information on construction is given, details of the investment transaction, data on contractors, etc. are announced.

During presale, 60–75% of tokens are sold. If the project initiators are confident of success, they continue to work with the whitelist, if not - open sale is announced. This removes most of the restrictions and decreases the minimum threshold for entry.

Stage 3. The main crowdsale

The last 15–25% of tokens sell openly and usually without any barriers to investors. This is necessary to draw attention to the project and reduce marketing costs: you can run bounty campaigns and airdrops.

What are the benefits of tokenization

Liquidity

According to the World Economic Forum, by 2025 more than 10% of global GDP will be nominated in cryptocurrency assets, which will be over 10 trillion US dollars. Moreover, most of these assets will be associated with equity ownership and liquidity premiums.

So, tokenization will allow to break the value of the property into hundreds or millions of tokens, which can be further divided into eighteen decimal places. Thanks to this, even the most expensive real estate can be virtually divided into shares (tokens), which will cost a penny.

Commercial Real Estate Asset Tokenization New World Trade Center

The skyscraper New World Trade Center (1WTC) was built on the site of the twin towers destroyed as a result of the September 11, 2001 terrorist attack

For example, if tokenisation of the New World Trade Center skyscraper in New York, which is estimated at $ 4 billion, dividing it into 1 million tokens, then the minimum threshold for investing will be only $ 40. At the same time, tokens can be sold without cross-border restrictions.

Studies show, that such changes increase the market volume by 20–30% due to the disclosure of its value through “liquidity premiums”. This growth will be a direct consequence of the opportunity to invest in real estate in any country from anywhere in the world, which can be accomplished, including through equity ownership.

Programmability

Programmability in the case of tokenization means the ability to embed simple business logic into smart contracts, so you can automate most of the workflow. This will facilitate the management of both real estate and investment.

Programmability is especially useful for:

  1. Implementing management rights. Thanks to the blockchain and smart contracts, tokens holders can make consolidated management decisions, being in different parts of the world, not knowing each other and not putting a single stamp or signature in any document.
  2. Payment Automation. Having written into the smart contract the formula for distributing profits from the sale of real estate or renting it out, there is no doubt that payments will be made on time and honestly.
  3. Operation speed. Traditional ways of managing commercial real estate are tied to long bureaucratic procedures that take months. On the blockchain, such procedures take minutes.

Immutability

The data in the blockchain cannot be changed or deleted, and the transaction details leave a public footprint. This allows you to confirm or track your ownership history and avoid fraud and mistakes.

What you need to remember when conducting tokenization

Lack of legal infrastructure

Tokenization is the creation of a digital security that falls under the jurisdiction of the US Securities and Exchange Commission. To conduct tokenization, it is necessary to register the emission of tokens, obtain permission and act within the law.

What kind of law depends on the specific tokensale (the value of the object, who is allowed to invest, whether there will be progress and what) and the rights that tokens give. This is covered in detail in the DAO Case Report and SEK’s warning about blockchain-start-up fraud.

Tokenization does not mean instant liquidity

Having the opportunity to purchase a token does not mean that it will be bought today or tomorrow. There is still no central market or markets in which one could find information about all real estate tokens. There are only separate sites with an audience of one or two hundred thousand users and a small list of tokens.

Commercial Real Estate Asset Tokenization Comparison of sites

Comparison of sites that are engaged in real estate tokenization

It is necessary to create liquidity at this stage of market development in the old way - with the help of advertising. In this case, the marketing strategy should be chosen very carefully, since promotion in a foreign country is risky, and advertising around the world will even ruin Bill Gates.

Always remember about KYC & AML

KYC, or Know Your Customer is an identification procedure, which is carried out to make sure that there are no scammers, criminals, fakes among investors. If you took a loan from a bank, then KYC also passed when employees scanned your passport or took photos with the document.

AML, or Anti-Money Laundering is a verification of personal data on Politically Exposed Persons (PEP) and other lists of potentially dangerous users, where they analyze information about citizenship, visiting countries at high risk of terrorist threat, looking for signs of possible money laundering, financing of terrorism or theft of personal information.

If you conduct tokenization in the USA, then you are obliged to conduct KYC & AML. Independently or with the help of third-party specialists, for example, through the Cryptonomos or Bitcoinsuisse.ch platforms.

There is no single standard for the requested information, but usually:

  • Full name, passport data;
  • country, city, postal index;
  • place of residence or address of registration;
  • mobile and / or landline number.

To verify the authenticity of this information are also asked to send:

  • photo or scan of your passport, driver's license or ID card;
  • selfie where you keep the document near your face;
  • paid utility bills.

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