Tokenized real estate assets—essentially digital shares of properties launched and tracked on blockchain networks—have been around for a few years, but tokenization as a method of raising capital hasn’t yet hit the mainstream of the commercial real estate industry.
Some real estate firms, however, are partnering with established fintech providers to utilize digital shares (tokens) and alternative trading systems to facilitate their offerings and investor liquidity.
“Creating the option of tokenization is really the icing on the cake,” says Brent Reynolds of Nolan Reynolds International, which recently launched their first deal with a tokenization option on the CrowdStreet Marketplace. “It gives the investor control over when and how much of their stake they sell, but with the stability of a traditional real estate deal.”
The vast majority of real estate investments require investors to hold their investment throughout the project’s full term, with realization only when the sponsor decides to refinance or sell the property. Another way for investors to realize their investment sooner and at their determined price is by selling shares on the secondary market via a stock exchange or alternative trading system (ATS). However, the traditional secondary market is inefficient and expensive, with multiple brokers, transfer agents, custodians, and service providers collecting fees and running processes, resulting in settlements that take at least three days, incur high transactions costs, and provide limited real-time pricing information, rendering those markets useful only for very large publicly-traded REITs.
Blockchain provides a technological advantage in this environment. Issuing and trading shares in blockchain form—tokens—enables streamlining and automating the process, eliminating the need for many of the expensive service providers, and improving trade speed and security, and price transparency. As fintech firms launch their ATS systems to enable investors to efficiently buy and sell tokens on the secondary market, we see an opportunity for significant growth in the secondary markets, making it possible for a larger range of real estate investments and real estate investors to benefit from liquidity options beyond the sale or refinance a real estate project. Tokenization and ATS markets can put more control in the hands of investors.
When a sponsor conducts an offering to raise capital for a real estate project, they can issue the shares in token form or they may elect to convert the shares into tokens in the future. They also may offer investors the opportunity to exchange shares for tokens in an upstream entity. The initial investment process for a crowdfunded real estate deal with tokenization is exactly the same as one without the option to tokenize. Initially, the difference will not be obvious to an investor. Sponsors may then complete required regulatory steps to enable private or public trading of the tokens, or offer investors the opportunity to exchange their shares for tokens of another entity that has completed those regulatory steps. The token is simply a digitized share and has the same economic rights as any other share. Once an investor’s share is tokenized, the tokens are recorded digitally on a blockchain and can be sold on secondary markets through the ATSs. Investors can then decide to sell all or part of their interest when they choose. They can also opt to hold onto their tokens for the entirety of the investment hold period, and receive their share of distributions throughout the lifecycle of the investment just as with a non-digital share.
Unregulated cryptocurrencies like Bitcoin and Ethereum use blockchain technology to facilitate payments and transactions, and they generally are not treated as securities by the Securities and Exchange Commission (SEC). On the other hand, digital shares offered by sponsors on the CrowdStreet marketplace are regulated securities and therefore come with investor protections, even though the tokens themselves are held on a blockchain ledger. Whereas Bitcoin and Ethereum are pseudo-anonymous and can be held by anyone, digital securities are only permitted to be held and transferred to parties who have undergone rigorous KYC/AML to ensure their eligibility.
Unregulated cryptocurrencies like Ethereum and Bitcoin trade on crypto exchanges that are not authorized by the SEC or Financial Industry Regulatory Authority (FINRA). Tokenized digital shares and the ATSs that trade them are subject to U.S. securities laws, including regulation, oversight, and approval of the SEC, FINRA, and other state and federal agencies, anti-money laundering rules, and other laws, just as they do with shares that have not been tokenized. Likewise, companies who issue the tokens rely on transfer agents to appropriately document the identities of shareholders. Ironically, the same technology that enables pseudo-anonymity for cryptocurrency is especially useful for providing transparency of ownership and secure transactions for digitized shares.
Looking forward, we expect that more firms will experiment with offering tokenization and facilitating secondary trading over the next few years. However, giving investors the option to tokenize and sell their share of a real estate deal is unlikely to be the norm anytime soon—because it’s a newer concept, there’s no one roadmap to set up a tokenization option, and the majority of commercial real estate firms still need to figure out the process for themselves. Successful secondary trading markets will depend on growing demand. But if investors take advantage of tokenized deals from early adopters, demand may push more sponsors to take the leap, which may drive a more streamlined process to tokenization.