When the tokenization of commercial real estate truly does come to fruition, there is little doubt it will radically change the investment landscape. Once implemented on a larger scale, tokenization will lower the barriers to entry for potential investors, provide a new source of equity financing for owners, increase liquidity of assets, improve transparency through the use of a blockchain-based system, and streamline a multitude of time and money consuming processes.
But for all of its potential, industry experts acknowledge that tokenization as a real force in investment sales still has a long way to go.
“I think the concept of private real estate being traded on the blockchain like stocks is a thing of beauty,” says Gary Brandeis, 30-year CRE veteran, proptech evangelist, and president of Vertalo, an SEC-approved digital transfer agent providing blockchain-based software as a service (SaaS) solutions for investors. “It will be a seismic shift in what we can do in the private real estate markets and it’s going to happen, but we’re not as far along as people are being led to believe.”
In simple terms, tokenization of commercial real estate is the process of fractionalizing a real estate asset into smaller micro-shares known as digital tokens. The tokens are created via an Security Token Offering (STO), with the total value of all of the tokens equivalent to the total value of the securitized asset (or the portion of the asset that has been set aside for the STO). The tokens are tradable assets stored on a blockchain—much like stocks issued on the stock market following an IPO. The blockchain is essentially a digitized and distributed ledger for managing recorded transactions that are shared on every computer connected to a blockchain network, in a way that makes it nearly impossible to change, hack, or corrupt the data
"There’s a recordkeeping element to blockchain that makes it better and more valuable than the way we do it today, and that’s one reason that this is definitely the wave of the future."
“There’s a recordkeeping element to blockchain that makes it better and more valuable than the way we do it today, and that’s one reason that this is definitely the wave of the future,” says Geoffrey Kasselman, SIOR, and partner at national real estate development and investment firm CRG in Chicago, who has been at the forefront of the digital revolution in commercial real estate since the beginning. “Blockchain eliminates the central body of trust, such as a bank or a government, and it puts the control of the data as it pertains to the topic in the hands of its stakeholders.”
Liquidity – There are a myriad of benefits to tokenization, but increased liquidity is the one generating the most excitement. Fractional ownership “democratizes” access to real estate investing, making it accessible to smaller dollar investors while distributing and minimizing the risks and labor involved with owning a property. It also provides a much larger pool of investors for developers of properties. “Tokenization creates a liquidity and/or a monetization opportunity for a property owner,” says Kasselman. “If they can’t raise money in a more traditional way or in lieu of raising money in a more traditional way, this could be a new way to raise capital.” It also allows investors large and small to diversify their portfolio, investing across the asset spectrum instead of a single property to reduce risk.
Efficiency – Another benefit is the reduced costs that would come with transacting on the blockchain versus traditional investment modes. Deploying smart contracts in tokenized real estate investments eliminates the middleman for a number of processes, allowing peer-to-peer only transactions to take place. (A smart contract is a self-executing contract with the terms of the agreement between buyer and seller directly written into the lines of code.)
Transparency – Decentralized blockchains are immutable, which means that each and every transaction recorded is irreversible. All of the transactions are verified, cleared, and stored in a block that is linked to the preceding block, creating the chain, so investors can look at the token’s history and pricing, as well as other transaction details at any time.
With all of the clear advantages that tokenization of real estate has to offer, then why hasn’t it gained traction with commercial investors?
In 2018, in what is largely recognized as the first major test case of tokenization, Elevated Returns—the ownership group behind the St. Regis Aspen Resort in Colorado—sold off 18.9% of their asset through the sale of digital tokens, dubbed Aspen Digital. Tokens were $1 each, with accredited buyers needing to purchase at least 10,000 at minimum. (The tokens, which are not registered with the SEC, represent common stock with no voting rights.) The sale was expected by some to herald the start of a new age in CRE investing, but that revolution has not materialized.
According to the Security Token Market Real Estate Report for May 2022, the market cap for St. Regis in May 2022 was $16.74 million, down from the initial $18 million offering, with a trading volume of $17,435.81 for the month. The Tokenized Real Estate Market Cap for the entirety of the market is just $53,752,509.03, according to the report. There have been other projects—including one launched in January by Alterra Worldwide—which issued 100 million tokens at $1 each for Tower 27, a mixed-use 24-story, 374-unit, Class A multi-family residential project in San Jose, Calif. with commercial space—but those tokens are not being actively traded.
"There’s a really large gap between the hype from the tech companies and the reality of the real estate world."
“There’s a really large gap between the hype from the tech companies and the reality of the real estate world,” says Brandeis. “The big idea is taking private assets, creating a digital representation of ownership, putting it on the blockchain, and being able to trade that token for cash. So liquidity, fractionation, democratization of real estate – that’s all part of the end game for tokenization. The problem is, we have a lot of work to do to get there. Not only on the totality side, but on the real estate side, and the regulatory side—the SEC and the IRS, because there is no platform, no regulatory environment for securitized tokens. So a lot of things have to fall in place for tokenization to actually work.”
In her excellent white paper for USC Gould’s Business Law Digest, “Tokenization of Real Estate: Revolutionizing Real Estate through Digitalization and Reduced Market Barriers”, author and law student Christina Mkrtchyan opines that regulation “poses the most significant hurdle to real estate tokenization.” Because tokenization is a relatively new investment form, she writes, regulators have yet to establish a clear and consistent framework to follow. While some regulators view real estate tokens as securities, others categorize them as real property investments. For example, the SEC categorizes most tokens as securities, the Commodity Futures Trading Commission considers some tokens to be commodities, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network categorizes some tokens as currencies, and the IRS considers some tokens to be taxable property.
CPA Brian MacFarlane, an audit senior manager with the Real Estate Services Group at accounting firm EisnerAmper, emphasizes the virtual token issuers must be careful to comply with all laws and regulations wherever they offer their tokens. “The steps that issuers may have to take include actively verifying that investors are accredited, and as virtual tokens are subject to more than just regulation as securities, some tokens may also be regulated under anti-money laundering, money-service laws and regulations, and general anti-fraud and consumer-protection laws. So issuers and investors should consult the appropriate legal representation and tax professionals to develop a complete strategy.”
And it’s that lack of clarity that has investors shying away—for now.
“Right now, the tokenization rules are kind of the wild west,” says Kasselman. “While tokenization democratizes real estate investing, who’s protecting you? Who’s regulating the seller of the token? Who’s making sure that if you lose your money there’s some sort of a safety net? Because right now there’s none. So before this market heats up at scale, there has to be some discussion by Congress or other regulatory body on how this is going to be treated. Is it a real estate transaction or a financial transaction? How is it taxed (if at all)? Who has oversight? There are the big decisions coming down the pike.”
Kasselman predicts that tokenization will remain “nickel-and-dime stuff” for the foreseeable future as the players figure out what the regulatory environment is going to be and “what will work at scale—and what won’t,” but affirms that no matter what benefits new technologies offer, the fundamentals of CRE investing are still the same. “It’s still location, location, location and the other components of strong fundamentals that have nothing to do with tech. People are going to want to buy tokens in properties that are well located with good cash flow and that can stand the test of time.”
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
Geoffrey Kasselman, SIOR