Of all the innovations disrupting the business of commercial real estate, blockchain technology may be the most revolutionary of all. A bold statement, perhaps. Yet, when you consider the number of steps and parties involved in executing every CRE financial transaction, the use of blockchain technology in the transaction process is a fundamental disrupter. By automating key aspects of the investment transaction process, blockchain technologies have the power to radically accelerate and transform the business of CRE investing.
Blockchain and the related technology of the digital security token can deliver CRE transactions with speed, security, transparency and efficiency—and the ever-important securities regulatory compliance. To understand how, start with what we mean by “blockchain.” As its name suggests, a blockchain is a database of digital blocks of transaction data, each block timestamped and connected to the previous block via secure programming. Each data block is highly secure and impossible to alter or erase, making blockchain a highly efficient way to store transaction documents such as property deeds, mortgages and shareholder agreements.
Think of blockchain as a digital ledger. But, instead of the digital ledger belonging to a single server and a single owner, it is replicated and stored on multiple servers all networked together. When a new data block is added to the chain, all the server nodes automatically update themselves to maintain identical copies of the ledger. So, there’s no human argument about who owns what share of a property, or who has the final version of paperwork—it’s all recorded in the blockchain ledger.
Reducing the cost of trust
Trust is fundamental to any real estate deal. To maintain trust throughout the process, a traditional financial transaction requires each party in the process to maintain their own paper and/or electronic files of relevant documents. Buyers, sellers, investors, real estate developers, lenders, appraisers, attorneys, title companies—all will spend significant time on emails, phone calls, secure record-keeping, filing, title searches, legal agreements and more to close and record the transaction. After this lengthy process, disputes may often arise.
From attorney fees to lost property income or sales proceeds, CRE investment disputes are costly. That’s why attorneys, notaries and government regulators are generally involved in investment transactions—getting it in writing is the cost of ensuring trust.
Using the distributed ledger of the blockchain drastically reduces the time and cost spent on ensuring trust. Since updates to the digital ledger are independently recorded by each node and the ledger is 100% reliable, blockchain-based transactions reduce the involvement of attorneys and regulatory compliance authorities whose jobs are to build trust into investment agreements.
Need to confirm the chain of title? Want to verify that Joe Moneybags should receive 75% of the sales proceeds for a property? It’s in the blockchain. Because it’s decentralized, a blockchain enables every participant in the transaction to safely create and share the same data. It’s ideal for documenting payments and financial records for CRE transactions.
Automating critical tasks—in compliance with securities laws
Another blockchain technology superpower is its ability to support “smart” contracts—digital contracts that not only record the terms of a deal, but also automatically execute tasks like distributing investment proceeds and loan payments to investment participants. Ethereum, with its cryptocurrency Ether, is an example of an entire blockchain platform that supports highly sophisticated automated operations.
Since Ethereum is an open source blockchain platform, software developers anywhere can build and deploy applications on the Ethereum network to do everything from computing complex financial transactions to managing confidential healthcare data subject to privacy regulations.
Of great significance to CRE, Ethereum supports highly customizable “smart contract” applications that execute important parts of a blockchain-based transaction. A smart contract can, for example, automatically record new ownership of an asset to the blockchain, ensure that a transaction is executed in compliance with applicable laws, automate distribution of investment proceeds and loan payments, and perform many other complex functions quickly and accurately.
Delivering liquidity to an otherwise illiquid business
As every seasoned CRE investor or lender knows, getting into a CRE investment can take some time. Getting out can take even longer—months, or even years, if a property is outdated, poorly located, oddly configured or has other issues. In fact, the illiquidity of investment real estate is why some investors stick to stocks and bonds. Fortunately, blockchain technologies can solve this problem, too.
Specifically, Ethereum or possibly other blockchain platforms can be used to create security tokens that represent ownership in some kind of asset or interest. In the case of CRE investment, a security token could represent a 100% or fractional ownership interest in a CRE debt or equity investment instrument, and would replace paper documentation of the ownership interest. And, a token can have a built-in smart contract that will accurately execute the terms of the ownership stake.
The beauty of security tokens is that, being digital, they can be easily bought, sold and exchanged—just like stocks. No more waiting around for the lawyers, appraisers, notaries, lender and everyone else to do their part—tokens with built-in smart contract capabilities will take care of all that and generate create real-time auditable records that help reinforce trust. Voila – a secondary market comes to life for CRE investments.
Soon, a CRE investor will be able to use a blockchain-based trading platform to access a wide range of CRE debt and equity opportunities involving nearly any type of commercial property. And, investors will be able to use the platform to quickly trade tokens directly with each other, assured that their tokens will accurately allocate and distribute rental income and dividends on equity, direct payments to lenders, and execute any number of other financial tasks.
Streamlining across the middle
With the ability to trade CRE investment instruments on whim, who will need lawyers and brokers? While CRE will always have actual humans performing some transactional roles, investors trading tokens on a blockchain-based trading platform with each other will have fewer reasons to call a lawyer or a broker. Instead, the trading platform will automate the critical tasks and record the results in the secure digital ledger.
The role of banks also will change on both the front and back ends of CRE investments. On the front end, a token-based trading platform would be a boon to banks and other institutional lenders and investors in search of CRE investments worthy of a loan or equity placement. Financial professionals can simply take a look at the array of tokens on a blockchain trading platform and purchase those that meet their lending or investment goals.
On the back end, blockchain streamlines the meaty part of CRE investment: disseminating payments to token owners. With built-in smart contracts and processing capabilities, tokens eliminate the need for banking and accounting services to service debt and equity agreements. That may be bad news for servicers, but it means greater accuracy and reliability for investors.
It’s not “whether or when”—the technology is already here
Contrary to popular perception, blockchain and tokenization aren’t speculative technologies. These technologies are already in place today, and we’re going to see greater adoption as the CRE industry becomes more familiar with the advantages of the blockchain. Throw out the filing cabinets—the blockchain has it covered.