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The Excitement and Confusion of Real Estate Tokenization

Despite the recent downturn, investors worldwide are still interested in digital assets like cryptocurrency. But despite the excitement, some confusion still reigns in these nascent markets. A majority of U.S. adults have heard at least a little about cryptos like Bitcoin or Ethereum, and a recent Pew Research Center survey revealed that 16 percent of American adults have personally invested in, traded, or used crypto. American men between 18 and 29 are especially likely to have used cryptocurrencies. While an increasing share of people is interested in digital assets, much of the field is largely unregulated and bound to confuse some folks.

A good example of this confusion is the differences between real estate tokens and cryptocurrencies. “The word tokenization has been used far and wide, and there’s so much ambiguity that people get things mixed up,” said Drew Sterrett, Co-Founder and Co-CEO of LEX Markets. “Tokenization has been used to describe so much. It’s become a catch-all phrase.”

While LEX doesn’t offer tokens, it does offer an innovative way to invest in
commercial real estate without purchasing a whole building. Sterrett has extensive experience in real estate investing, and his company, LEX Markets, fractionalizes ownership in individual real estate properties. LEX currently has a handful of properties listed, and as long as you have a brokerage account, you can sign up and invest.

Sterrett told me this confusion between crypto and real estate tokenization has consequences because some people may attach crashing Bitcoin prices with efforts to tokenize real estate. He said crypto has run wild, and the ones crashing spectacularly right now are working in an unregulated place. Federal lawmakers are currently working on crypto regulations and deciding how exactly to do it. But in the meantime, Sterrett said it’s “been like the Wild West.”

What’s real and what’s not?

So, what’s the difference between crypto and real estate tokens? Cryptocurrency is a native asset of a blockchain network that can be traded, used as a standard of exchange, or as a store of value. Basically, a cryptocurrency has the information of its chain of ownership embedded into it and can be put on an exchange in order to be traded or exchanged for fiat currency. 

Tokens are a different digital asset class than crypto. Tokens, like cryptocurrency, can store value and be traded, but they can also be designed to represent ownership of other things, such as real estate. Creating tokens representing a property or a piece of real estate is known as tokenization.

Tokenization is a relatively new term describing a process called securitization where investments are broken down into smaller pieces in order to make them easier to buy and sell. The shares are known as “security tokens,” and they’re secured through blockchain technology and then made tradeable on crypto exchanges or other exchanges.

Regulation with real estate tokens is also more straightforward than in cryptocurrency. With real estate tokenization, everything must go through the SEC because tokens are considered securities, much like the physical assets that they represent. Tokenizing real estate assets is mostly about making investments more accessible to a broader pool of investors. 

Sterrett said big financial institutions may not be doing as much real estate tokenization now because they’re trying to evaluate what’s happening with digital assets, and there’s so much noise. “They have dedicated teams looking into this,” he said. “They want to know what’s real and what’s not.”

While the “crypto winter” has commenced and prices are crashing, Sterrett explained that prices for building stocks on LEX Markets have been stable. “LEX stocks are inversely correlated with the market right now,” Sterrett said. “As the markets have moved down, the stocks for our buildings haven’t.”

Shares are available on LEX for 286 Lenox Avenue, a commercial office and retail property located in New York’s Harlem neighborhood. (Source: Goodbye Waitlist. Hello 286 Lenox Ave (lex-markets.com)

The stock and crypto markets have been incredibly volatile, but real estate tokens are tangible assets and are often shielded from volatile swings. It’s easier to understand a tokenized real estate asset than a cryptocurrency because the buildings have income and can be compared to other similar assets. “It’s based on physical asset value,” Sterrett continued. “The asset value won’t drop from $100 million to $50 million overnight.”

A tokenized future

But the question remains, why tokenize real estate in the first place? Real estate investment trusts (REITs) already exist, which are a way to fractionally invest in real estate assets without actually owning a building. A significant difference between tokens and REITs is that REITs invest in a pool of real estate assets, while tokens are investments linked to specific properties. REITs are currently a more accessible option for most retail investors, but token exchange platforms could develop in the future similar to app-investment companies like Robinhood that would challenge traditional investment brokerage.

Tokenization advocates say one advantage is that it removes the middle man, making it easier to buy and sell real estate and for owners to raise capital. Investors can trade tokens almost instantly and usually for very low fees. For building owners, tokenization also makes it possible to raise capital without financial intermediaries to underwrite projects.

Tokenization can also democratize real estate investing by removing entry barriers for small investors. With tokenization, assets are divided into smaller amounts, and transactions occur virtually. Investors can also invest in real estate without the headaches of the legal process of transferring ownership. DJ Scruggs, Founding Member of REI DAO, a collaborative real estate investing platform, explains that much commercial real estate work can be unbundled, and tokenization can unlock potential in the real estate market. “Instead of hiring an investment relationship person, the person can get an ownership stake,” Scruggs said.

Many commentators also point to tokenization’s potential to solve liquidity problems in real estate. Traditionally, various parties must be involved in the legal transfer of real estate assets, and tokenization drastically simplifies buying and selling properties. Without the middleman, ownership stakes can be traded and transferred directly from investor to investor.

Scruggs agrees that tokenization may eventually solve commercial real estate liquidity issues, but it’s too early in the game to see the results. “The platforms are all promising liquidity, but the vast majority of people hold onto their investments,” he said. “If you’re expecting liquidity, the only time it is really worth measuring is if it’s in the tens of thousands of assets.” Scruggs said there usually isn’t as much frequent activity and liquidity as one would expect, and tokenization platforms promise, though that may not be the case in the long term. “If you are thinking about real estate tokenization, get into it now, so you’re ahead of the game,” Scruggs continued.

Perhaps the most significant advantage of real estate tokenization is the increased transparency from blockchain technology. The distributed ledger where tokens are stored gives undeniable proof of ownership. Any changes to the ledger are sent to all participants instantly, and each transaction is validated to mitigate issues arising from various ownership claims. Scruggs believes most real estate assets in the future will be tokenized, and the verification benefits of the blockchain are the main reason. “It will get to the point where the question is more so, ‘Why aren’t you tokenized?’ ‘What are you trying to hide?’” Scruggs said.

Leading the charge

St. Regis Aspen, a luxury hotel and resort in Aspen, Colorado, is a pioneer of real estate tokenization. The resort tokenized its property in 2018 via the Aspen Digital Token, an asset-backed coin distributed to investors through a Reg D 506 c offering compliant with SEC securities laws. St. Regis raised $18 million through the token offering, and there are currently about 1,000 investors.

 Investors can invest in the St. Regis Aspen Resort and enjoy fractional ownership by holding one or more Aspen Coins. (Image credit: Aspen Digital Inc.)

The price of one Bitcoin right now is down to around $20,000 (as of June 28th), less than one-third of its all-time high, so owning one is expensive and risky. But currently, the cost of one Aspen Coin digital token is equal to $1.02, down just under 20 percent from its all-time high. St. Regis Aspen owner Stephane De Baets, a Belgian-born hospitality and real estate entrepreneur, said the world of hotel ownership is usually very closed off and “either you have to be a billionaire or a big corporation” to jump in, but tokenization changes this. “Democratization of ownership is bound to happen in the next 5 to 10 years, and we’re happy to be a leader in that direction,” he said.

The St. Regis offering was initially issued on Ethereum, but the team has since switched to Tezos because they see it as a superior blockchain for asset tokenization because of a greater focus on smart contract security. The tokens are listed on an exchange called tZERO, and investors can receive cash back on their stays when they visit the luxury hotel. However, to invest in Aspen Coin, only accredited investors can participate, and they are defined as, among other things, an individual whose net worth or joint net worth with a spouse exceeds $1 million.

Krypital Group, a global venture capital firm, analyzed the Aspen Coin offering and, while commending the resort for being an early adopter of tokenization, raised some concerns. “With limited disclosure, uncertain dividend distribution schedule, high bar to get in, and a one-year lock-up period, it may not necessarily be a better investment avenue for retail investors,” Krypital wrote. They said Aspen chose a security token offering because it had a shorter time with easier procedures than an IPO. Also, based on the criteria of accredited investors, the current disadvantage of Aspen Coin is the issuer has access to a smaller target group.

‘A lot of Main Street investors’

Another new tokenization project has made waves in California. Alterra Worldwide announced at the end of 2021 that it would launch the tokenization of Tower 27 in downtown San Jose, issuing 100 million tokens at $1 each issued on an Ethereum blockchain standard. Tower 27 is a 24-story Class A multifamily building, and construction of the $237 million development began in the first quarter of 2022. Alterra CEO Mike Sarimsakci isn’t depending entirely on the tokenization offering to finish construction and is still simultaneously securing funding through traditional means.

The tokenized shares of the building, under the brand T27 Silicoin (T27S), are official representations of bearer stocks of Tower 27 Partners LP. Alterra is marketing the T27S tokens as part of a five-year investment strategy for the apartment tower that’ll serve as housing for an influx of 20,000 new tech workers. Google is building an 80-acre tech campus a few blocks from the Tower 27 site in the heart of Silicon Valley. Token holders will get annual dividends and be part of a profit-sharing system that Alterra says will increase their estimated IRR by more than 18 percent over the five-year investment period.

The T27 Silicoin Security Token is currently the largest single real estate token offering in the U.S. The investment roadmap expects the construction of Tower 27 to be complete in 2024, the finalization of lease-up in 2025, and project exit and distribution of profits in 2026. If investors hold their tokens for five years, the company says the percentage of return will increase up to 12 percent per annum by the profit distribution at the exit. If the company makes a profit on the exit, token holders will receive a 50 percent profit from that share in proportion to their shares.

There are advantages for the company to tokenizing the Tower 27 project, including opening access to a larger pool of investors. But the crowdfunded ownership model comes with risks, too. “The developer is attempting a crowd-sourced, Go Fund Me-style investment strategy, which is risky and unlikely to pass muster with any commercial lenders or insurance company in the U.S.,” said Kelly Snider, an urban planning professor at San Jose State. “The construction cost will be $200-million plus. That’s a lot of Main Street investors and it’s hard to manage that way.”

Nevertheless, Alterra assures institutional investors that Tower 27 will be completed no matter how many T27S security tokens are sold. The token offering will last up to one year within the framework and compliance with SEC regulations, and there will undoubtedly be many observers watching how the massive tokenization project fares.

Ready for disruption?

A new global market for real estate tokenization is forming, a trend toward crowdfunded ownership that could open investment access to scores of new people. Institutional investors may be wary for now, awaiting more clarification for regulatory rules, but many younger investors also driving the growth of crypto are eager for a chance at fractional investing.

Real estate tokenization promises many benefits, such as increased liquidity and transparent transactions. It can also drive down transaction costs and use smart contracts to replace piles of unnecessary paperwork. Many early adopters say a wave of tokenization is indeed coming. “Tokenization may be at a relatively early stage, but it is absolutely going to be a disruptor in global property markets,” said Dan Natale of Moore Global’s real estate group.

The number of publicly announced securitized token offerings increased in real estate, technology, and consumer services between 2019 and 2020, and the highest growth segment in 2020 was real estate, according to Coin Telegraph research. While the adoption of real estate tokenization is increasing, the practice is still new, leading to some complications.

Confusion about tokenization and digital assets is still widespread among some users in these emerging markets. Defining tokenization is hard enough for some retail investors, let alone throwing their money into it. Convincing someone unfamiliar with the blockchain to invest in a fractional token of a property rather than conventional ownership is an adoption problem for the industry. But over time, these problems will likely get sorted out as tokenization goes mainstream. Tokenization is probably coming to disrupt the real estate world sooner or later, so investors and owners who don’t do their homework on it now may find themselves in a bind when the technology truly takes off.

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