Tokenised real estate has been debated as a leading use for digital securities for many years. Yet, there were really no successful sales that took place. Some of the most notable and commonly promoted ventures were prearranged to signify good optics and had side deals to attract investment. While tokenized real estate eventually emerges, the advantages over current financial offerings still do not deliver the degree of value required to resolve market inertia and to scale successfully.
It’s no surprise that many property owners have an interest in selling their property through a digital security fundraise. By “fractionalizing” real estate sellers can ask for higher prices than they would sell wholesale by breaking down investments into smaller pieces. Alternatively, those who can’t find buyers in traditional markets turn to digital securities as a last resort selection.
While this looks appealing to sellers, who would buy those offers? Consider a real estate investor’s typical profile — conservative, interested in preserving wealth, sensitive to cost margins. In general, they don’t want what they feel most is experimental investment technology. In addition, with the increasing availability of public REITs, fund managers, real estate crowdfunding, and direct investments, the advantages of liquidity and access to international inventory are now open to many security token evangelists. The investor’s short-term benefit, at best is marginal and comes with a high perceived technology risk.
Ultimately, to achieve product-market fit, the real estate asset class suffers from the lack of the high upside. A great investment in real estate could yield 20 percent a year for a passive investor. Why take all this potential risk and implement a new conduct if available investments can produce comparable returns without the unknowns? Because of adverse selection, current structures of the public and private markets, and investor characteristics, it is difficult to find a scenario under which both sides of the transaction will consider interest that is sufficiently significant to surpass the threshold to implement new behaviour.
Today, the pool of digital security investors is small and consists mainly of investors with blockchain/ICO-savvy status. These people, who are still nostalgic for their returns from 2017 of +1000 per cent, have high-risk tolerance, want high returns, and understand technology. They don’t want a real estate debt product of 8 percent fixed-income.
The primary exception to this may be those in countries with tight capital controls (aka China), which want to expatriate their wealth into stable, foreign assets. In this case, the principal benefit of security token real estate, in short, is the ability to hide from government the movement of capital. I don’t know about you, but it’s not why I got involved with blockchain – to hide cash for the wealthy and circumventing national governments.
While digital real estate securities remain poor, their use-case offers a useful tool to explore what a successful investment will look like. Both parties in a transaction must benefit from a “good” deal. The Real Estate and Security Tokens unfit product-market raises the question of what would a good deal look like at the moment? Which is the ideal security token?
Ideally, digital security or not, there is no risk and infinite upside to a best investment. While such a perfect investment is unattainable, features such as insurance against downside risks (which can take several forms), an established market, and available liquidity may help push an offer in the right direction. At the same time, ownership based on blockchain needs to offer some unique capability which requires a digital approach to security. This could take the form of highly complex financial structures, streamlined asset diligence or blended value-added “utility token” benefits. This is not real estate.
Revenue streams backed by equity, a bond, or other options for conversion may offer one strong example. In this case, a company may offer investment in a new product line or intellectual property asset and offer conversion into company equity or other available assets if the upside doesn’t manifest (as measured by some predetermined milestone). If successful, the company could fund its CAPEX needs in better terms and without diluting shareholders while investors could gain high-upside exposure in otherwise inaccessible investments. Additional benefit could also come in extending the exposure of companies or markets through this fundraise.
Imagine an investment in the future revenues of a new SpaceX rocket model, for example. Typically, capital-intensive requirements to create such a technology would lead to dilution of equity and less internal control of the business. SpaceX could engage the public in a STO raise, find financing on better terms, avoid dilution, and offer high returns upon the product’s successful commercialization. In the event of failed marketing, investors may be able to convert to SpaceX equity at some predefined conversion ratio. This approach could be meaningful in comparison with the compromises made through traditional financing means.
The market is sure to ripen. Basically, a blockchain-based security will deliver all of the functionality of traditional securities with new ones — cost savings and enhanced distribution. Basically, they are better. Incremental gain on an evolving market, however, like a token for real estate, does not catalyze a seismic change in capital markets. The potential future advantages for real estate portfolio managers are clear, but how to start this marketplace remains unknown. Real estate is just sort of boring.
Compliance with regulations is unavoidable and necessary, but those in the industry (including myself) could benefit from asking more frequently, what do people really want? The ICO world is imperfect, but the ethos of STOs — middle-aged white men in blazers, their lawyers still by their side, arguing about multi-asset tranches of EB5 in finance jargon — might benefit from the imagination, boldness, and excitement of the crypto-craze that brought us here.