Real Estate Crowdfunding & Tokenization; Benefits & Challenges.
Updated: Feb 1
Real estate crowdfunding and tokenization have the potential to revolutionize the way the real estate is funded and traded. Real estate estate is the single largest asset class in the world, but its annual transacting volume vis-à-vis its total size of $333 trillion (2022 estimates) is dismal when compared with the trading volume of other 'store of value' asset classes such as Gold. Real estate is traditionally a bulky asset that is illiquid, which means it would take effort and time to trade, buy or sell one piece of real estate. Unfortunately, investors and buyers would normally apply a discount on any asset that is illiquid, this discount is literally called 'illiquidity discount'. Therefore, by dividing the single real estate asset into many units of economic interests and rights (fractions, fractionalization), one single real estate could now be sold to many people (or its economical interest ownership), could be hundreds or thousands of co-owners, and hence making what was previously inaccessible investment opportunity for the many now very accessible. This process is called real estate crowdfunding, and it could be done in real estate tokenization, which uses technologies like blockchain to create tradeable tokens that represent the economical interest in the real estate, be it a single real estate, a REIT, or property debts and mortgages.
Real Estate Tokenization and Crowdfunding
We list below few of the benefits of real estate crowdfunding and real estate tokenization, and we will leave more benefits for another post:
One major benefit of real estate crowdfunding is increased liquidity. Through these platforms, investors can buy and sell small fractions of real estate assets on those platforms own market or their secondary market if existing, making it easier to enter and exit these investments. This can be especially beneficial for individual investors who may not have the capital to purchase an entire property on their own. Real estate investments were often considered to be relatively illiquid, as it could take a long time to sell a property and the process often involved significant costs. Crowdfunding platforms have the potential to make it easier and more cost-effective for investors to buy and sell real estate, attracting millions of people previously unable to participate in real estate investment, and by fractionalizing the real estate into smaller units and rendering them tradeable and more accessible, it arguably increases the liquidity of these assets from their current levels.
Real estate crowdfunding and tokenization also has the potential to reduce barriers to entry for investors. By pooling money from multiple investors, crowdfunding platforms can make it easier for individuals to access a diverse range of real estate projects. This enables investment diversification, a strategy that is largely recommended when investing. Through diversification, it is possible that this could lead to higher returns than if the investor had invested in a single property on their own. In the past, real estate investing was often seen as being out of reach for many individual investors due to the high upfront costs and other barriers. Crowdfunding platforms have the potential to democratize access to real estate investing, allowing more people to participate in this asset class.
#Security: Blockchain technology and smart contracts added transparency and security
Tokenization, meanwhile, offers increased transparency by providing a secure, transparent record of ownership and other relevant information about a real estate asset using blockchain technology. This can help to reduce the risk of fraud and other issues that can arise in the traditional real estate market. The use of smart contracts, which are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code, can further enhance transparency and automation in the real estate market.
#HomeEquity: Home owners can take out some money without mortgages
Real estate crowdfunding and tokenization can provide a number of benefits to homeowners, particularly those who do not have a mortgage on their property. By tokenizing a small percentage of their home, homeowners can take out some equity from their property while still maintaining ownership and being able to continue living in their home. This can provide them with access to additional funds for home improvements, investments, or other expenses, without having to sell their property or take out a traditional loan.
#LandMonetization: Land owners can monetize their land
Landowners and farm landowners can also benefit from real estate crowdfunding and tokenization. These individuals often find it difficult to monetize their land, which can make it challenging for them to participate in the financial system. However, by tokenizing a portion of their land, landowners and farm landowners can raise funds and access capital, without having to sell their property or give up control of their land. Tokenization can also make it easier for these individuals to allow others to participate in owning land, or economical interest in the land, such as through a crowdfunding campaign, and it can also provide a way for them to earn a return on their investment through the appreciation of the tokenized land.
There are also potential benefits for real estate developers and other industry participants. Crowdfunding and tokenization can provide an alternative source of funding for real estate projects, potentially allowing developers to access capital that may not have been available through traditional channels. Additionally, the use of digital tokens can make it easier for developers to sell and transfer ownership of real estate assets, streamlining the process and reducing the need for intermediaries.
However, it's important to note that real estate crowdfunding and tokenization are not without their problems. One major issue is the lack of regulation in the sector or uncertainties around it, which can leave investors vulnerable to potential fraud and other risks. In some cases around the world, crowdfunding platforms are not subject to the same level of regulatory oversight as traditional financial institutions selling securities, which means that there may be less protection for investors in the event of potential problems or fraudulent schemes. Another issue is whether liquidity is truly unlocked without a vibrant secondary market, and the last issue we will mention for the day is the potential misalignment of interest between the issuing platforms and investors; therefore if you are interested in real estate crowdfunding, fractional real estate or tokenized real estate, pay extra attention to the underwriting quality of the real estate, and ensure the platform's interest and their financial gains are aligned with your own interests.
There are at least 10 other major benefits of digitizing real estate into fractional units, enabling crowdfunding and tokenization; we will discuss those in future posts, so stay tuned.
Araa Tradeable Real Estate Marketplace Team with help from AI