Digitising Real Estate

March 18, 2018

Myungsung Daniel Dong

Real Estate and the Emergence of an Alternative Technology

Real estate is without a doubt the largest asset class in the world, with reports showing its value to be US $228tn in 2017. Yet, despite the substantial size, it is inefficient, illiquid, costly, and prone to frauds and disputes. Additionally, among many other concerns, it is considered to be inaccessible by many, as one would be required to procure large funds before even attempting to engage with the market. How then can a unique database technology like blockchain quell these worries?



Advantages of Blockchain Implementation

Implementation of blockchain technology provides some interesting and cost-efficient solutions to specific problems with the market. With the technology in question, it is possible to make digital units that are impossible to copy and digital files and processes that cannot be manipulated or tampered with. The following will outline key issues within the market and how some companies use creative ways to use the above characteristics to implement a more efficient way of engaging with the real estate market.

Commercial Real Estate Leasing – Problems and Solutions

In relation to commercial real estate leasing, Deloitte suggests key issues that blockchain use cases tackle: fragmented information, cumbersome due-diligence process, and complexities in managing ongoing lease agreements.[i] The following will provide a short outline of each suggested solutions and explore key driving mechanisms behind the companies’ methods.

Issue 1: Inefficient property search process – REX Multi Listing System (MLS)

In the current model, parties involved in commercial real estate transaction use a MLS to gather information on properties in question, such as data on its features, location, floorplans, photos, and rates. These are usually paywalled, often outdates and inaccurate with costly intermediaries in between.[ii] Furthermore, the search process can be inefficient, as the data is fragmented across multiple platforms resulting in delays and additional costs for landlords and tenants and inefficient transaction between parties.

One company, Rex MLS, proposes a solution of a decentralised database of listings – the RexIndexer – built on the Ethereum blockchain, and identifies two problems and solutions: the first being that of ownership of real estate data and the second being inefficient transactions. For the first problem, Rex suggests that the solution is to build a global and shared real estate database, property identification layer, and data exchange utilising Ethereum and InterPlanetary File System (IPFS).[iii] Through this, users will maintain ownership and control of their data. For the second issue, the solution they propose is that of providing an escrow transaction layer that will facilitate security and efficiencies in document sharing.[iv]

So how can utilising Ethereum and IPFS help solve the issue of control and ownership of real estate data? As data is stored in a server and the server is usually owned or leased by a corporation, there is an unnecessary increase in cost of maintenance and little interoperability between systems. With the IPFS, Rex can distribute real estate data in a decentralised manner. As the white paper puts it, when a listing or transaction documents are submitted to Rex, Rex hashes the data and pushes the content to IPFS. The data is then encrypted and disseminated globally to machines running the IPFS instance. Since the data is distributed and not stored on a single computer, costs are reduced, and access is universal.[v] Given the decentralisation of data, blockchain implementation would mean that organisation of said data is possible without a central figure. Ethereum makes compilation of the aforementioned and currency possible; REX tokens can be exchanged for Ether. With the tokens, Rex can reward contributors for providing and curating content, a key feature of this platform, while offering a digital exchange where real estate data can be freely traded.

So how does this work in practice? As mentioned before, Rex is built on three key features: blockchain, decentralised data distribution, and the currency. Users engaging in the platform are paid REX tokens for providing accurate data on a real property that is not flagged or voted as spam. In order to list it as spam, a user will have to pay some REX tokens, after which the listing goes into a 3-day arbitration period where REX holders can vote to approve or disapprove. If approved, the listing goes through and the flagger loses the deposit. If voted as spam, the flagger receives the listing reward and pool that voted the listing as spam receives the losing pools REX. In this way, by involving tokens, users are incentivised to act honestly and flag incorrect data. With curation, market sponsorships, featured brokers, and landlord professional profiles all being paid for with the tokens, and listings voted on, the RexIndex can maintain a similar-in-style platform as the legacy portals that we are used to, while increasing transparency, accuracy, and lowering transaction costs.

Issue 2: Cumbersome offline due-diligence process – ChromaWay

Pre-lease due diligence is time consuming in the current commercial real estate leasing model. Proofs of identity and documents stored in siloed places have limited flexibility; these documents include history of ownership, tenants, and repairs and maintenance activities – all information relevant for potential lessees and investors. Handling these pre-lease due diligence and manually verifying documents is prone to errors, heavy on administrative tasks, and time consuming.

In consideration of these issues ChromaWay, with collaboration with Telia (telecom provider) and Lantmäteriet (Swedish land registry authority) among others, tested a new method of handling pre-leas due diligence. The demo[vi] suggests that the process involving blockchain database will look like the following.

The process involves five actors (buyer and seller, real estate agent, bank, and the land registry) each with an individual app. The buyer and seller login to the app using their Telia (telecom provider) IDs, which will be verified on the blockchain. Then, using the app, the seller appoints the real estate agent who does the property due diligence and invites potential buyers. Interested buyers invite their bank to the transaction through the app and the bank verifies the property ownership through their app. After that, an agreement is signed by both the buyer and seller using their digital signatures and IDs. The buyer then instructs the bank to make the payment. Once complete, the registrar receives a notification to initiate title transfer and the registrar digitally transfers the title from the seller to the buyer. The transfer is updated on the app and visible to all parties. In this way, authorised third parties such as banks, buyers and sellers, and real estate agents can verify the information. Through these steps, Jorgen Modin (chief solutions architect at ChromaWay) suggests that the time from signing a contract to registering a sale can be reduced to hours, instead of three to six months in the legacy system.[vii] Alongside the advantage of reducing transaction time, improved data security and a reduction in human errors is possible during the verification process. Additional considerations are that of the elimination of the need for physical archives of contracts and files, automatic confirmation of final land title at the date of transaction, eliminating duplication errors, and more. In essence, this could mean that a transaction can be done within just a few clicks, once all documents are prepared.

What characteristics of the system then, makes this application plausible? Firstly, all involved actors will have a digital file representing the agreement of ownership of the real estate, mortgage deeds, and the transaction process; these files can be stored in the method of the actor’s choosing.[viii] The authenticity of the process, the signatures, the file confirming ownership, and mortgage deeds among other documents will be secured on a private blockchain by the Swedish Lantmäteriet, but the blockchain will also be stored and validated by other actors. The records and files that should be public according to Swedish law will be public and those which should be confidential will remain so, in accordance with the owner’s interests.

ChromaWay describes the use of blockchain as an efficient solution to the issues with the current model of the Lantmäteriet. In Sweden, the Lantmäteriet is only involved in a few steps at the end of the transactions. As a result, majority of the process is not transparent. Moreover, the system is slow at registering the transactions; the time between signing the purchase contract and the Lantmäteriet receiving the bill of sale make the approval take up to six months. Through implementing a blockchain based model, the aforementioned is possible.

Despite it being a proposed solution, ChromaWay acknowledges that there are potential issues that may arise from such transactions. The first of it is that of privacy and compliance with the General Data Protection Regulation (GDPR). However, they imply that since compliance with Swedish law requires most real estate ownership to be public anyways, this should not pose larger issues. A second issue is that of digital signatures and the uncertainty around its validation according to European law. However, practice in Sweden indicate that digital signatures are largely accepted. Physical signatures can still be applicable by making digital copies of paper-based contracts, but for the system to function properly, digital signatures must be legally unambiguous.[ix]

Issue 3: Complexities surrounding leasing and subsequent property and cash flow management – Midasium

Management of a commercial real estate property tends to be complex, due to the involvement of multiple parties. These include auditors as part of preparation and review of financial statements, banks for (re)financing related decision, financial regulatory authorities for monitoring purposes, and appraisers for property appraisals. As a result, real estate companies have rigorous accounting, compliance, and cash flow management needs and related costs. How can a blockchain model solve these inefficiencies?

Executing transactions through smart contracts can combat some of these challenges. The traditional lease contract can morph into a smart tenancy contract – thus enabling improved transparency of lease terms and transactions.[x] This type of a contract could trigger automated rent payments to owners, managers, and stakeholders. It could also initiate deposits on a lease and their end-of-lease repayment, govern terms of use of the deposit payment, and could trigger payment of the security deposit back to the tenant after adjusting for damages. Such an automated system would provide clarity, transparency, and ease in managing of a real asset.

One company, Midasium, suggests that it has a solution – the Smart Tenancy Contract. It describes its smart contract as the contract being simply a small computer program representing the mutual agreements contained in a traditional real estate contract as lines of software code that self-executes and self-enforces, with the power to move funds between bank accounts, transfer property titles and reconcile payments.[xi] The contract has specific advantages that differ from the common notion of a smart contract: it is tailored specifically for real estate agreements and configurable to any real estate transaction, it is legally binding despite many concerns over legislative compliance as it can be converted to a traditional contract form for legal purposes, and no crypto-currencies are used for payment; it is based on fiat currencies.

These smart contracts are stored on the Midasium Blockchain. This model takes a shape different than the common models. It classifies itself as an alternative blockchain to the Bitcoin blockchain, a consortium chain (authorised business entities are permitted to endorse the validity of transactions), and a permission-based chain where participants must be identified and authorised to use the system (they must comply with various financial regulations).

What does this process look like for the landlord and the tenant? First the landlord creates a Smart Tenancy Contract with the key attributes of the tenancy such as property details, tenant details, rent amount and payment frequency. The tenant is notified and reviews the details as necessary – similar to the traditional contracting model. The tenant agrees to the terms, which is accepted by digitally signing the contract using a digital key that represents their identity. To receive a key, the tenant must complete the registration involving a 100-point identity check.[xii] The landlord then signs the contract and the legally binding digital document gets published on the Midasium blockchain. Once this is done, the more interesting feature is available: management of the flow of funds.

The smart contract, once a deposit is received from the tenant, places the funds in a secure account with only two functions: reversing the funds to the tenant’s account or disbursing an agreed proportion to the landlord’s account if both agree. The smart contract debits the tenant’s account every month – the funds are instantaneously dispersed to the landlord’s account. If an outstanding invoice appears, i.e. that of maintenance or ad-hoc repairs, the smart contract allocates a proportion of the month’s rent to settle the invoice. Upon termination of the lease, the tenant’s deposit is disbursed to the tenant and landlord, according to what has been agreed between both parties to cover any damages or other expenses. The main advantage of this process seems to be that of transparency – any expenses taken from the deposit can be seen, tracked, and automatically invoiced as necessary. This would mean that management of cash flows is made much easier and reconciliation of payments becomes faster.

Exploring New Avenues - Fractional Ownership

Along with providing solutions to current issues that constrain smooth transactions in the commercial real estate leasing, blockchain provides opportunities for new methods of transaction, namely that of fractional ownership. This would mean that the barrier to real estate investing will be lowered, as in the traditional model investors will either require a significant amount of money or seek to pool the money together, which makes them susceptible to frauds and uncertainty with the management of the assets. With a blockchain model, an investor could have access to a simple trading app where they can buy and sell fractions of tokenised asset, with a further advantage of removing the necessity to manage the property themselves. Additionally, this creates a new method of procuring cash for property owners; instead of mortgaging or using property as collateral, the owner could have access to quick cash through selling fractions of the property on the trading app.

LAToken

LAToken seems to have a much larger ambition – their goal is to tokenise various asset classes, such as equities, debt, real estate, metal, and works of art. For the purpose of this article, the following will outline how trading of tokens linked to illiquid assets work on their platform, why using blockchain is necessary, and what value this adds.

In general, the asset token creation and sale on the platform consists of certain steps: transferring ownership rights to a Trustee, the Trustee issuing tokens and selling them to cryptoholders on the LATOKEN platform, and the asset owner buying back asset tokens on the settlement date or the Trustee selling the asset at a fiat auction.[xiii] In between the last two steps, the cryptoholders may sell asset tokens on a secondary market.

For the seller of the asset, this may be a user-friendly platform, but the system is more elaborate than one might think. In case of real estate tokenisation, the first step is to fill out a questionnaire in relation to the asset an owner wants to tokenise. They fill out basic information about the property, the share they want to tokenise (with a limit of 80%), settlement date, and their household finances in order for LATOKEN to pre-approve or reject the application. In the pre-approved stage, the asset owner receives a non-binding estimate of his property’s value and is then asked to provide a full package of documentation and complete an application.[xiv]

After this step, the asset owner is required to select a LATOKEN-certified independent vendor to conduct appraisal of the property. The report is shared with owner upon completion and an insurance requirement is presupposed. Afterwards, a LATOKEN-certified Trustee receives the documents preserving the right to exercise the sale of the property in case it is not bought out. The next step is the asset tokenisation and its subsequent sale at an auction on the LATOKEN platform to cryptoholders, where the proceeds are transferred to the asset owner. The final step is the buyback stage. The pre-determined settlement date stipulates that the asset owner can buy back the asset tokens; the price will be determined based on the property’s second appraisal conducted prior to the aforementioned date. The price is determined in USD value and then converted to LA (the platform’s token) at the current exchange rate. Once asset tokens are bought back, a deed of reconveyance is issued to the homeowner and the asset tokens are eliminated. If a homeowner decides not to proceed with the buyback, the Trustee will sell the real estate via fiat currency auction where the proceeds will be distributed among the asset token holders. In summary: an asset owner sells part of the asset to a certified custodian (Trustee), the custodian issues tokens in relation to the asset value and sells them to cryptoholders (where they may sell the tokens on a secondary market), and the owner either buys back the tokens on a settlement date or the asset may be sold at a fiat auction where the proceeds are distributed among the token holders.

Although investors and asset owners may pose questions about these intricate steps, the real value is in two forms: exposing real assets to cryptoholders and making these assets more liquid. The asset classes that LATOKEN tokenises, including real estate, total up to approximately $517 trillion[xv] and tokenisation of illiquid assets allow for fractional ownership and access to these opportunities for a larger range of investors. As for the second benefit, asset owners can gain instant liquidity through tokenisation, as the platform can greatly reduce the time and costs of transactions, and the taxes associated with it.

What does the future hold?

Given the the rising numbers of cryptocurrency holders, blockchain implemented projects, and the demand for digitised land registries, it seems to be the case that this is where the market is heading. Moreover, with the improvements in transparency, time and cost savings, and security that these projects aim to provide, it is important for all potential investors to understand the changing dynamics of the trade. For detailed analyses of aforementioned projects, please revisit the article as subsequent articles will be published soon, and links will be provided.

Endnotes
  • [i] Deloitte (2017). Blockchain in commercial real estate The future is here!. [online] Available at: https://www2.deloitte.com/content/dam/Deloitte/us/Documents/financial-services/us-fsi-rec-blockchain-in-commercial-real-estate.pdf
  • [ii] Rexmls.com. (2017). A CRASH COURSE IN BLOCKCHAIN FOR REAL ESTATE PROFESSIONALS. [online] Available at: http://rexmls.com/blog.html
  • [iii] Rexmls.com. (2017). REX WHITE PAPER. [online] Available at: http://rexmls.com/white-paper.html
  • [iv] Ibid
  • [v] Ibid
  • [vi] Chromaway.com. (2017). BLOCKCHAIN AND FUTURE HOUSE PURCHASES. [online] Available at: https://chromaway.com/landregistry/
  • [vii] Zuckerman, M. (2018). Swedish Government Land Registry Soon To Conduct First Blockchain Property Transaction. [Blog] COINTELEGRAPH. Available at: https://cointelegraph.com/news/swedish-government-land-registry-soon-to-conduct-first-blockchain-property-transaction
  • [viii] Chromaway.com. (2017). The Land Registry in the blockchain - testbed. [online] Available at: https://chromaway.com/papers/Blockchain_Landregistry_Report_2017.pdf
  • [ix] ibid
  • [x] Anon, (2018). Blockchain and Smart Contracts Could Transform Property Transactions. [online] Available at: http://deloitte.wsj.com/cfo/2018/01/03/blockchain-and-smart-contracts-could-transform-property-transactions
  • [xi] MIDASIUM CONTRACTS. [online] Available at: http://midasium.herokuapp.com/smart-contracts
  • [xii] SMART TENANCY CONTRACTS. [online] Available at: http://midasium.herokuapp.com/smart-tenancy
  • [xiii] Cdn-new.latoken.com. (2017). LATOKEN White Paper - Get exposure to real asset prices via crypto. [online] Available at: https://cdn-new.latoken.com/common/files/whitepaper/latoken-whitepaper-en.pdf?_ga=2.33395646.1238207299.1521319042-1504661536.1521319042.
  • [xiv] Ibid
  • [xv] ibid