Tokenization Opens New Vistas for CRE Investors

Earlier this year, Brazilian bank Banco BTG Pactual made news in the digital coin community when it revealed it would back its blockchain-based token, called ReitBZ, with distressed Brazilian real estate assets. Perhaps even more significantly, it also said it would set up a secondary market for the tokens—that is, give investors an exit strategy.

The intended investor base for this development? Presumably anyone interested in the portfolio, which according to the announcement was to be seeded with properties in the Brazilian states of Rio de Janeiro and Sao Paulo that had been impacted by the economic recession in Brazil and now offer “potentially significant economic upside.” But as BTG Pactual CEO Roberto Sallouti made clear in prepared remarks, there was a group that specifically stood to benefit. “The technology associated with this offering allows us to be a pioneer in providing access to asset classes that have historically been difficult for global retail investors to access,” he said.

Fast forward several months to the summer of 2019, when the bank’s project has grown by leaps and bounds, exceeding the original projected $15 million of sales to reach $1 billion. It has also moved to a larger, more global blockchain and plans to use it for a number of asset tokenization projects ranging from core real estate to prominent global sports clubs, as well as equity and debt interests, according to the Tezos Foundation, which is providing the blockchain. “We see Tezos as a global player with a robust blockchain for asset tokenization” said Andre Portilho, BTG’s Partner responsible for the Security Token Offering initiative.

Banco BTG Pactual was among the world’s first investment bank to offer a STO, hence the excitement in the fintech space. However, it also raised interest in the commercial real estate industry because the project may well actually prove what many have said is theoretically possible: tokenization will unlock the liquidity of smaller investors by democratizing access to opportunities—even global ones—by providing fractional real estate opportunities. There are many exciting proptech developments but perhaps none are better positioned to be a game-changer than tokenization.

“This opens up a new world with respect to real estate investments and real estate ownership because we can now use blockchain technology to create faster, more efficient ways of transacting ownership,” says Katya Fisher, a partner who leads the law firm Greenspoon Marder LLP’s blockchain, digital assets and technology transactions practice.

Tokenization also introduces new investors to commercial real estate. These range from smaller companies and individuals that can’t afford to acquire say, an apartment building in Brazil, to global institutional investors that want to be more strategic by buying stakes in certain assets.

A BRIEF PRIMER

For the uninitiated, this technology—the crux of which is blockchain—no doubt seems daunting.

Fisher describes blockchain technology as allowing the sharing of files and digital assets in a peer-to-peer manner, without middlemen and duplicate copies. This makes digital money possible without the fear of replication that can lead to counterfeit. Unlike Napster, where people were able to share copies of files so piracy could proliferate across the Internet, blockchain more resembles a shared database with authorized access where every transaction is recorded.

“The technology is a distributed ledger that allows all the parties to a transaction to actually witness the transaction in real time and certify the terms of the transaction,” Fisher explains.

With tokenization, the digital asset does not represent currency. It can represent stock, shares in a company or any type of asset on the digitized ledger, including, of course, real estate. Instead of paper certificates of shares, these digital assets are issued.

TOKENIZING THE ST. REGIS ASPEN

The US commercial real estate industry got its own taste of tokenization last year when Elevated Returns, which owns the St. Regis Aspen Resort in Colorado, decided to sell security tokens backed by the hotel on a blockchain. “Asset backed coins like the Aspen Coin not only offer a transformative way to invest in real estate, but also establish a new way to store wealth by utilizing collateralized and income generating digital assets,” said Stephane De Baets, founder and president of Elevated Returns when the initiative was announced. “We believe that the real estate tokenization model has tremendous potential in that it brings liquidity and disintermediation to the world’s largest asset class.”

Elevated Returns ultimately closed $18 million for the sale of a small stake in the hotel.

A CUMBERSOME PROCESS

Typically in such transactions, the seller will either have to form a real estate investment trust—as Elevated Returns did with the St. Regis Aspen Resort—or raise capital with syndicated investments.

The latter can be particularly cumbersome, according to Mark Fawer, a real estate partner at Greenspoon Marder LLP, who explains the mechanics when an investor syndicates a project. The investor will receive a partnership or membership interest in the entity that owns or is developing a property. If the asset is income producing, the investor will receive monthly or quarterly distributions, but the ownership interest is extremely illiquid.

Now, real estate investment holders have to wait for a purchaser, maybe the sponsor or another investor, to buy out their shares. That requires finding the buyer, negotiating terms, and entering into documentation. The seller needs permission from the general partner, the managing member and needs to submit paperwork into a transfer agent. This can take weeks or months, Fawer adds.

“With tokens on the private market, on private exchanges, you’ll be able to see bids and asks for those tokens,” says Fawer. Whether it’s restricted to existing investors or by invitation, it will be completely open. He describes the possibilities: They can get pricing intelligence. There will be greater transparency. There will be greater protection in making sure it’s limited to accredited investors and that security compliance and anti-money laundering laws are followed.

Over time, this seemingly cumbersome process should become easier, especially as liquidity is introduced in the back end.

“We believe that over time a robust secondary market will develop in not just real estate investments but investments in all alternative assets, whether they be investment in hedge funds, portfolios of fine art, coin collections, you name it,” says Fawer. “If someone wants to sell, if they want out, they don’t have to wait.”

Fisher predicts robust movement in real estate tokenization in the next couple of years.

Head of global technology strategy for Deloitte’s real estate group, Kevin Shtofman also predicts that there will be activity in this area sooner rather than later. For instance, he believes that blockchain-enabled tokens on a limited basis will be listed on major exchanges, including Nasdaq early as Q4 2020.

Similar developments will happen globally as well. Shtofman notes his sources say that SIX Group, the Swiss stock exchange, will begin trading tokenized assets in Q3 2019.

SIMPLIFYING THE PROCESS

Some companies are taking steps to ease this process as much as possible. San Francisco-based company, Harbor provides an online platform that tokenizes alternative investments including real estate, investment funds and private equity. Founder and CEO Josh Stein explains that his company provides greater liquidity using blockchain for private placements.

Similar to Fawer, Stein describes the current cumbersome private sale process: “Oh, it’s brutal. It’s people trading documents back and forth and signing and scanning and emailing again. It’s all fragmented, stored on Excel spreadsheets or in people’s email boxes. There are some software tools out there but they only do one part of the process and there’s no marketplace where it’s easy to trade these things.”

No matter whether an investor forms a REIT or uses a syndicated structure, there are 10 to 200 people in a series with private securities that are exempt from registration, he says. Stein calls it “a giant paper drill.” Someone needs to keep track of who has signed the documents, who wired money and whether the sent amounts matched the person’s commitment. Sometimes people sign the documents but don’t wire the money or wire the wrong amount or fail to sign the documents or sign the wrong version of the documents.

With Harbor, clients receive an email with a link, set up an account (similar to online banking, with a username, email address and password). They’ll receive a non-disclosure agreement to electronically sign, then will be directed to a data room. The website describes the investment and walks clients through the materials, including the private placement memorandum. Harbor provides a subscription agreement and performs automated Know Your Client and Anti-Money Laundering compliance checks. Online, the entire process expands the global reach of raising capital.

Stein sees this “low friction” blockchain process a game changer in how private placements will be handled in the future.

OPENING DOORS

With this plethora of approaches and the potential of massive amounts of red tape, why would investors even bother with tokenization?

The oft-cited—and quite viable—reason is that tokenization opens the doors to all sorts of investors new to commercial real estate. “Maybe family offices who don’t want to write a $25 million check, will want to write a $500,000 check,” says Deloitte’s Shtofman. “A tokenized offering can open up a new potential capital pool of investors.”

So far, the industry has only seen trial runs, but Shtofman expects that to change. He says that 2018 was the year people test out the technology. 2019 is shaping up to be the year companies will look at the technology’s actual value. As for 2020—it will be the year of adoption.