A Token Change
REITs can realize advantages by leveraging blockchain technology to offer tokenization.
Tokenization will revolutionize fundraising for commercial real estate investments. Real estate investment trusts are particularly well situated to capitalize on the benefits of tokenization due to a well-developed real estate management infrastructure and practice in regulatory reporting and compliance.
First, what is tokenization? In short, it is the process of digitally evidencing ownership in a “thing” on a distributed ledger. This ledger is commonly referred to as a blockchain. Second, why tokenize? Within the context of real estate transactions, much of the conversation centers around increased liquidity, trust, and automation. REITs are, perhaps, uniquely situated to take advantage of these benefits. (A quick note: This discussion will focus on the tokenization of entities that own real estate, mainly because the tokenization of the “dirt, sticks, and bricks” that is real estate has its own set of complexities and legal hurdles.)
On a basic level, tokenization transforms one's evidence of property ownership (thus a beneficial interest in real property) from a piece of paper (that is, your name on a schedule to an LLC operating agreement) to a state on a digital ledger. This process is like the evolution of traditional stock issuances; stock ownership is now tracked with a centralized digital ledger, controlled by the issuer's administrator, rather than by physical stock certificates. The significant difference between traditional stock ownership and tokenization is that tokens, in addition to evidencing ownership, can also carry other, more robust functions, including the ability to transfer, vote, and receive economic benefits virtually instantly. This transformation could have profound implications, especially for privately held securities. Once one's beneficial interest in real property is tokenized, then, arguably, that interest becomes significantly more liquid — for the creator and subsequent holders.
Of course, a few questions need to be answered to determine whether tokenization is possible, including:
- Can one find and access a licensed security platform currently trading such tokens?
- Is that security-trading platform linked to a robust enough “white list” (a way of confirming that the acquirers of the token satisfy various legal requirements) of potential participants to create a liquid market?
- Are new automated platforms or apps developed to satisfy the foregoing and comply with legal requirements
Presuming these issues are addressed, tokenization could provide token holders in private REITs with much of the same benefits as unitholders in public REITs by providing them with tradeable, and thereby liquid, tokens (in lieu of traditional, non-tokenized units). Second, and perhaps more importantly, it provides REITs (public and private) with the ability to raise money at different asset levels and at more favorable terms.
Most stakeholders in REITs own shares in a public company that is the general partner in an umbrella partnership (an UPREIT) or units in the UPREIT itself, each of which directly or indirectly owns all the real property assets of the REIT. Also, some REITs have a DownREIT, which is a partnership below the UPREIT that only owns a few of the REIT's assets. Tokenization can unlock several additional variations of the foregoing arrangements, enabling unique debt and equity issuances and thereby creating more ways for REITs to fundraise.
Tokenization may also reduce administrative fees and costs by cutting out brokers, servicers, and other third-party service providers by leveraging automation via smart contracts.
For example, a public REIT may decide to tap into the token economy in lieu of seeking traditional public or private equity or debt for a particular property acquisition or refinancing. Tokenization could allow the REIT to tap a wider, non-traditional group of investors. Such an issuance would, arguably, provide access to cheaper capital, due in part to the investors' presumably fragmented, and thereby less powerful, position in the market. It could also provide more flexible terms (including for debt, such as more favorable debt covenants and less restrictive prepayment penalties). Finally, tokenization may also reduce administrative fees and costs by cutting out brokers, servicers, and other third-party service providers by leveraging automation via smart contracts.
It is important to consider what token holders stand to gain from tokenization. Investors who otherwise would not have access to certain investments could find themselves, thanks to tokenization, swimming in new investment opportunities with reduced transaction and administrative fees as a result of efficiencies captured by the REIT. In addition, the token could be coded with “smart contracts,” providing token holders with clarity with respect to transaction terms, servicing/payment, voting/control, and real-time information and reporting.
For more on this topic, check out CCIM Institute's “Blockchain is Coming ... Is the Commercial Real Estate Industry Ready?” webinar.