Tokenization of Real Estate

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TABLE OF CONTENTS I. INT RODUCTION 3 II. THE PROBLEM (AND PROOF) 4 A. Real Estate is Highly Illiquid 4 B. Investing In Real Estate Requires Significant Amounts of Upfront Capital 5 C. Real Estate Investment Trusts Are Not the Answer 6 D. Special Purpose Vehicles Are Not the Answer 7 Ill. THE SOLUTION 8 A. Tokenization and Fractionalization of Real Estate Via Blockchain Technology 8 i. What is Blockchain Technology? 8 (a) Blockchain is a Distributed Database 8 (b) Shared Among the Nodes of a Computer Network 9 (c) Simplified Explanation of Blockchain Technology and Its Benefits 9 ii. What is Real Estate Tokenization and Fractionalization? 10 (a) Real Estate Tokenization 10 (b) Real Estate Fractionalization 10 iii. Benefits of Real Estate Tokenization and Fractionalization 10 (a) Lower Barrier to Entry 10 (b) Increased Liquidity 11 B. Challenges to Tokenization 12 i. Lack of Regulatory Clarity 12 IV. PROPOSED REG ULATORY SOLUTION-T OKENS: CONTAINERS FOR RIGHT S 13 A. T he Liechtenstein Approach 13 B. Liechtenstein Application to Tokenized Real Estate in the US 14 C. T he Blocksquare approach 15

Tokenization of Real Estate - and its Potential to Increase

Investment Accessibilitywas produced and published by

T he Tokenizer.

T he Tokenizer is the world's leading data and information platform for the growing asset tokenization industry. T he Tokenizer A/S H0jbro Plads 10, 1200 Copenhagen, Denmark @TokenizerlO +45 9399 3883 Please reach out to us for information about coming reports. Photos: Ricardo Gomez Angel Ivan Bandura Peter H Danist Soh © 2023 by T he Tokenizer A/S All rights reserved.

I. INTRODUCTION Real estate has long been a favored investment

where investors of all levels can participate and

choice for many individuals seeking to diversify

benefit from the advantages of real estate

their portfolio and build long-term wealth.

investment. This white paper will explore the

However, traditional real estate investing often

concept of tokenization of real estate, its potential

requires a large amount of upfront capital and

to increase investment accessibility, and the

involve complex and time-consuming

potential legal implications that come with this

transactions, limiting accessibility for the average

innovative approach to real estate investing.

investor. With the emergence of blockchain technology, real estate investment opportunities are becoming more accessible and streamlined

We would like to thank Blocksquare for

through the process of tokenization.

sponsoring this report

Tokenization, relating to real estate, is the process of representing a fractional ownership interest in a parcel of real estate or some other derivative in which real estate is the underlying asset c1J. Simply put, tokenization allows real estate assets to be divided into digital "tokens," which can then be sold to investors, providing fractional ownership of the asset. The result is a more democratized and liquid real estate market,

1. Josh Morton, Blockchain Holds Potential for Commercial Real Estate, Law360, 1 (2021 ).

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A. Real Estate is Highly Illiquid

Real estate is the single biggest asset class in

The single biggest negative attribute of real

the world, with the global real estate market

estate investing is illiquidity (4). Unlike stocks and

worth around an estimated $228 trillion c2).

other investment vehicles, real estate

However, just 3% of the global population have

transactions can take months, sometimes even

invested in real estate, while over 80% view real

years to complete, making it difficult for investors

estate as a good investment (3).

to quickly access their capital. This lack of liquidity can be a significant issue for investors

So, we have the largest source of wealth in the

who need access to cash quickly, such as in the

world, with a miniscule portion of the population

case of an unexpected financial emergency or

able to access it. Why might this be? The

new investment opportunity.

problem with real estate investing as it is today boils down to essentially two problems: (I) real

The average time to close on a real estate

estate is highly illiquid; and, as a direct result of

transaction is roughly 30-45 days from the date of

real estate's illiquid nature, (11) real estate

acceptance of an offer to the day the new owner

investing requires a significant amount of upfront

receives the keys cs). Of course, this number can


vary greatly depending on a number of factors such as location, market conditions, and property type. Regardless, when compared to the ease and efficiency of which users can buy and sell shares of companies on the stock market, the real estate transaction process is lengthy and complex, involves multiple parties and rigorous legal requirements. All of which make it challenging for investors to liquidate their assets easily, efficiently, and cheaply, further limiting their ability to take advantage of new investment opportunities or respond to changing market conditions. 2. Id. 3. Id.

4. Max Dilendorf, Rika Khurdayan, and Gleb Zaslavsky, Tokenization of

Real Estate: What, Why, and How, Dilendorf Law Firm, 2, (Sept. 1, 2020). 5. What is the Average T ime to Sell a House?, ZILLOW, (Mar. 13, 2023),


B. Investing In Real Estate Requires Significant Amounts of Upfront Capital

Clearly, the average US investor is going to have a tough time coming up with all that cash for an investment property, while likely still paying the mortgage on the home they live in. This is no easy task, and the proof is reflected in the numbers. As mentioned before, just 3% of the global population have invested in real estate.

Another challenge with traditional real estate

However, real estate has nearly always been

investing is the significant amount of upfront

considered a relatively safe investment, and for

capital required to purchase an investment

good reason.

property. For example, in the United States ("US"), to qualify for a mortgage for a one-unit

Going back just five years to April of 2018, the

investment property, most lenders require at

average home price in the US was $212,313(9).

least a 15% down payment with a 680-credit

Using the above-mentioned average home price

score csJ.

in April of 2023 of $327,514, that's an appreciation of roughly $115,000, or an increase

To get an idea of what kind of cash we are really

in home value of approximately 54.2%. Compare

talking about, consider the average home value

that number to the 5-year average return on the

in the US, $327,514 (7). At this price, an investor

US Stock Market from 2017 - 2021 of 17 .04% c10J.

would need to come up with a minimum of

Take that, Warren Buffet!

$49,127 for a down payment. In addition to the down payment cost, there are many other

Sadly though, 97% of the population does not get

significant costs associated with purchasing a

to enjoy these returns since they are essentially

property. Consider the following, non-exhaustive list of some of the closing costs associated with buying a property cs>:

locked out of the real estate investment market due to the significant

- Loan origination or broker fee (0-1% of loan amount); - Processing or Underwriting Fee ($300 - $900 each); - Title search fee and Title insurance ($300 $2,500+);

- Home appraisal fee ($500 - $1,000+); - Prepaid taxes and insurance ($1,000 $4,500+);

- County recording fees ($20 - $250);

6. Victoria Araj, Buying an Investment Property. 3 Signs You're Ready and What You Need to Know, Rocket Mortgage, (Mar. 31, 2023). 7.United States Home Values, Zillow Home Value Index, Zillow, (2023). 8. Gina Freeman, Average Closing Costs in 2023: Complete List of Closing Costs, THE MORTGAGE REPORTS (Oct. 17, 2022), sts-what-average-mortgage-costs-are-and-how-to-keep-yours-low#aver age 9. United States Home Values, Zillow Home Value Index, Zillow, (2023). 1 0. Rebecca Lake, What is the Average Stock Market Return?, SOFI FINANCE, INC. (Mar. l 3, 2023),


Compared to REITs or SPVs, tokenized real

Overall, tokenization and fractionalization offer a

estate would offer investors more direct

more efficient and accessible way for investors to

ownership and control over their investments.

participate in the real estate market, while also

Investors can buy and sell their "shares" in the

increasing the liquidity and potentially the value of

property without having to rely on a third party or

the underlying real estate assets. By increasing

middleman, such as a REIT manager. This can

liquidity and providing greater transparency and

reduce the fees and expenses associated with

control to investors, these innovative technologies

REITs and other real estate investment vehicles,

can help create a more equitable and sustainable

while also providing greater transparency and

real estate market for all stakeholders involved.

control to the investor.

B. Challenges to Tokenization iv. Lack of Regulatory Clarity

Despite the many potential benefits of real

estate tokenization and fractionalization,

there are still plenty of persisting issues that hinder the growth and adoption of these

technologies. One major issue is the lack of

regulatory clarity surrounding tokenized

assets. Security regulations vary significantly

from jurisdiction to jurisdiction and may

potentially apply to not only the creation and offering of the tokens, but also to the trading

of the tokens on secondary markets (5oJ. It is

still unclear how tokenized assets will be

treated under existing law. The SEC

considers most, but not all tokens to be

securities, while the Commodity Futures

Trading Commission (the "CFTC") considers

some tokens to be commodities (51).

Generally, tokenized real estate will likely be

considered a security (52). However, a

case-by-case analysis of each specific token

should be considered (53). What this means is

that the issuance of tokenized real estate will be subject to SEC registration and reporting

requirements. Issuers of real estate tokens who do not wish to register with the SEC must rely on one

of the several available exemptions, including

Regulation CF, Regulation D, Regulation S, and

Regulation A+ (54). Each regulation imposes different

requirement on the offering, limiting who can invest, the limits on amounts to be raised, and the

restrictions on the resale of the tokens (55). However, as previously mentioned, the uniform

status of tokens, including tokenized real estate, is

unclear. Whether they are securities, commodities,

or some other type of investment instrument is not

yet fully defined, leading to legal uncertainty and

potential compliance risks for investors and issuers

alike, creating significant barriers to entry and

limiting the growth and adoption of this technology.

Without a clear and consistent regulatory

framework, the potential benefits of tokenization and fractionalization will not be fully realized.

50. Josh Morton, Blockchain Holds Potential for Commercial Real Estate, Law360, 2 {2021). 51.ld. at 2 52. Id. at 2 53. Michael C. DeCosimo and Colton Riley, The Tokenization of Real Estate: An Introduction to Fractional Real Estate Investment, Dentons, 2 {Sept. 26, 2022). 54. Max Dilendorf et al., Tokenization of Real Estate: What, Why, and How, Dilendorf Law Firm, 10 {Sept. 1, 2020). 55. Id.


Ultimately, the Act is designed to be flexible and

This approach enables the Act to accommodate

easily adaptable to existing laws. Instead of

current and future technological advancements in the

creating an entirely new framework specifically for

blockchain and tokenization space, without the need

tokenized assets, the Act integrates tokens within

for constant revisions or amendments. The Act's

the current legal system. By defining tokens as

flexibility ensures that the legal landscape can

containers for rights, it allows for the

effectively respond to the evolving token ecosystem

representation of various types of assets, rights, or

and provide regulatory clarity tor all stakeholders.

claims under existing laws.

B. Liechtenstein Application to Tokenized Real Estate in the US

Applying the Liechtenstein Token Act's token

This approach could revolutionize the real estate

container model to the tokenization and

industry, making it more inclusive, efficient, and

fractionalization of real estate in the US would

responsive to the evolving needs of investors and

involve creating a legal framework that integrates

property owners alike.

tokens with the existing property and real estate laws. This framework would define tokens as representations of various property rights, allowing for the seamless transfer and trade of these rights on blockchain networks. To facilitate this, lawmakers could introduce provisions that outline the responsibilities and obligations of token issuers, service providers, and investors, ensuring legal clarity tor all parties involved in tokenized real estate transactions. Additionally, the US could adopt the concept of a Physical Validator, who would be responsible for enforcing the rightful transfer of ownership in the physical world when tokenized property rights are traded or transferred. By implementing a flexible legal framework that accommodates tokenized real estate within existing laws, the US could foster innovation and open up new opportunities in the property market. Fractional ownership, enabled by tokenization, would allow investors to buy and sell portions of real estate assets, increasing liquidity and accessibility for a broader range of individuals.

C. The Blocksquare Approach Another innovative approach to tokenizing real

This layered approach was demonstrated through a

estate, distinct from the Liechtenstein model, has

pilot project tokenizing a parking space in Ljubljana,

been developed by the blockchain company

Slovenia. The notarized loan agreement was

Blocksquare. Specifically, Blocksquare has

successfully registered in the national land registry,

developed a unique protocol for tokenizing real

marking the first instance of a tokenized real estate

estate assets that bridges the blockchain world

asset being recorded by a European land registry (70).

with traditional legal protections. At the core of their approach is the creation of a digital token called

By bridging on-chain and off-chain elements,

the Blocksquare Property Token ("BSPT") which

Blocksquare delivers robust legal protections to token

represents fractional ownership in a real property

holders. The corporate resolution confers clear

asset (64).

property rights, while the loan agreement offers recourse if those rights are violated. Blocksquare's

To initiate the process, the real estate asset is

hybrid model provides a template tor effectively

valued and a smart contract is created to represent

tokenizing real estate in a legally compliant manner.

the BSPTs. This ERC-20 compliant contract contains identifying details about the property and

With $74.4 million of tokenized property across 18

encodes the transactional rules of Blocksquare's

countries, Blocksquare demonstrates the viability of

protocol (65).

fractionalizing real estate on the blockchain (71). Their novel approach merits consideration as jurisdictions

To legally link the BSPT to the underlying real

around the globe develop regulations for digital assets

esta te, Blocksquare first establishes a Public

and tokenization.

Corporate Resolution, a formal document signed by the legal representative of the property owner (66). This resolution delineates the rights conferred

to BSPT holders, such as revenue sharing, and the obligations owed to them by the owner (67). The resolution is published on-chain, creating an immutable record that binds the token to the real estate asset. Blocksquare then implements a loan agreement, with the property owner as the borrower and Blocksquare as the lender of the BSPTs (68). The property itself serves as the collateral. This agreement is notarized and registered with the land registry, preventing the owner from transacting with the property until the loan is repaid in BSPTs (69).

64. Peter Mere, Real-World Asset Tokenization 2.0, Blocksquare, (Sept. 27, 2023), a tion-2-0-€stablished-bridge-between-blockchain-and-land-reg istry-1/. 65. Id. 66. Id. 67. Id. 68. Id. 69. Id. 70. First tokenized real estate in Slovenia registered land registry, Slovenian Press Agency, (Sept. 28, 2023),€state-in­ slovenia-registered-in-land-registry. 71. Blocksquare [@blocksquare_10]. Another week, Another Tokenized Property, (Sept. 25, 2023),.


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