REAL ESTATE: THE NEW KID ON THE BLOCKCHAIN

Property is a data-rich business that represents an immense store of wealth around the world. So it’s not surprising that the tech behind bitcoin is coming to real estate.

Real estate might seem an odd candidate for digital transformation, given that its value is built entirely around bricks-and-mortar or land. But few industries stand to benefit more from the introduction of blockchain than real estate.

A reminder: blockchain is an open, distributed ledger of records – or blocks – that is linked sequentially in an unbreakable chain. Each block contains a cryptographic hash of the previous block, a timestamp, as well as any transaction data – allowing anyone to see an up-to-date version of the ledger containing a single version of the truth.

This matters for real estate because, historically, property has been an opaque business, with a wide variety of local practices, valuation metrics, and uneven reporting standards. There are whole industries of intermediaries, and other entrenched participants, who profit from the inefficiencies in the way property transactions are handled, contracts agreed and titles recorded. 

Dealing with corruption

Then there’s a minefield of corrupt influences that has proved difficult to combat with the tools that are currently available to the industry – and law enforcement.

Transparency International, a global corruption watchdog, reports that real estate investment remains an important tool of money launderers. They often use property, particularly in expensive urban addresses in the West, to hide billions of dollars from investigators, tax authorities and others tracking criminal behaviour.

Dishonest practices distort prices in real estate markets to the detriment of investors in the sector. Portfolio managers, in particular, face problems when they purchase large-scale properties through structures such as Real Estate Investment Trusts.

As investment vehicles, REITs are well established in the US and in recent years have become popular as publicly listed entities in Europe and the Asia-Pacific region, because of their high yield and tax advantages for investors. Unlike most  property investments, they aim to be very liquid, offering retail investors opportunities to easily trade in and out in response to changing market conditions.

But because they are composed entirely of real estate assets of one type or another, REITs are vulnerable to the costs and risks resulting from complex real estate transactions, questionable counterparties, corrupt intermediaries – or some combination of all three. 

Costly operational challenges

Even without these external issues, keeping track of what properties investors own, how they’re performing, what they’re worth and what titles and permits are attached is a significant and costly challenge. Many real estate investments are underpinned by complex long-term contracts for letting or maintenance – further confusing the picture for owners, tenants, investors and investment managers.

These are all areas where blockchain can help. Because it is resistant to modification of historic data, it’s useful to all parties in a transaction as a source of reliable information about what exactly is being bought and sold. Title deeds, for example, can be stored in a way that avoids conflicting claims.

This not only improves trust and transparency across the real estate industry, it also makes transaction processes far more efficient and limits the need for intermediaries. One important result of this is that blockchain could significantly cut the cost of buying and selling property.

Streamlining opportunities

For REITs and other institutional property investors, blockchain is also a blueprint for eliminating siloed databases, integrating investment data into a single platform so that fund managers can gain a 360-degree view of their investments in real-time.

Using blockchain, the revolution in property portfolio data management can be extended across borders, allowing investments around the world to be integrated into a single platform.

Another exciting prospect using blockchain is the digital ‘tokenisation’ of property assets. This effectively securitises real estate, allowing shares of a property to be securely traded on a secondary market. So instead of buying and selling units of bitcoin on an exchange, investors could buy and sell fractions of a real estate portfolio.

That would allow REITs and other property holders to attract new market participants, enable new investment strategies, and create liquidity in the market for real estate. At the same time, tokenisation would also eliminate whole layers of administrative costs, including the need for intermediaries and transaction fees.

Finally, tokenising property into a digital currency that is standardised, viable and tradable opens property assets to an international market of buyers and sellers. 

The promise of smart contracts

Bitcoin isn’t the only popular use of distributed ledger technologies (DLT – often used synonymously with blockchain). One of the most promising alternative uses is Ethereum, a blockchain that uses its blocks to store applications – including a form of cryptographic ‘smart contract’.

Smart contracts are computer programs executed in a restricted, or ‘sandboxed’, environment to agreed specifications. Like the data on a standard blockchain, these apps are immutable and can be set to trigger automatically based on a variety of inputs – such as a warehousing system acknowledging receipt of a shipment or a notarised change in the ownership of an asset.

This allows them to verify automatically who owns a property asset, say, and where the cash or credit that is needed to complete a purchase is located before the transaction takes place. Because of the distributed nature of blockchain, these transactions are effectively impervious to hacking or manipulation. Another use might be monitoring rental agreements on commercial property and triggering dividend payouts to investors.

When fully integrated, technologies associated with blockchain offer the prospect of establishing a fully liquid, round-the-clock global market for real estate akin to what currently exists for currencies, equities or government bonds.

That would make real estate opportunities not only easier for individual investors to access, but far easier for their inclusion in diversified global investment portfolios.

 The need for standards

We’re not there yet. As with many of today’s disruptive technologies, the need to adopt new regulatory approaches to respond to a blockchain-based real estate market may be growing faster than authorities recognise – although agencies such as Her Majesty’s Land Registry are already experimenting with blockchain.

One important issue to resolve is mark-to-market accounting. During the last financial crisis, this contributed to a worsening of credit and liquidity conditions by forcing banks to write off property assets on their books based entirely on their sharply falling open-market prices. The possibility of a similar shock to the financial system due to a new class of securitised assets held around the world isn’t difficult to imagine.

Another consideration for regulators is who would have jurisdiction over transactions that will regularly cross borders. Similarly, regulators may need to ponder how to account for ever-fluctuating currency exchange rates and market volatility in the design of smart contracts.

But considering the potential scale of opportunities presented by digitising the real estate industry, the effort required to make it happen seems well worth it.