Real Estate <> Blockchain

Real Estate meets Crypto. Crypto meets Real Estate.

Nov 08, 2021

Hello readers,

This week we’re covering the intersection of Real Estate and Blockchain technology. An unlikely pair that turns out to be a lot like chocolate & peanut butter - two great tastes that taste great together.

In this report, we’ll break down how and why blockchain technology will radically transform real estate markets this decade.

Topics covered:

Why are real estate assets illiquid and what does that mean in terms of unlocking value?
Differences today between public markets and private market assets like commercial real estate
How blockchain technology changes the game
Why does this matter? What are the benefits to owners, managers, and investors of real estate?
A peek into what these markets could look like in the not too distant future

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I spent 10 years working in commercial real estate before moving into the blockchain/crypto/DeFi space where I now spend all of my time (which is amazing because I was previously spending half my time on this stuff anyway). Furthermore, I recently took a position as the Director of Ecosystem Strategy at Inveniam. Inveniam is an emerging start-up in the space that utilizes blockchain technology and AI to facilitate price discovery of private market assets, with a particular focus today on commercial real estate.

It all comes down to data. In this report, you’ll get an inside look at how blockchains facilitate trusted data within capital markets. This will ultimately unlock immeasurable value within illiquid private market asset classes like commercial real estate.

Let’s go.

Why are Real Estate assets illiquid and why does this Impair Value?

The path to price discovery in highly liquid markets goes like this: Trusted, transparent data = information. Transparent information facilitates understanding, trust, and conviction amongst market participants. This allows buyers and sellers to make decisions regarding the value of various assets. Which allows for price discovery. Price discovery leads to liquidity.

Liquid assets are generally more valuable than illiquid assets because they can easily be converted into cash or cash equivalents.

The foundation to all of this is *trusted data*. Without trusted data, market participants lack the information needed to make a decision.

Liquidity differences between Public and Private Markets

Public Markets:

Publicly traded assets like stocks are highly liquid. Investors prefer this because they can easily get in/out of a trade. As market conditions evolve, investors can easily exercise optionality in managing their positions due to the liquid nature of public markets.

Publicly traded companies face stringent rules and regulations around the disclosure of material information relating to their business. In addition to filing quarterly and annual reports with the SEC, public companies must implement internal accounting controls and hire independent 3rd party auditors to review and sign off on their financial statements.

These regulations are in place to protect retail investors but also as a way to ensure that all market participants can converge around the same information about a company, and *trust* that information. When this is achieved, we can reduce the asymmetry of information within the market and establish price discovery. As mentioned, price discovery leads to liquidity.

Private Markets:

Private markets do not have these stringent rules and regulations. Private companies are required to follow various rules for accounting and taxes, but there are no disclosure requirements to the general public. The market has no way of knowing anything about these assets and hence their value. Therefore, when private market assets like commercial real estate are listed for sale, it can take 3-6 months for price discovery to occur. That’s 3-6 months before the asset can be converted to cash. As we’ve experienced over the last few years, a lot can happen during a 3-6 month timeframe.

What does this mean for owners, managers, and investors of private commercial real estate assets?

1. The asset is never sale-ready.

2. Because the asset is never sale-ready, the bank/lender has to cover the increased illiquidity risk associated with that asset. They cover this risk with lower than optimal loan to value ratios (the owner/manager must put more $ down on loans) as well as elevated debt servicing costs that are passed onto the owner/manager.

3. Because of the lower loan to value as well as financing costs, capital is “stuck” and not making its way to its highest and best.

4. The average investor does not have the option to invest in private commercial real estate today. Due to the illiquid nature of the assets and lack of reporting requirements, regulators historically have allowed only accredited investors ($1m net worth or $200k annual income) to make these investments. With that said, we are starting to see some regulatory exemptions for crowd funding sites like Fundrise. But the investable assets on these platforms are still very illiquid.

Blockchain Technology Changes the Game

As we’ve noted, liquidity starts with trusted data.

Blockchains, at their most primitive level, are simply immutable ledgers of data.

One of the key breakthroughs of blockchain technology is that we now have the ability to aggregate data and create digital scarcity with it.

Example:

Using blockchain technology and AI, we can automate the process of aggregating all of the data pertinent to pricing a commercial real estate asset.

Audited financials. Leasing and occupancy data. Legal and environmental data. Title & deed. Building efficiency data. Key fob data. Capital project data. Etc.

All of this data can be aggregated into a single source of truth and anchored to a blockchain (Ethereum or Polygon for example). In this process, a digital asset is created. A digital twin of the physical asset, represented by the validated and trusted data pertaining to that asset.

But here’s the key takeaway: the data never leaves its place of rest. What I mean is the owner/manager of the data never gives up control. And the data aggregated is validated and trusted because we can see the provenance of it - we can see where it came from. For example, an audited financial statement from a landlords Yardi accounting system.

Furthermore, the digital asset we created is commutable. It can be transferred/exchanged via the blockchain. It can also be fractionalized so that small investors from all over can gain access to the investment.

And because all of the relevant property data is underpinning the digital token, market participants can converge on this transparent, trusted, validated, and indexed data. Price discovery can occur.

Ultimately, we envision the marketplace for private market assets to trade on blockchains and have a similar liquidity profile as public equities today.

In case you were wondering, the market for private assets is massive:

What are the benefits to owners and managers of these assets?

Improve accounting treatment - move from level 3 illiquid asset to level 2 liquid asset per FASB 157. This facilitates #2.
Improve financing costs and loan to value.
Mark the asset to fair value monthly in an automated fashion. This saves time and $ for accountants, asset managers, etc during the annual or quarterly appraisal process. Additionally, marking the asset to fair value enhances the balance sheet which can then be monetized in capital markets.
Maintain a sale-ready asset. Save time and $ on due diligence.
Increase optionality for managing your portfolio - recapitalize the portfolio for new opportunities without selling off 100% of key, high-performing assets.
Deploy more capital to its highest and best use.
Monetize your data. Instead of having a company like Costar sharing your data and profiting from it, we see a future where owners/managers of assets control their data and can sell bits and pieces of it to a company like Costar should they choose to.

None of this was possible before blockchain technology.

A Look Into the Future

Today we see the base layer infrastructure being built upon which private market assets will eventually trade on marketplaces that look similar to public markets today.

This is where Inveniam sits. Physical asset data —> token.

The next level up is Token —> Investor. Platforms that can automate KYC/AML compliance and the administration related to investment fund structures. This level is being built today by players like Tokeny and Securitize. These platforms will automate waterfall calculations, provide custody solutions, and ultimately integrate with global exchanges.

The final layer is the global trading of fractionalized assets on secondary markets that will look similar to public markets today. Want to buy an ETF of commercial assets in the Northeast? Trade that against a similar ETF in the Southwest? Want to gain access as a small investor in a skyscraper in Dubai? Want to buy into a passive stream of income via a tokenized lease instrument?

We see this playing out over the next 2-4 years with broad-based adoption this decade.

Why is this Inevitable?

The unprecedented monetary policy over the last decade has pushed interest rates to near zero, forcing investors into private markets in search of the returns they used to be able to achieve in public markets. Has anyone looked at a chart of debt to GDP around the world lately? We don’t see this trend reversing anytime soon. Furthermore, the volume of private market assets has grown 4x that of public market assets over the last 20 years.

Finally, blockchain technology facilitates the following:

Superior asset settlement rails: open 24/7, 365 days/year
Instant and final settlement (2 days in traditional markets)
Blockchains remove friction and unnecessary middlemen, opening up efficiencies in capital markets
Blockchains provide for enhanced security since the data is anchored to a decentralized set of computers around the world. There is no single point of attack.
Blockchains introduce triple-entry accounting, serving as an automatic audit function

As private markets become more liquid, we should expect to see a wall of capital move into this space.

Show me the incentives and I’ll show you the outcome.

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