Real estate of 21st century and the tokenized revolution:

Real estate market is currently experiencing an unprecedented rate of growth, largely driven by the rapid development of surging economies like India and China. Notably, China has witnessed significant growth in its real estate sector as compared with India in the past decade. However, India is at the new fore front in the race to get ahead of its rival to boost its real estate sector.1 The market size of the real estate industry in India was valued at around 120 billion U.S. dollars in 2017 and is estimated to reach one trillion dollars by 2030.2

The global commercial real estate market has been on a strong recovery path as the economy emerged from the Covid-19 pandemic. Between 2019-22, global investment in commercial real estate reached a record-breaking US$1.3 trillion in 2021—up by 55% from 2020 and 21% from 2019.3

Real estate is generally termed as tangible asset, including land, natural resources, flora, fauna, and buildings, categorized into Residential, Commercial, Agricultural and Industrial properties and others depending upon its use. Conventional real estate investment entails direct acquisition, providing benefits such as competitive risk-adjusted returns, a substantial tangible asset value, and a consistent income stream through rent and leasing.4 Given the inherent importance of real estate as an asset class, it is crucial to comprehend the challenges it encounters and explore potential solutions leveraging technology and other efficient means. It is crucial to address the current shortcomings in real estate market through innovative approaches that has the potential to transform it into a viable, thriving, and accessible asset class.

Real estate problems and blockchain revolution:

The traditional challenges arising out of real estate investments includes shortage of funds for investment, high cost of construction material and high dependency on physical workforce. Whereas, on the other hand complicated domestic real estate law, legal challenges surrounding land acquisition, creating strong impenetrable database, and increasing competition are some other challenges associated with the market.5

The undermined hinderances of real estate have implications for the overall efficiency of the market. While there have been improvements in the conventional mechanisms of information flow and transaction completion, many growing economies are only at the initial few steps in terms of adopting new technological aspects like digitization of the assets in terms establishing better transparency mechanisms, which could be a new gateway for solving issues related to Real Estate assets.6 Now that we have an understanding about the classical problems of real estate, without a viable solutions in sight, there is a pressing need for participants in the real estate market to remain informed and actively explore the latest technological advancements in the industry.

To address the traditional limitations of real estate sector requires a concerted effort to embrace the transformative potential embedded in technological developments. Blockchain technology has introduced unparalleled transparency that has fundamentally changed horizon by deploying faster dissemination of information, safe storage for data and organising contractual obligations, saving costs, and reducing the time frame. Furthermore, Real World Asset Tokenization can be seen as a rare and an untapped opportunity in most of the world. Consequently, purchasers now could conduct transactions in an immutable manner through tokenized real estate.7

Real World Asset Tokenization

In the recent times, both experts and investors have raised concerns or offered critiques about the limited incorporation and acceptance of technology to align with prevailing conventional transactional methods.8 Nevertheless, the emergence of blockchain, along with the tokenization and fractionalization of Real Estate and Real-World Assets (RWAs), has significantly contributed to introducing new dynamics and efficient avenues for investing and profiting from the burgeoning economic sector. A key argument that emerged with the introduction of blockchain technology is its practical utility and value. Tokenization and fractionalization of assets now stand as a concrete example, offering genuine utility and value to both the assets and their investors. Fractional ownership may allow for more inclusive access of small and retail investors to somehow restricted asset classes, while enabling global pools of capital to reach parts of the financial markets previously reserved to large investors.9

Tokenization can also be understood as converting all or some of the rights of an asset to a number of units called tokens,10 various types of securities and assets can be tokenized, including real estate, art and collectibles, stocks and equities, commodities, funds and investment vehicles. In practical terms, a tokenized security serves as a digital representation of a real-world asset existing off the blockchain. It can exhibit various characteristics, functioning as a utility, security, or governance token, either individually or in combination. The nature of these tokens, whether they are Fungible Tokens (FTs) or Non-Fungible Tokens (NFTs), depends on the type of real-world asset undergoing tokenization. Subsequently, these tokens can be traded on exchanges or other platforms.

Conventional methods bridging with technological advances:

As we already know the process of asset tokenization involves generating digitized version of RWA like gold, movable, or immovable property, which is converted into digital tokens such that one can perform actions on a fraction or complete real-world asset. Tokens represent rights in tangible assets and are issued on the blockchain. These tokens are dispensed on the blockchain and offered through an Initial Coin Offering (ICO) / Security Token Offering (STO), commonly known as a tokenized security offering or a tokenized asset offering.11 Each segment of ownership is transformed into a token generally termed as 'fractionalized ownership' and subsequently encrypted to confer ownership and rights to trade.

The transfer of ownership or other rights can then occur directly between investors on digital securities marketplaces, providing nearly instant transactions at a comparatively reduced time frame and modest cost.12 The delegated or sovereign authorities can oversee and govern the issuance of tokens. In USA, regulatory oversight over the issuance or resale of tokens and digital assets classified as securities, is generally within the purview of the Securities Exchange Commission (SEC).

In Singapore under Section 2(1) of the Securities and Futures Act (CAP.289) (SFA), "capital market products" has been defined as any securities, futures contracts, or arrangements for the purposes of foreign exchange trading, and such other products as Monetary authority of Singapore (MAS) may prescribe as capital markets products.13 MAS scrutinizes the structure and features of a digital token, including the associated rights, to ascertain whether it qualifies as a type of capital markets product under the SFA.14

The United Arab Emirates ("UAE") has robust 'asset tokenization' regulatory framework which is governed by the Securities and Commodities Authority ("SCA"), responsible for regulating and supervising securities and commodities markets in the UAE. For businesses intending to issue or invest in tokenized assets are subject to the same regulations as other securities. SCA issued 'SCA Decision No. 23 of 2020 concerning Crypto Assets Activities Regulation' ("CAAR") in November 202015 to regulate the offering, issuing, listing, promoting and trading of digital assets and related financial services in UAE. Further the 'Administrative Decision No. (11) of 2021 concerning Guidance for Crypto Asset Regulations' ("Crypto Assets Guidance 2021") was issued in March 2021 to govern crypto assets in UAE.16 The tokenization of real estate in the UAE is becoming increasingly popular, with the creation of tokenized real estate investment trusts ("REITs") and other investment vehicles.

SCA Regulations include licensing requirements, anti-money laundering and counter-terrorism financing ("AML/CTF") measures, and investor protection measures. Notably, the UAE government, financial authorities and independent regulators like Dubai Financial Services Authority and Financial Services Regulatory Authority have adopted a proactive stance towards fostering the growth of the tokenized assets market.

Developing similar laws in India would necessitate a sophisticated methodology, involving a series of strategic steps to seamlessly integrate tangible assets into the digital realm while ensuring legal compliance, regulatory oversight, and investor protection. This whole process of combining legal compliance regime for the regulation of tokenization of RWAs requires a sophisticated methodology with a series of strategic steps, each contributing to the seamless integration of tangible assets into the digital ones. The basic steps involved in tokenization can be understood from the following:

The theoretical potential of asset tokenization is considered boundless, suggesting that virtually any real asset has the capability to be "placed on the blockchain". For instance, the real estate token represents fractional ownership of rights when one tokenizes a property. Real estate tokens, being units of data on a blockchain, are tradable, primarily linked to the value of a tangible asset and capable of asserting various rights, including:

  1. Equity interest in an entity overseeing real property;
  2. Stake in a debt backed by real property;
  3. Entitlement to a portion of the profits generated by real property;
  4. Rights to distribution of rental income from the property.

Scope of tokenization rights under Indian Laws

The conventional marketplace provides investors with mechanisms for generating returns from income-producing real estate, and one prominent avenue is through REITs. In India REITs are required to be registered with Securities & Exchange Board of India (SEBI) to carry out the activity prescribed under SEBI (Real Estate Investment Trusts) Regulations, 2014.17 REITs are trusts that own, operate, or finance income-generating real estate and are traded on major stock exchanges, offering investors liquidity and exposure to real estate assets without the need for direct property management or financing. REITs are required by law to distribute 90 percent of net distributable cash flow to unit holders in the form of interest/dividend contributing to their frequent consideration for their income-generating potential.18

Investors can buy REIT shares as they would with any other publicly traded company, and they have the flexibility to trade these shares on the stock exchange.19 SEBI also introduced a framework for self-sponsored REITs, which has been defined to mean the Manager of a REIT who has dual responsibilities of both the Manager20 as well as the sponsor21. Self-sponsored REITs will create space for mature and independent professionally managed Managers to emerge and will provide a further exit option for the Sponsor in addition to the exit option through the change of sponsor presently envisaged in the REIT Regulations.22 The investment in such assets can be made directly or through Special purpose vehicle i.e. SPV/Holding Company.

Recently SEBI has made two significant amendments to the rules of investing in REITs in India:

  • The previous minimum requirement of INR 50,000/- for an investor to invest in units of REITS, has been done away with. Presently, the minimum investment amount required is INR 10,000/- to INR 15,000/- only, for investment through initial public offerings and follow-on offers; and23
  • The minimum lot size of REITs traded has been reduced from 100 units to 1 unit.

Recent amendments by SEBI have eliminated the previous minimum investment requirement, making REITs more accessible with a reduced minimum investment amount. The Amendment has also changed the requirement of minimum unit-holding by Sponsors. The Sponsor would be required to hold a certain minimum unit-holding on a reducing scale for the entire life of the REIT. Also, the mandatory unit-holding of the Sponsor shall always be locked in and be unencumbered.24 Currently, there is a 15 per cent unit holding lock-in for at least three years. Under the amended regulations, it starts at 15 per cent for up to three years, then reduces over time with the lower of 1 per cent of unit capital or ₹500 crore after 20 years.25

It's worth noting that while REITs offer certain advantages, such as liquidity and diversification, they also come with risks and can be influenced by factors affecting the real estate market, interest rates, and economic conditions. Since there are limitations to this model, investors interested in REITs should conduct thorough research and consider their investment goals and risk tolerance.26

Another popular way of investing in a real estate is through a Special Purpose Vehicle (SPV). SPV is an independent legal entity established for the purpose of development and managing real estate. It functions as a separate company with its distinct assets, liabilities, and legal standing. An SPV is formed to achieve a particular goal as a strategy for dispersing the risks associated with a designated pool of exposures held by the SPV, redistributing these risks to investors willing to undertake them. This arrangement enables investors to access opportunities that might not otherwise be available and creates an additional avenue for revenue generation for the entity supporting the SPVs.

Current Developments in Asset Tokenization in India

The International Financial Services Centres Authority (IFSCA) a statutory authority established by Government of India has formed a committee tasked with the formulation of regulations pertaining to the tokenization of assets, alongside an assessment of the legal validity inherent in smart contracts. This initiative stands as the inaugural and substantive effort by any authority to devise a regulatory framework specifically addressing the tokenization of physical and real world assets.

The terms of reference for the Expert Committee on Asset Tokenization in Gift City encompasses several key objectives. Firstly, the committee is entrusted with the responsibility of formulating comprehensive regulations and policy guidelines governing the tokenization of both Real and physical assets within the Gift City framework. Additionally, the committee is tasked with assessing the legal validity of smart contracts within this context. Moreover, the committee is directed to develop a robust risk management framework specifically tailored for digital tokens, ensuring a prudent approach to their utilization. Furthermore, the committee is required to scrutinize the role of digital custodians within the asset tokenization model and formulate operational policy measures to guide their functions within this domain. This multifaceted mandate underscores the committee's pivotal role in shaping the regulatory landscape and operational framework for asset tokenization within the Gift City.27

Apart from this the Telangana Government has established a Blockchain District28, aiming to serve as a collaborative platform for the convergence of academic institutions and industry. Govt of Telangana, IIIT – Hyderabad, Centre for Development of Advanced Computing (CDAC) and Tech Mahindra are the Founding Members of Blockchain District. Govt. of Telangana, Department of Information technology, Electronics and Communications has also published a Technical Guidance Note on Asset Tokenization. The document aims to provide guidance on the technical intricacies involved in tokenization and proposes how standards in this domain could be structured. It also outlines an approach that companies or startups may consider when embarking on the path of tokenization of assets.29

Conclusion: Navigating the Evolving Landscape of Blockchain in Real Estate

The evolving landscape of real estate, particularly in the context of India, is witnessing a significant paradigm shift with the integration of blockchain technology. This shift is largely driven by concerted efforts from both governmental authorities and the private sector to harness the potential of blockchain in transforming traditional real estate practices.

A landmark development in this transformation is the initiative taken by the International Financial Services Centres Authority (IFSCA). The formation of a committee by the IFSCA marks a pivotal step in establishing a regulatory framework specifically targeting the tokenization of physical and real-world assets. This committee's comprehensive mandate includes formulating regulations and policy guidelines for the tokenization of assets within the Gift City framework. This framework is poised to address the intricate legalities surrounding smart contracts, creating a robust risk management structure for digital tokens, and delineating the role of digital custodians in the asset tokenization model. This initiative is indicative of the Indian government's commitment to integrating cutting-edge technologies into its financial sectors, paving the way for more efficient and transparent asset management practices.

In tandem with these regulatory advancements, the Telangana Government's establishment of a Blockchain District signals a significant stride towards fostering innovation and collaboration in the blockchain sphere. This initiative, supported by key academic and industry partners, including the Government of Telangana, IIIT – Hyderabad, CDAC, and Tech Mahindra, aims to create a conducive ecosystem for blockchain technology. This collaborative platform exemplifies the government's proactive approach in leveraging blockchain for real estate and other sectors.

Furthermore, the Department of Information Technology, Electronics and Communications of the Government of Telangana, has published a Technical Guidance Note on Asset Tokenization. This document is a critical resource for understanding the technical nuances of tokenization, offering guidance on standardization and best practices for companies and startups venturing into asset tokenization.

The real estate sector, which has long faced challenges such as liquidity constraints, opacity, and accessibility issues, stands on the cusp of a revolution. Blockchain technology, with its inherent attributes of decentralization, transparency, and security, offers a viable solution to these age-old problems. The integration of blockchain-based smart contracts, as emphasized in the article, serves as a catalyst for enhancing efficiency, due diligence, security, and transparency in real estate transactions. The advantages of blockchain in real estate, such as global investment facilitation, automation, time savings, enhanced security, and transparency, are set to redefine the industry.

However, it is crucial to acknowledge the challenges that lie ahead, particularly concerning the regulatory and legal framework necessary for the widespread adoption of blockchain technology in the real estate industry. The need for standardization, along with industry-wide acceptance, poses significant challenges. The collaboration between coders/ developers, legal experts, and other stakeholders is essential for the successful implementation and execution of smart contracts, highlighting the importance of a multidisciplinary approach in this domain.

In conclusion, the integration of blockchain technology and the tokenization of real-world assets in India's real estate sector is a testament to the country's embrace of technological innovation. This move promises to address longstanding issues such as liquidity constraints, opacity in transactions, and high entry barriers for smaller investors. As India continues to navigate and shape the regulatory and operational landscape for blockchain and asset tokenization, it stands on the cusp of revolutionizing not only its real estate sector but also setting a global benchmark in the adoption and regulation of emerging financial technologies. The journey ahead, though laden with challenges, holds immense promise, and India's proactive approach in this domain serves as a beacon for other nations grappling with similar technological and legal intersections.

Footnotes

1 https://www.jll.co.in/en/trends-and-insights/research/the-2022-story-indian-real-estate-rise-from-the-lows

2 https://www.statista.com/statistics/955598/india-real-estate-industry-market-size/

3 https://www.cbre.com/insights/briefs/2021-global-investment-volume-hits-record-level

4 "Real Estate Sector in India", Research and Policy Insights on Financial Markets and Economy by Prof. Prashant Das and Poorvi Anchalia available at https://www.iima.ac.in/sites/default/files/2023-03/MCFME_Real%20Estate.pdf

5 https://www.forbes.com/sites/forbesrealestatecouncil/2021/01/11/16-challenges-for-real-estate-investors-and-how-to-deal-with-them/?sh=74dcafef50e7

6 The real estate industry's transparency challenge - and how it can solve it, Christian Ulbrich available at https://www.weforum.org/agenda/2020/10/why-real-estate-markets-are-on-the-right-track-with-transparency-efforts/

7 Heines, Roger & Dick, Christian & Pohle, Christian & Jung, Reinhard. (2021). The Tokenization of Everything: Towards a Framework for Understanding the Potentials of Tokenized Assets. available at https://www.researchgate.net/publication/352903703_The_Tokenization_of_Everything_Towards_a_Framework_for_Understanding_the_Potentials_of_Tokenized_Assets

8 https://www.ey.com/en_us/real-estate-hospitality-construction/how-commercial-real-estate-firms-use-technology-to-secure-a-future

9 OECD (2020), The Tokenisation of Assets and Potential Implications for Financial Markets, OECD Blockchain Policy Series, www.oecd.org/finance/The-Tokenisation-of-Assets-and-PotentialImplications-for-Financial-Markets.htm.

10 What Is Tokenization and How Does It Work? By Taylor DeJesusforGOBankingRates available at https://www.nasdaq.com/articles/what-is-tokenization-and-how-does-it-work

11 Security token offerings: The next phase of financial market evolution? Available at https://www2.deloitte.com/content/dam/Deloitte/cn/Documents/audit/deloitte-cn-audit-security-token-offering-en-201009.pdf

12 Konashevych, Oleksii. (2020). General Concept of Real Estate Tokenization on Blockchain. Available at https://www.researchgate.net/publication/341149204_General_Concept_of_Real_Estate_Tokenization_on_Blockchain

13 https://sso.agc.gov.sg/Act-Rev/SFA2001/Published/20211231?DocDate=20211231

14 A GUIDE TO DIGITAL TOKEN OFFERINGS available at https://www.mas.gov.sg/-/media/MAS/Sectors/Guidance/Guide-to-Digital-Token-Offerings-26-May-2020.pdf

15 https://www.sca.gov.ae/Content/Userfiles/Assets/Documents/8004151b.pdf

16 https://www.sca.gov.ae/assets/download/fe72b1d3/circular-11-2021-e.aspx

17 Securities And Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014.

18 Revised framework for computation of Net Distributable Cash Flow (NDCF) by Real Estate Investment Trusts (REITs) https://www.sebi.gov.in/legal/circulars/dec-2023/revised-framework-for-computation-of-net-distributable-cash-flow-ndcf-by-real-estate-investment-trusts-reits-_79656.html

19 https://www.nseindia.com/products-services/final-offer-documents-reits

20 Reg 2(1)(w) "manager" means a company or LLP or body corporate incorporated in India which manages assets and investments of the REIT and undertakes operational activities of the REIT

21 Reg 2(1)(zt) "sponsor" means any person(s) who set(s) up the REIT and designated as such at the time of application made to the Board and shall include an inducted sponsor.

22 Securities and Exchange Board of India (Real Estate Investment Trusts) (Second Amendment) Regulations, 2023

23 Reg 14 (14) of The Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014

24 Reg 11 (3) of The Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014.

25 Ibid

26 Vinayak Chavan, Prof. Chandani Patel, "A Study of Tokenization of Real Estate Using Blockchain Technology", VIVA-IJRI Volume 1, Issue 4, Article 189, pp. 1-8, 2021. Published by Computer Engineering Department, VIVA Institute of Technology, Virar, India. Available at https://www.viva-technology.org/New/IJRI/2021/189.html

27 https://ifsca.gov.in/IFSCACommittees

28 https://blockchaindistrict.telangana.gov.in/

29 https://it.telangana.gov.in/wp-content/uploads/2023/12/Technical-Guidance-Note-on-Asset-Tokenization.pdf

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