Issuing property tokens on the blockchain and creating a marketplace for owners, retail and institutional investors, could energize the regional real estate market. Getting involved in fractional property ownership using tokens requires legal knowledge.
A Q&A with Nadim Bardawil and AMEinfo.
Are individual and constitutional investors in this region legally comfortable with this blockchain-based setup?
The majority of investors in the region are still unsure about what blockchain is or how it operates in practice. There also are some misconceptions with regards to what owning a “token” means from a legal standpoint and whether it provides for free and unfettered access to the underlying asset. We note that this is not only a regional trend but seems to be a global trend as there has been a marked slow-down in real estate tokenization projects worldwide. Institutional investors would especially look for regulatory supervision on the tokenization of assets to provide sufficient comfort.
Do tokens represent equity in actual property assets or equity in the company having an underlying property?
This depends on the model being used for tokenization. Prior to tokenization, REITs were commonly used to fractionalize real estate ownership and the model used here was where an owner owned a portion of a vehicle or a unit in a fund that owned the underlying property. With tokenization, the token itself can be in the actual asset or in a vehicle/fund which owns the asset.
Does tokenization give greater control over the sale and purchase of property assets?
Not necessarily as this would depend on whether the token is tradable on an open/public platform or works as a closed-loop token that can only be sold on a closed/private platform. We also need to keep in mind that depending on the jurisdiction, the land registry may need to have oversight on the sale of property which means that even if a property is tokenized, the sale of said token must occur with the approval and oversight of the land registry.
Where does the government have control over what takes place on the blockchain, when it comes to:
a) Launching a blockchain-based real estate tokenization equity model?
The tokenization of an asset should ideally occur within a regulatory framework of an STO or Security Token Offering as the tokenization of any asset is generally deemed to be a financial transaction as well as a real estate transaction. The UAE is one of the few countries that has STO regulations in place and these would require the approval of the relevant financial regulator.
b) Smart contracts between seller and buyer?
A smart contract (or any contract for that matter) is a private arrangement between 2 parties and would not fall under government oversight unless the underlying transaction is one that is regulated by a specific regulatory body, for example, the sale of a security or sale of a real estate asset.
c) Token transactions (sale, secondary trading, swaps, …)?
This would be regulated as part of the same regulations described in answer a) above.
d) Fee exemptions aimed at encouraging a blockchain economy?
This would depend on whether the transaction occurring on a blockchain is regulated. If the transaction in question is part of a regulated activity, then the fees may need to be disclosed or approved by the relevant government entity.
Can tokens be pooled into a fund that can be managed for re-investment purposes or is this too legally complicated to achieve?
From a structural perspective, yes this is possible. We have even seen owners of real estate able to sell portions of their real estate assets by way of tokens on an open market thus raising equity instead of debt. The holders of the tokens are then allowed to re-sell these on an open market. By using Distributed Ledger Technology (DLT), if the specific build allows for this, holders and issuers of tokens can easily track how many times the token has been sold and for what price.
What legal documents should issuers have ready/prepared before investors jump on board?
Any entity serious about tokenizing real estate should first have a very clear understanding of the security laws in the specific jurisdiction, as they will need to comply with any active STO regulations. Typically, issuers would have a prospectus that has already been vetted and approved by the relevant regulator to present to investors. Once investors show real interest, issuers would then provide them with the relevant legal documentation that would enable them to receive tokens in exchange for transferring FIAT currency to the issuer.
How can investors assess the risk factors associated with the issuer or the assets themselves?
Very simply, if you deal with any issuer of a tokenized asset who does not have the backing of a credible regulatory entity, you should stay away. While cryptocurrencies are largely unregulated and have a certain place in today's economy, tokenization of brick and mortar assets should follow a specific framework that is defined and has the correct amount of oversight by a third-party entity specialized in this field.
What legal recourse do investors have in the case of an issuer default or bankruptcy, scam, or misleading information about the properties themselves?
When it comes to tokenization, the first concern would be to secure access to the tokens themselves as securing ownership would be the first battle.
If ownership of the token is secured, the next step would be to ensure that the token is in fact directly tied to the ownership of the real estate asset. If there is no legitimate ownership tie-in, the only recourse available would be a civil claim against the issuer who would most probably be long gone by the time any type of default creeps up.
In the event where the token is clearly owned and is clearly tied to the real estate asset, this may put investors in a better position as the real estate asset may always have value whether it is yet to be built or already built.
Originally Published by AMEinfo
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