No One Is Buying Your Real Estate Token

Apr. 12, 2019 8:29 AM ET

Summary

Tokenized Real Estate Lacks Features for Success.
Product-Market Fit Remains Deficient.
These Offerings Are Instructive in Seeking Better Offerings.

Tokenized real estate has long been discussed as a leading use for digital securities. Yet, really no successful sales have taken place. Some of the most notable and widely marketed projects were pre-arranged to signal successful optics and had side deals to incentivize investment. Though tokenized real estate will eventually emerge, the benefits over existing financial offerings do not yet offer the level of value needed to overcome market inertia and successfully scale.
It’s no surprise that many real estate owners have an interest in selling their property via a digital security fundraise. By “fractionalizing,” breaking down investments into smaller pieces, real estate sellers can ask for higher prices than they would selling wholesale. Or alternatively, those that can not find buyers in traditional markets turn to digital securities as a last resort à la adverse selection.
Though this looks attractive to sellers, who would buy these offerings? Consider the typical profile of a real estate investor - conservative, interested in wealth preservation, sensitive to margin costs. Generally, they do not want what most perceive to be experimental investment technology. Furthermore, with the extant availability of public REITs, fund managers, real estate crowdfunding, and direct investments, the benefits of liquidity and access to foreign inventory espoused by many security token evangelists are already available. The short-term benefit to the investor is marginal at best and comes with a high degree of perceived technology risk.
Ultimately, the real estate asset class suffers from the lack of high upside to achieve product-market fit. A great real estate investment for a passive investor might yield 20% a year. Why take all of this perceived risk and adopt a new behavior when available investments can offer similar returns without the unknowns? Due to adverse selection, existing public and private market dynamics, and investor characteristics, it’s hard to find a scenario by which both sides of the transaction could find value meaningful enough to exceed the threshold for adopting a new behavior.
The pool of digital security investors today is small and comprised of, predominantly, blockchain/ICO-savvy investors. These people, still nostalgic for their +1000% 2017 returns, have a high-risk tolerance, want high-returns, and understand technology. They don’t want an 8% fixed-income real estate debt product.
The primary exception to this may be those in countries with tight capital controls (aka China), that want to expatriate their wealth into stable, foreign assets. In this case, the primary benefit of security token real estate, in short, is the ability to hide the movement of capital from their government. I don’t know about you, but hiding cash for the wealthy and circumventing national governments is not why I got involved with blockchain.
Though real estate digital securities remain weak, their use-case provides a helpful tool in exploring what a good investment would look like. A “good” deal must benefit both parties in a transaction. The product-market unfit of Real Estate and Security Tokens raises the question of what, currently, a good deal would look like? What is the ideal security token?
Ideally, digital security or not, the best investment has no risk and infinite upside. Though such a perfect investment is unattainable, features like downside risk protection (which can take many forms), a known industry, and available liquidity can help to move an offering in the right direction. At the same time, blockchain-based ownership needs to offer some unique capability that necessitates a digital security approach. This could take the form of high-complexity financial structures, streamlined asset diligence, or blended “utility token” benefits offering added value. This isn’t real estate.
Revenue streams backed by equity or a bond or other conversion options may offer one strong example. In this case, a company may offer investment into a new product-line or intellectual property asset and, if the upside doesn’t manifest (as measured by some predetermined milestone), offer conversion into company equity or other available assets. If successful, the company could finance their CAPEX needs on better terms and without diluting shareholders while investors could gain exposure to high-upside in an otherwise unavailable investment. Additional benefit could come in broadening company exposure or markets via this fundraise as well.
For example, imagine an investment into the future revenues of a new model of SpaceX rocket. The capital intensive requirements for creating such a technology would typically lead to equity dilution and less internal control of the business. In an STO raise, SpaceX could engage the public, find financing on better terms, avoid dilution, and offer high returns upon the successful commercialization of the product. In the event of failed commercialization, investors could convert into the equity of SpaceX at some pre-defined conversion ratio. Compared to the compromises made via traditional means of financing, this approach could make sense.
The market will surely mature. A blockchain-based security can ultimately offer all the features of existing securities with additional ones - reducing costs and increasing distribution. They are fundamentally better. However, incremental benefit in an immature market, like a real estate token, will not catalyze a seismic shift in capital markets. The potential future benefits for portfolio managers of real estate is clear, but how to jumpstart this marketplace remains murky. Real estate is just kinda boring.
Regulatory compliance is unavoidable and important, but those in the industry (myself included) could gain from asking more often, what do people actually want? The ICO world is imperfect, but the stodgy ethos of STOs - middle-aged white men in blazers, their lawyers ever by their side, talking in finance jargon about tranches of multi-asset EB5 blah blah blah - could benefit from the creativity, boldness, and fun of the crypto-craze that got us here.
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The views and opinions expressed are those of the author and do not necessarily reflect the official policy or position of Atomic Capital, Inc. This is not intended as investment advice. Any content provided is not intended to malign any religion, ethic group, club, organization, company, individual or anyone or anything.