How the blockchain and distributed ledgers will transform the real estate market

Blockchain technology has grown in popularity

Blockchain technology has grown in popularity

Blockchain technology has grown in popularity because of the rise of bitcoin, a cryptocurrency based on it. The term “blockchain” is also often applied to other digital currencies and projects of Everledger, a ledger of diamonds, to Follow My Vote, an online voting platform, but not all of these projects use the blockchain in its technical sense. What they actually have in common they use distributed or shared ledgers, a promising innovation that, in my opinion, will change the global real estate market radically over the next 10 to 15 years.

A distributed ledger is a type of database. Like conventional databases, the ledger can contain any type of information, from data on financial transactions to family photos. However, what sets this technology apart is that copies of the ledger are simultaneously kept by all its users and updated automatically. The system’s reliability is provided by cryptographic algorithms, which ensure that records entered into the ledger are impossible to delete or forge. The legitimacy of adding new records is achieved using so-called consensus methods, which are also computer algorithms that vary between systems but share the same function of excluding the technical possibility for the data to be corrupted (e.g. due to computer failure or malice).

In its 2016 Distributed Ledger Technology: Beyond Block Chain report, the UK Government Office for Science deemed the impact of blockchain and other DLTs probably as significant as foundational events such as the creation of the Magna Carta and the steam engine.

I am certain that the introduction of these innovations to the real estate market would make it much more transparent and increase real estate investments easier and more accessible.

What can the blockchain bring to the real estate market?

Distributed ledger technologies would prove useful in almost all types of real estate activities, including money transfers, property registration and agreement conclusion.

Money transfers – Purchasing property for cryptocurrency to avoid the scrutiny of banks is already a reality. For instance, in 2014, properties in Bali and Kansas, each over US$500,000 in value and a house in California (US$1.6 million) were sold for bitcoin. In the near future, the blockchain is expected to be used not only to pay for transactions in cryptocurrency but also to transfer conventional (fiat) money and national digital currencies issued by central banks.

Property, transaction and title ledgers – Information on real estate, transactions, title registration, property encumbrances and conditions would be entered into distributed ledgers that are accessible via desktop computers and mobile apps. Several countries have already launched pilot projects to test such systems. For instance, the Sweden Land Registry has been conducting major research since 2016 to evaluate the potential of the blockchain in managing its land registry.

I expect that every property would soon have a “blockchain ID” containing all its technical characteristics. Among other benefits, this would make property appraisal easier and quicker, as each transaction currently requires correspondent documents to be ordered anew and these Bureau of Technical Inventory (BTI) certificates are not always trustworthy. I think there will be portals and multiple listings service (MLS) databases where properties would have blockchain IDs.

Smart contracts – Smart contracts are transactions and other agreements concluded entirely digitally whose execution (i.e. transfer of ownership) is guaranteed by computer protocols with no human involvement. The same protocols automatically check the transaction possibility and legitimacy; they will not allow the agreement to be concluded if its terms do not meet established standards.

The idea of smart contracts dates back to the 1990s, but the blockchain and similar technologies can make smart contracts safer and more reliable. Property sales and rental transactions can be realised through such contracts. In September 2016, Deloitte announced the launch of a pilot project for registering rental transactions via the blockchain in association with the City of Rotterdam, the Netherlands and Cambridge Innovation Center.

Escrow accounts are often used in buying and leasing real estate. For instance, many landlords in the United States require their tenants to place a rental deposit in an escrow account, from which the money cannot be withdrawn without the landlords’ permission. Today, escrow accounts are primarily operated by notaries and banks, but distributed ledgers can change the situation. For instance, buyers can place their money in a blockchain escrow account. After commissioning the new build and the buyer getting the right of ownership, the money would automatically be released to the developer via a smart contract.

Voting – Owners of flats in apartment buildings often make decisions affecting shared infrastructure, for instance, major repairs or works on common areas, by voting. Distributed ledger technologies would guarantee reliable remote voting and give owners the certainty that their votes have been registered correctly. The blockchain would also prove useful in other situations, such as when real estate decisions are made by voting, for instance, in unitholder or stockholder voting.

Practical benefits of distributed ledgers

With the adoption of the blockchain and other distributed ledger technologies, real estate activities would become easier, quicker and cheaper. The market would also be rid of unnecessary intermediaries, becoming safer, more transparent and, consequently, more liquid.

Lower transaction costs – According to the Vedomosti newspaper, the first real blockchain transaction became known in September 2016 when British bank Barclays, Israeli technological startup Wave and Irish dairy producer Ornua carried out a US$100,000 letter of credit transaction as collateral for exporting a parcel of Ornua cheese and butter to the Seychelles Trading Company. The transaction, which took less than 4 hours, usually takes 7 to 10 days due to document processing.

Speed – Instead of weeks and months, the time needed for paperwork to close real estate transactions would be reduced to hours or even minutes. Cross-border fund transfers and conversions would be quicker and cheaper, and technical operating costs related to the transfer of ownership would be reduced. Transactions would also become cheaper. For instance, there would be no need to pay a notary or transaction registration fee, which now account for 1–2 % of the property price.

Safety – To falsify an existing distributed ledger entry, one would need to hack every computer on which a copy of the ledger is stored, and this number can be enormous (e.g. the number of bitcoin users is estimated at several million). The entries cannot be deleted or modified post factum, which significantly reduces the opportunities for fraud and embezzlement.

Transparency and liquidity – Using open blockchain-based ledgers, sellers and buyers would gain customisable access to all documents related to a transaction and be able to check the accuracy and authenticity of every one of them. This increase in transparency and liquidity would make real estate a more liquid investment vehicle and may lead to a stronger capital inflow.

Smart contracts may also stimulate the development of collective investments as they provide almost infinite opportunities for structuring property and investment project rights, which enable the construction of different crowdfunding formats. In addition, the active development of collective cross-border investments would be strengthened by voting mechanisms using blockchain-based identification, the reduction of capital structuring and transaction costs and the absence of governmental restrictions on the withdrawal of funds.

For example, Tranio is working on a crowdfunding project that will enable crypto capital owners to enter into club transactions along with conventional clients. Private investors will be able to realise the strategies of capital maintenance and earning on real estate, avoiding banks and their commissions by using the blockchain to conclude agreements, transfer money and, consequently, receive higher incomes.

Problems with the blockchain

The distributed ledger industry is still at the start of its development, and its use in the real estate market is still problematic.

Absence of regulation – This fast-moving technology is running ahead of governmental regulation and there is still no legal framework to regulate the blockchain. Many advantages of distributed ledgers will only materialise once there is a framework to defend smart contracts and other blockchain operations in court.

High conversion costs – Converting conventional (fiat) capital to cryptocurrency and vice versa is high. For example, the commission on transfers to MasterCard and Visa ranges between 0.5% and 5%. However, this is likely to shrink over time. Several startups are already claiming they will be able to reduce the commission to zero.

KYC – Crypto capital owners are likely to be subject to the standard source of funds verification procedures, which are technically difficult to accomplish today. Banks, obliged to check the origin of funds by law, are not ready to work with cryptocurrency owners yet.

In the case of collective investments, the absence of bank regulation and compliance potentially allows developers and any fund recipients to collect money at a lower cost and not to be bound by obligations. However, this presents risks, in particular, dishonest developers.

High volatility – High volatility and high returns of cryptocurrencies would restrain investment in the real estate market for some time. Development projects in good locations yield about 15% per annum and rental projects yield 5% per annum on average, while bitcoin has surged by 100–200% in short periods of time. At the same time, this constant growth is making cryptocurrencies lose their stability, an important payment instrument characteristic, and they are instead becoming something like stocks of a rapidly growing company. Few people would want to sell stocks that are on an upward trend for fear of missing out on future profits. However, investors active in the cryptocurrency market might soon want to consider placing a portion of their capital in a simpler, physical and more stable investment vehicle, such as real estate.

Eventually, lower regulatory barriers and transaction cost will enable crypto capital to become a powerful driver for cross-border real estate investment transactions, allowing investors to increase their yields. Successful startups would then be able to complete with established real estate funds.

According to forecasts by consulting company Accenture, in 2018–2024, the blockchain will span many different types of assets, and by 2025 it will be a mass phenomenon and an indispensable part of global capital flows.

“It is already clear that, within this revolution, the advent of distributed ledger technologies is starting to disrupt many of the existing ways of doing business”, the company said in its report for the UK Government Office for Science.

I am convinced that this “advent” will result in positive transformations not only in the real estate market but in all sectors of the economy.

Originally published in Bitcoin Magazine
George Kachmazov, managing partner at Tranio
 
 
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