When considering selling a commercial property, in most cases recent transactions will provide an anchor point for pricing. Available data on cap rates, vacancy and lease terms will be thoroughly scrutinized as this becomes the basis of a seemingly endless DCF pricing spreadsheet. The analyst will go at great lengths to derive a reliable relationship between observed data points and bring that insight in the valuation exercise of the considered property. But what happens when different sources in the market tell you different things about the property’s vacancy rate? Or about the actual cap rate? Whom should you trust? Perhaps the data was faulty entered in the database. You would need to pay for a second subscription to check this against another data provider. Maybe there was a strategic reason for misreporting the data in the first place, something no data seller can fully insure against. A myriad of different reasons may act as probable causes for the observed discrepancy. Property valuation relies on inputs that are costly, opaque and susceptible to manipulation.
Blockchains are designed to tackle exactly these problems. To understand what they are and how they transform information sharing, think about them in the first stage, as a database. What makes them special, are several innovative features. Blockchains are databases stored on several computers simultaneously, this is also why they are called distributed ledger technologies, or DLT in short. All participants hold equal rights with respect to how information is written and read, no party can unilaterally change the functioning principles of the ledger (decentralization). The blockchain can be accessed by anyone, if we consider for example permissionless blockchains such as those powering Bitcoin or Ethereum. Entries in the database are allowed only according to a pre-specified rule, known to all participants (consensus mechanism). The rule specifies the action required from participants willing to write data in the blockchain. It represents primarily a mechanism which insures that the common goal of the members in the ecosystem (insure only honest transactions go through, for example) is not hijacked by private interests of any one participant. Depending on the architecture of the DLT, a digital token may be issued to agents validating, or writing a transaction. This is the incentive provided to maintain the Bitcoin blockchain alive, for example. The last important feature is immutability. No participant can alter transaction already registered in the ledger. It is important to stress the general meaning of transaction: it may refer to a monetary exchange, the transfer of an asset title or more recently, the purchase of virtual cats. Anything can be traded on the blockchain, even crypto kitties.
Real estate, the new kid on the blockchain
Suppose now that the data registered on the blockchain, rather than representing transfer of cryptographic tokens between different parties, represents information related to an actual sale or, to keep with our introductory example, a commercial lease. Contractual rent and how it’s related to sales or revenue, use and term clauses, how costs related to maintenance are split among tenants and landlord, all can be stored on the blockchain, hidden behind cryptographic keys. The data is validated by several parties, who through their involvement in making the deal happen, have intimate knowledge with the transaction. They may be brokers, lawyers, accountants and notaries who jointly backup the data submitted to the ledger. The design of the blockchain may be such that only registered parties are allowed to write and only those permitted can read the data. As a small detour, think about the strategic implications for real estate data providers. In our case, our truth machine offers an unbiased, collectively reinforced view of the transaction data. Blockchains are technologies that turn truth into trust. If our building is also a sensor-loaded smart building submitting data to the ledger, then welcome to real-time pricing based on actual daily space usage.
Understanding any commercial property as a portfolio leases, secured on the blockchain, opens new business models. Blockchain powered marketplaces can allow any interested party to browse a multitude of rental income profiles, with different durations and volatility. Landlords can relieve themselves from leases which imply too much risk, yield-hungry investors can buy slices of a building, fit to their risk profile.
Going further, a cryptographic token representing partial ownership of one or more leases, may be issued and transacted on any of the existing public blockchains at costs several orders of magnitude smaller than traditional products. By reducing issuance and management costs, tokenization established an investment market to a much larger base of investors than before. Building owners can then sell the tokenized lease to a multitude of small or large investors. Once the lease is tokenized and all income and exposes are available online, additional investment demand will come from any party, interested and able to judge the value of the lease. The model stands in stark contrast to the current setup. This type of deal is usually structured over the counter by a bank who matches the buyer and seller, keeping in the process a hefty fee.
This overly simplified example highlights one of the many new avenues possible for the real estate industry. It does nevertheless show the power of blockchains and cryptocurrencies to reshape property markets down to their molecular level.
Author: Mihnea Constantinescu, Cofounder at PrepayWay
Extra Reading: https://pixelprivacy.com/resources/what-is-the-blockchain/