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5 ways blockchain will transform the real estate industry

Blockchain technology is driving change across a range of industry verticals, with the real estate sector appearing ripe for disruption. So how will blockchain make real estate transactions more efficient?

The internet made it possible for individuals to transfer information, quickly and cheaply, without obtrusive intermediaries. Blockchain technology offers the same advantages, but makes it possible for individuals to transfer value. So if the internet is for transfering words and pictures, blockchain platforms are for transfering money, assets, and value.

Traditional real estate transactions are complex, costly, and time consuming. The management processes in the real estate sector (buying and selling, renting and leasing, financing and administration) are time-consuming and inefficient. Even today, these processes are largely paper-based and require the use of intermediaries such as asset and property managers, utilities, banks, land register offices, notaries, brokers, lawyers and other advisors.

Blockchain technology is transforming inefficient industries, and real estate is no exception. This article looks at the key use cases for blockchain in real estate and the likely transformation across five main areas:

  1. Disintermediation
  2. Fraud prevention
  3. Smart contracts
  4. Programmable money
  5. Tokenization

1. Disintermediation

Transacting real estate is cumbersome, opaque and expensive due to the requirements of middlemen such as brokers, government property databases, title companies: insurance and property databases, escrow companies, inspectors, appraisers, and notaries.

These middlemen exist because they hold information that can be difficult to access, or they have the skills/licenses that are needed to operate in the existing real estate ecosystem.

A public blockchain is a distributed database where anyone can record information, without it being censored, and without needing permission. Equally, anyone can access that information.

Consider property titles. County recorder offices and title insurance companies maintain databases of property ownership records. This information includes the address, previous and current owners, and various encumbrances such as mortgages. Prior to the internet, these government and title companies were necessary to verify and record property data. How can blockchain replace these middlemen?

Jason Ray, Urban Land Institute Executive Vice President and CTO says that blockchain technology will soon enable every property to have a corresponding digital address that contains details of occupancy, finance, legal, building performance, physical details, and a record of all historical transactions. “The data will be immediately available online and correlatable across all properties,” he says. “The speed to transact will be shortened from days/weeks/months to minutes or seconds."

At present, the title to a property is a piece of paper. To transfer a property, you fill in the blanks on a deed, sign it with a pen, drive to a notary who approves it, and then this paper must be delivered to the county recorder’s office to be placed in their database. Not exactly an efficient, digital process.

Using the blockchain for property records, we can create a digital title. This is a cryptographically secure record that can be transferred or verified as quickly and cheaply as an email. Before email, to send a letter you needed envelopes, stamps, trucks, sorting facilities, and postal workers to organize and distribute the mail. The digitization of messages disintermediated the mail middlemen. Once people can easily verify property records themselves and transfer a title digitally, brokers, escrow companies, title insurance companies, county recorders, and notary publics will follow the decline of the post office.

By removing these third party intermediaries, the associated costs can be reduced. The use of blockchain and smart contracts to automate these processes will save time and money. The result will be an improved, more efficient experience for both buyers and sellers.

2. Fraud prevention

Real estate fraud is rampant. At the low end it is perpetrated by petty thieves on $500 subleases, and at the high end the world’s largest banks and mortgage lenders have created havoc with misleading subprime leases.

How can the blockchain prevent real estate fraud?  By offering an immutable database, updated by an unlimited number of participants, that does not rely on the trust of any one party, has no single point of failure, whereby the sender and recipient of funds are logged, and where digital ownership certificates for properties are saved. The blockchain has the potential to make forged ownership documents and false listings a thing of the past. The unique digital ownership certificates would be almost impossible to replicate, and would be directly linked to one property in the system, making selling or advertising properties you don’t own almost impossible.

Sweden was one of the first countries to consider blockchain real estate use cases and the creation of immutable title transfers – working with Chromaway and Kairos Future – and the UK government has announced** **a plan to transition towards a blockchain-based land registry system by 2022.

3. Smart Contracts

The goal of a smart contract is to reduce the need for humans to process, trust, and verify an agreement. A smart contract is automated and will execute an action when certain conditions are met. Blockchain platforms such as Ethereum have the ability to perform ‘smart contracts’, a term first popularized by digital money pioneer Nick Szabo. He gave the example of a vending machine which releases an item after a selection is made and the correct value is deposited. So how would a smart contract be used in a blockchain property transaction?

Andrew Hinkes, a partner with Berger Singerman LLP’s Dispute Resolution Team explains how smart contracts could drastically alter the way simple real estate transactions are conducted. “Party A and Party B would enter into a contract that requires Party A to pay $200,000.00 to Party B in exchange for Party B agreeing to convey title to Party B’s condominium unit to Party A upon receipt of payment”, explains Hinkes. “At present, if Party A pays the money, but Party B later refuses to convey title, Party A is required to hire an attorney to seek specific performance of that contract, or to obtain damages. The determination of the outcome will be made by a third party: a judge, jury, or arbitrator.”

However, Hinkes says that the use of a smart contract can avoid the potential for one party to perform while the other refuses or fails to perform. “Using a smart contract, Party A and Party B can agree to the same transaction, but structure it differently,” he explains. “In this scenario, Party A will agree to pay $200,000.00 worth of virtual currency to Party B, and Party B will agree to transmit the title to the condominium in a specialized type of coin on the blockchain. When Party A transfers the virtual currency to Party B, this action serves as the triggering event for Party B, which then automatically sends the specialized coin which signifies the title to the condominium at issue to Party A. The transfer is then complete, and Party A’s ownership of the condominium is verifiable through a publically available record on the blockchain.”

Structuring this transaction as a smart contract ensures that the transfer occurs as soon as funds are received, and results in a publically available, verifiable record of the transfer. Because the contract automatically performs based upon the predetermined rules agreed to by the parties to the contract, there is little risk of fraud, and virtually no need for external measures to enforce performance of the agreement. Thus, no specific performance action would ever be necessary to compel the transfer after payment is made because the coin, which represents title to the condominium, is automatically transferred, and the transfer is automatically published to third parties on the blockchain. 

4. Programmable money

While cryptocurrency in real estate has proven too price volatile to be effective as a payment currency, the real power of digital currency in a real estate sense is that it is programmable digital code. With fiat money, you need humans and banks, but digital money can be programmed to escrow and distribute itself.

When someone rents an apartment, the landlord takes a security deposit in case the tenant damages the property. By law they are supposed to keep the funds in a separate escrow account and not spend it. Once the lease ends, the tenant has to rely on the good faith of the landlord to return the deposit. But if you’ve ever attended small claims court you know how frequently this human/trust-based system fails.

Bitcoin has a function called multi-signature. When sending bitcoin, you use your private key to approve the sending of the digital currency to another person. With “multisig,” you can create a transaction with three private keys, where at least two are required for sending the currency.

Using this feature, it is possible to create a programmable escrow. Instead of sending the landlord dollars to a bank account, the tenant and landlord create a multi-signature transaction. The tenant and landlord each has one private key, and a third one is given to a neutral third party who can act as arbitrator. For the security deposit to be spent, two out of the three people will need to use their private key. The funds are locked in crypto-escrow for the duration of the lease.

The tenant will almost always want his deposit back, and so they will approve the transaction with their private key. When the lease ends, if the tenant didn’t damage the property, the landlord uses their private key to release the bitcoin deposit.

If the tenant damaged the property, then the landlord will send evidence to the arbitrator. The tenant can respond. After the arbitrator hears both sides, they will use their private key to send the deposit to the winning party. The bitcoin can be sent instantly, 24 hours a day, 7 days a week. No waiting on a mailed paper check or dealing with routing and account numbers and banking hours for a wire transfer. By using blockchain, real estate escrows can be done securely, quickly, and cheaply.

5. Tokenization

Digital securities, or security tokens, are traditional securities that are underpinned by blockchain technology. Digital securities can represent a holder’s ownership stake in tangible assets, such as real estate. Digital securities allow investors to view ownership structure on a verifiable blockchain network and are designed to provide increased transparency.

The ability to purchase a digital token that represents a fraction of a piece of real estate lowers the barriers to real estate investing. Typically, investments would require significant capital upfront in order to acquire property. Alternatively, investors could pool their money to acquire bigger ticket properties. Through blockchain, investors would simply have to access a trading app to buy and sell fractions of tokens as they see fit. In addition, fractional ownership will offer the benefits of real estate investing without the administration tasks involved in having to manage the properties themselves. At scale, Tokenized real estate would dramatically widen the potential pool of investors, and increase the flow of real estate liquidity globally.

tZERO is a technology firm that builds and commercializes blockchain-based platforms that offer solutions for trading digital securities and digital assets. In July, the group announced that it had entered a partnership with Aspen Digital Inc. to enable its digital security, ASPEN, to trade on the tZERO ATS.

Aspen St Regis HotelThe Aspen St Regis Hotel

The ASPEN shares will represent US$18 million of indirect ownership in the St. Regis Aspen Resort, a five-star, 179-room luxury hotel located in Aspen, Colorado. This is just one example of blockchain for real estate enabling the tokenization of large scale real estate projects.

Summary

Around the world the COVID-19 pandemic has had a disruptive effect on the real estate industry. With many in the industry in survival mode, it will take time for industry incumbents to move to new solutions.

However, blockchain is fast emerging as the best new technology stack for real estate platform services, real estate management and operations, leasing and brokerage functionality, research and valuation services, planning and construction, and Smart City solutions. Delivering cost savings, efficiencies, fraud reductions and conveniences, the result of the widespread integration of blockchain in real estate will be an improved, efficient experience for both buyers and sellers.


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