Introduction
The concept of Real World Assets (RWA) is not a recent development within the cryptocurrency market; it has been around since at least 2018, with asset tokenization and Security Token Offerings (STO) that share similarities with today's RWA concept. However, due to immature regulatory frameworks and the lack of significant advantages in potential returns, these early initiatives did not evolve into a mature market segment.
In 2022, as the U.S. continued to raise interest rates, the yields on U.S. Treasury bonds significantly surpassed those of stablecoin lending rates in the crypto market. As a result, tokenizing U.S. Treasury bonds as RWAs became increasingly attractive to the crypto industry. Consequently, established DeFi projects like MakerDAO, Compound, and Aave, as well as traditional financial institutions such as Goldman Sachs, JPMorgan Chase, Siemens, and even some governments, have started exploring RWA.
Over the past two years, several real estate RWA projects have emerged in the market. They aim to expand the real estate investment market in various ways, diversify real estate investment products, and lower the entry barriers for real estate investors. This study conducts case studies on such projects to analyze the design advantages and disadvantages of real estate RWAs and their potential market. Since these projects primarily target North America’s real estate assets and investors, the relevant policies, regulations, and market conditions discussed will predominantly pertain to North America’s real estate market.
Approaches to Tokenized Real Estates Market
The real estate market is a vast sector brimming with investment opportunities. Research in March 2023 from Statista indicates that the listed real estate market in North America is valued at an impressive $1.3 trillion. And the global listed real estate market is $2.66 trillion.
The core objective of tokenizing the real estate market is to achieve one or more of the following goals: to create more diverse and flexible real estate investment products, attract a broader range of investors, and increase the liquidity and value of real estate assets. The main manifestations of these products are generally in three forms:
1) Fractionalized real estate ownership for financing.
2) Specific regional real estate market index products.
3) Tokenized real estate as collateral.
Additionally, tokenization and blockchain integration enhance transparency and democratic governance of real estate assets.
If you’re familiar with Real Estate Investment Trust(REIT), which is a company that owns, operates, or finances income-producing real estate. REITs provide an investment opportunity, like a mutual fund, that makes it possible for everyday investors, presents the opportunity to access dividend-based income and total returns, and helps the region’s real estate market grow. REITs and real estate RWAs share similarities in offering fractional property investment opportunities, effectively lowering investment barriers and enhancing the liquidity of real estate assets. However, traditional REITs typically do not afford management opportunities or ownership to investors, maintaining a centralized operational model. Despite this, their rigorous asset scrutiny and investment structuring within strict regulatory frameworks serve as a solid blueprint for real estate RWA projects.
In the past two years of project operations concerning real estate RWAs, we have gained a clearer understanding of their advantages and disadvantages.
Typically, real estate RWA projects have the aforementioned attributes. Upon delving into specific cases, I find that due to differing management and product approaches, the actual scenarios encountered during the operation of each project vary.
Case Study
In this chapter, I have selected three real estate RWA projects for analysis. Each employs a different method to tokenize the real estate market and is the most receptive in its domain. It's important to note that these are still early-stage projects, and their products have not yet undergone long-term and extensive market validation and testing.
‣ RealT
RealT was launched in 2019 and is one of the oldest real estate RWA projects on the market, focused on making US residential real estate available for investment through the Ethereum and Gnosis blockchain(mainly on Gnosis).
RealT acquires residential properties and tokenizes the entities possessing the property deeds in compliance with U.S. regulations. The management, maintenance, and rent collection responsibilities for these properties are delegated to a third-party — management agency. Following the deduction of expenses, the rent accrued from a particular property is distributed to its token holders. While RealT oversees the tokenization process, they are legally distinct from the company holding the real estate assets. As delineated on its website, should the company default, token owners retain the option to appoint an alternate company to manage the company holding the property deeds. It is noteworthy that they are not mandated to co-invest in the properties they introduce to the market. Token holders of the property can receive a share of the property's rental income each month, exclusive of a maintenance reserve of around 2.5% and a management fee, which is generally about 10% of the value.
Taking this property in Montgomery as an example, the total value of the real estate tokens is $323,020, with each token priced at $52.10 and a total of 6,200 tokens issued. The property generates a monthly rental income of $2,600. After deducting operating and management expenses totaling $622, the net monthly profit is $1,978, amounting to $23,736 annually. Consequently, each token receives a distribution of $3.83, resulting in an annual percentage rate of 7.35%.
For this property, RealT is offering 100% of its token, which means RealT didn’t need to co-invest with the clients and maintain a near-risk-free model to operate. The management agency takes 8% of the rent and whatever is left from the maintenance expenses, and the investment platform takes only 2% for tokenizing the property, selecting the management agency, and supervising the management. With this method, the RealT team can save themselves a lot of time in management and focus on finding qualified properties and tokenizing them to the market.
But while fractional ownership facilitates risk sharing among investors, it also introduces challenges. When the investor’s financial interest is too small, such that company management costs become infeasible. A report by Laurens Swinkels explains the conflict of interest between real estate token holders and RealT. RealT selects a management agency to manage the properties it owns; RealT can reduce agency costs if it has substantial ownership of the properties; hence, inefficient management will negatively affect them. However, if RealT’s stake is too large, this may negatively affect token liquidity, and small owners may also become free riders. These owners may expect that large shareholders are available to monitor whether the hired management agency is financially viable. On the other hand, if RealT's stake is minimal, RealT may lack the incentive to adequately select a management agency or engage in the supervisory process, and it’s hard for many investors to take the responsibility to oversee the management agency effectively.
I took the latest ten sold-out tokens on the RealT marketplace and used the related blockchain explorer to find out how many holders each property has.
As you can see in the chart, RealT factionalized the property into different amounts of tokens, so each token can be priced around $50. Most of the properties are located in Detroit and have about 500 token holders, with two properties having surpassed 1,000 holders. Now, combine this with each holder token amount to figure out the investment range of RealT investors.
About 90% of RealT investors invested less than $500, around 9% invested $500 to $2,000, and 1% invested more than that. This indicates that RealT has, at a level, successfully created a real estate investment market for small investors and increased the liquidity of the housing market.
Drawing from transaction data of the RealT wallet (Gnosis Wallet Address: 0xE7D97868265078bd5022Bc2622C94dFc1Ef1D402), RealT has disbursed roughly $6 million in total rent payments. The platform fee, fluctuating based on maintenance expenses, insurance, and taxes, ranges approximately between 2.5%-3% of the rent, equating to around $150K to $180K in platform revenue from the past two years. However, as RealT is not obligated to participate in real estate investments, and there are no specified limitations or guidelines regarding the extent of its participation if it chooses to invest, the revenue derived from rental income for RealT remains undisclosed.
From a corporate structure perspective, RealT has established Real Token Inc. in Delaware as the company's central entity. This entity does not own any real estate assets; it serves solely as the operational entity for the RealT project. Additionally, RealT has formed Real Token LLC in Delaware as the parent company for a series of real estate companies. Like Real Token Inc., Real Token LLC does not own any real estate assets; its primary purpose is to streamline legal procedures, allowing users to engage in investments across all properties by entering into contracts with just one company. Lastly, RealT establishes a corresponding Series LLC for each property invested in. As subsidiaries of Real Token LLC, each Series LLC owns a specific property and corresponding tokens. This structure aims to ensure that financial or legal issues with one property do not impact the other properties under RealT nor the operations of the parent company.
‣ Parcl
The Parcl Protocol is a DeFi investment platform that allows users to trade the price movements of real estate markets around the world. Parcl is for getting perpetual exposure to synthetic assets using an AMM architecture. Parcl introduced Parcl Labs Price Feed to create indexes for specific region real estate based on their sale history. The sale history period length can be varied depending on the transaction frequency of the properties. After index creation, investors are provided the opportunity to speculate on property values, enabling both long and short positions on real estate prices.
This approach removes Parcl from legal issues since no actual real estate was involved in the platform operation. One may argue if it’s actually a real estate RWA project since it doesn’t fit the criteria mentioned above. However, it is a relatively popular RWA project invested by Coinbase, Solana Ventures, DragonFly, and many other big names in the industry. It would be reasonable to include a discussion of the diversified possibility of real estate RWA.
Parcl's testnet launched on Solana in May 2022, and right now, it has $16 million in TVL. After more than a year of operation, Parcl doesn’t seem to be attracting much attention, with less than $10K in daily transaction volume and less than 50 daily active users.
(The volume drop on October 26th is due to Parcl V3 upgrading and changing the pool address and closing lots of the pools, so the trading volume after that date is not included)
Parcl’s product is simplified and rapidly developed. The Parcl Labs Price Feed and index market are well-designed and easy to use.
Operation-wise, the Parcl team is actively launching Parcl Point, Real Estate Royale, and other user acquisition programs. Despite these advantages and the backing of numerous well-known investment institutions, Parcl still maintains a relatively low market profile, with a small user base and limited transaction volume. Maybe the market is not ready for real estate index products yet.
‣ Reinno
Large cryptocurrency companies like Ripple and MakerDAO are also exploring the possibility of allowing users to tokenize their real estate as collateral for a loan. Ripple made an announcement in July that their Centre Bank Digital Currency team is working in that direction. MakerDAO has integrated with RobinLand for supporting real estate backed loans. RealT provides the option to use tokenized real estate as collateral for loans, though this offering is confined to the tokens they have issued. Essentially, this service is more akin to a token lending product and does not substantially increase the capital liquidity of real estate owners.
Reinno is a deserted project that launched in 2020 and stopped operation in 2022. Although it has not left much of a mark in the market, it introduced two more products related to real estate RWA that are worth mentioning.
The first product is a loan service based on tokenized real estate. When property owners require financing, they can submit their property files to Reinno. Upon approval, Reinno will create a special purpose vehicle company(Also known as SPV, which is a subsidiary created by a parent company to isolate financial risk. Its legal status as a separate company makes its obligations secure even if the parent company goes bankrupt. For this reason, a special purpose vehicle is sometimes called a bankruptcy-remote entity. SPVs are often the same as LLCs in the U.S.) in Delaware for the transaction. Then, Reinno will create a smart contract for the real estate token, and owners can deposit the token as collateral for a loan. The loan limit will be based on token value.
(You may wonder why RealT, Reinno, and many other projects all choose to register in Delaware; that’s because 1. Delaware has the most comprehensive, rapidly updated, and specialized corporate law system in the United States and arguably worldwide, offering more security and reliability compared to other states in the U.S. and jurisdictions globally; 2.The majority of American tech startups, two-thirds of Fortune 500 companies, and 80% of U.S. IPO companies choose Delaware for company registration; 3.Any individual worldwide can easily set up a Delaware company from home using online services, with a minimum fee of few hundred dollars.The registration service even provides access to all operational tools and documents needed to run a company, including an Employer Identification Number (EIN) and tax ID, and automatically generates company bylaws.)
The second product is mortgage financing, where after a user purchases a property with a mortgage, they can tokenize the property ownership for financing. The funds acquired can then be used to pay off the bank mortgage, with the client subsequently repaying the loan at a fixed interest rate.
Reinno’s operation remains a centralized and offline model where clients need to visit the office and submit real estate documents. There are some obvious risks when taking an approach like Reinno does. Firstly, if the borrower chooses to default and cease loan repayments, Reinno, as a tokenization service provider rather than the lender, would find it challenging to sue the borrower. Reinno does not actually own the mortgaged property; the loans are essentially provided by users choosing to lend on Reinno. Currently, there is no comprehensive legal framework to protect these lenders due to the lack of a direct loan contract between them and the borrowers, particularly in the context of fractional real estate financing. Reinno has not provided detailed measures for mitigating this default risk. Secondly, if the property owner decides to sell the house after borrowing or ceases to continue mortgage repayments to the bank after completing mortgage financing on Reinno, such actions leading to the transfer of property can not be prevented by Reinno, essentially resulting in "Double Spending" of the property by the borrower. Those obvious risks may contribute to the project being deserted, and a mature legal framework will be needed to solve those issues for the future real estate RWA.
There are some other real estate RWA projects that are not included due to the following reasons: 1, it’s very similar to the mentioned projects and has a smaller market share; 2, it’s still in the concept stage and lack of information for constructive discussion; 3, it’s a RWA project that has a foundation for real estate, but its business at the moment is focus on other RWAs like bond, or security. This is the list of those projects for whoever may be interested.
Conclusion
Real estate RWA is a relatively new concept that has not yet established a fixed market size or produced leading projects. The projects currently operational in this sector are relatively small in terms of market size and user base. This sector requires strict compliance operations and a mature legal framework for regulation. Some projects have adopted a risk-isolation company structure or chosen property-related financial products as investment targets to reduce operational risks. However, to tap into the most significant potential of real estate RWAs—property buying, selling, and collateral loan—legislative progress and operational compliance are inevitable.
Legislation-wise regarding real estate, RWA has yet to establish a clear and consistent framework to follow. The SEC categorizes most tokens as securities, the Commodity Futures Trading Commission considers some tokens to be commodities, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network categorizes some tokens as currencies, and the Internal Revenue Service considers some tokens to be taxable property. Additionally, there is no international regulatory framework to reference. The inconsistency among regulators about how to categorize real estate tokens leads to unclear rules and confusing processes, both of which deter potential investors and threaten the long-term viability of tokenization.
Despite the current chaotic regulatory environment, many famous finance institutions and established crypto projects are still making efforts to explore real estate RWAs, and a small number of projects have demonstrated the feasibility of their products on a limited basis over 1-2 years of operation. Given the substantial scale of property in the financial investment sector, it is believed that with the establishment and refinement of relevant legal frameworks, real estate RWAs will experience rapid and robust development.
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