Blockchain — the distributed ledger technology best known for supporting cryptocurrencies like Bitcoin and Ethereum — has hundreds of applications across dozens of industries. Networks can be either public, private or permissioned — offering users varying degrees of privacy, security, immutability and scalability. Though the commercial real estate industry is notoriously resistant to change, a number of investors and companies have expressed interest in blockchain technology. Because it could make real estate transactions simpler, speedier and more secure, blockchain technology appeals to commercial real estate investors all across the world. According to a summary of Deloitte’s “Blockchain in commercial real estate: The future is here” report, blockchain could address many existing challenges. This new technology could “transform core CRE operations such as property transactions like purchase, sale, financing, leasing, and management transactions.” Blockchain-based smart contracts could cut out intermediaries and embolden peer-to-peer lending while tokenization of commercial real estate could open the industry to non-institutional investors. Both in the metaverse and in the real world, blockchain-enabled property transactions are already gaining traction. As Natalia Karayaneva notes in her article “Click, Click, Close: How Web3 Is Re-Engineering Real Estate” for Forbes, there have been “over $4 billion of real estate transactions recorded on blockchain.” In this post, we introduce first-time investors to commercial real estate and explain how blockchain technology is changing the industry. Follow below to learn what beginner investors should know about blockchain and commercial real estate.
What is Commercial Real Estate?
In her article “What you need to know about leasing commercial real estate” for WeWork, Elizabeth Harper defines CRE as “any real estate used exclusively for business purposes.” Most commercial real estate investors make their money off asset appreciation and lease payments. In 2018, REIT.com estimated that the entire United States commercial real estate market was worth $16 trillion USD.
Investment in major asset classes like office buildings and hospitality fell during the first year of the pandemic. Supply chain woes, labor shortages, eviction moratoria and other artifacts of the COVID-19 pandemic all impacted the commercial real estate industry. Since 2020, most asset classes have recovered.
According to American commercial real estate services and investment firm CBRE in a post from February 2022, global commercial real estate investing “reached a record annual total of US$1.3 trillion in 2021” – up 21% compared to 2019. Emerging asset classes like data centers, co-working spaces and fulfillment centers are responsible for a large chunk of this growth. Existing asset classes – like multifamily housing, warehouses and hotels – all experienced significant investment growth over the last couple years. From virtual plots of land to office buildings in the real world, below is a complete list of commercial real estate asset classes.
Commercial Real Estate Asset Classes
According to Robert Reffkin and the MasterClass staff in their post “Understanding Commercial Real Estate,” there are eight categories of commercial real estate. Other sources divide CRE into four or six asset classes. These include office, industrial, multifamily housing, retail, hospitality, mixed-use, land and special purpose. Most are self-explanatory, but there can be some overlap between asset classes – especially as each class evolves over time.
For example, multifamily housing typically refers to apartment buildings, condominiums and townhouse complexes, but could also include manufactured housing and senior living communities. Industrial space refers to “any real estate used for the purpose of industry, including heavy manufacturing, light assembly, bulk warehouses and flex spaces.” Land includes both vacant land and land used for mining or agriculture.
Special-purpose real estate includes properties that do not easily fall into the categories listed above. Some industry participants and CRE executives consider data centers part of the industrial sector, while others define them as “special-purpose.”
Commercial Real Estate in the Metaverse
Most CRE transactions are related to real property. In fact, global real estate remains the world’s oldest and largest asset class. However, interest in metaverse real estate — currently sold as digital plots of land — has grown over the last couple of years.
In a recent article for CNBC, Robert Frank notes that real estate sales in the metaverse “topped $500 million last year and could double this year.” As of early 2022, investors could participate in the virtual commercial real estate industry through both direct and indirect investment — i.e. buying into REITs and funds.
For example, Metaverse Property’s MetaSpace Real Estate Investment Trust (MREIT) and Republic Realm’s real estate investment fund launched late last year. Republic currently owns nearly two thousand virtual real estate NFTs spread over more than a dozen virtual worlds. For more information about virtual CRE investment, head over to the post “Everything You Need to Know About Investing in Metaverse REITs and Funds” from Torii.
Of course, tokenization of commercial real estate has also become a reality beyond virtual worlds like Sandbox and Decentraland. We explain how tokenization of real world CRE works in greater detail below.
How to Invest in Commercial Real Estate
There are two main ways industry players invest in commercial real estate. Writing for Investopedia, James Chen explains that some property owners “make money through property appreciation when they sell,” but most investors make money by collecting rent from lessees. Investment in commercial real estate is either direct or indirect.
When investors purchase property and serve as that property’s landlord, they are participating in direct investment. According to Chen in his article for Investopedia, “people best suited for direct investment in commercial real estate are those who either have a considerable amount of knowledge about the industry or who can employ firms who do.” If you co-own a property but still participate in day-to-day management of that property, you are directly investing in CRE.
Indirect investment is when investors do not purchase the entire property themselves. Instead, they invest in part of that property through a third party. In some cases, that third party chooses and manages your investments for you.
Indirect investment allows CRE investors to diversify their holdings across asset classes instead of spending all their money in one place. With lower cost thresholds than direct investment, indirect investment opens participation in the commercial real estate industry to a wider array of potential investors.
REITs and Funds
Real estate investment trusts and real estate investment funds are both examples of indirect investment in commercial real estate. In our recent post “Everything You Need to Know About Investing in Metaverse REITs and Funds,” we explain the difference between REITs and funds. We note that “real estate investment trusts or REITs are real estate companies that buy up income-generating properties and debt across a variety of industries.” While some REITs are private, most are publicly traded on stock exchanges making them more liquid than other real estate asset classes.
Unlike most REITs, real estate investment funds are actively managed. Writing for The Balance, Erin Gobler explains that real estate investment funds are “pooled investments” like mutual funds that “take money from many investors and use it to invest in a variety of securities.”
Barriers to Investment in CRE
Lack of funds, industry knowledge and connections to developers, real estate companies and institutional investors all prevent beginners from investing in commercial real estate. Financing is a major barrier for the first-time investor. Both direct and indirect investment in commercial real estate can be costly.
According to Barbara Bellesi Zito in an article for NASDAQ, “it costs much more to invest in commercial property than residential property, and it can be difficult for newer investors to secure loans without a hefty down payment.” While the down payment for a residential property ranges anywhere from 3.5% to 20% of the sale price, financial institutions usually ask for between 20% and 35% when lending to commercial real estate investors. Without established banking relationships, securing a construction loan or other type of CRE financing that has favorable terms can be incredibly difficult.
Purchasing shares in a commercial real estate development or participating in REITs and funds can also require significant up-front, all-cash investment. According to Kevin Voigt in a recent article for NerdWallet, “public non-traded REITs and private REITs…can have much higher account minimums — $25,000 or more — to begin trading.” Other investment vehicles charge steep fees or require accreditation.
Gaining access to or information about these investment opportunities can be impossible for non-accredited investors. For example, private REITs and funds are rarely open to non-accredited investors. Even opportunities available to non-accredited investors often require minimum investments of $500 USD or more.
What is an Accredited Investor?
As mentioned above, some commercial real estate investment opportunities are limited solely to accredited investors. Opportunities deemed “high-risk, high-reward” and brand-new investment vehicles without much performance history tend to be available only to accredited investors. First-time investors might not know what it means to be “accredited” versus “non-accredited” in the real estate world. In their article “What Does It Take To Be An Accredited Investor?” for Forbes, E. Napoletano and John Schmidt explain the difference.
Napoletano and Schmidt write that not all investors can participate in investment opportunities that “are exempt from a whole range of rules and regulations [designed to] protect regular investors from the risks involved.” Accredited investors, however, are allowed to participate in these “unregulated securities” because they have “the money or the know-how to handle all of the risks involved.”
According to the SEC – a government oversight agency that regulates securities markets within the US – accredited investors make a reliable annual income of at least $200k, have a net worth totaling $1M, hold relevant licenses or are “‘knowledgeable employees’ of certain investment funds.” In order to qualify as an accredited investor based on net worth, one cannot factor in the value of their primary residence to meet the $1M threshold.
By meeting one or more of these requirements, accredited investors can buy into “venture capital, angel investments, real estate investment funds, private equity funds, hedge funds [and] specialty investment funds like those focusing on cryptocurrency.”
How Blockchain is Changing Commercial Real Estate (CRE)
Proponents of applying blockchain to commercial real estate transactions and other industry operations argue that the technology will lessen or eliminate some – if not all – of the barriers described above. They believe blockchain technology will help make the industry more transparent and democratic while reducing redundancy, improving efficiency and providing cost savings.
Blockchain has the potential to transform the commercial real estate industry by streamlining complex, opaque processes traditionally bogged down by an array of third parties. In his article “Four Technologies That Will Transform The Future Of Real Estate” for Forbes, CEO and founder of Royal Palm Companies (RPC) Daniel Kodsi underscores this. Kodsi writes that “blockchain is playing a prominent role in the digitization of real-world assets…[by bringing] security, clarity and efficiency to real estate transactions.”
Smart Contracts and Direct Investment
Smart contracts – which automatically execute an agreement when terms are met and record all steps on a blockchain – play a major part in leveraging the technology to overhaul existing systems across the CRE industry. CRE investors, property owners and companies could automate and record all sorts of transactions – from crowdfunding new developments to collecting rent from tenants – by applying blockchain technology.
According to the Deloitte Center for Financial Services report “Blockchain in commercial real estate: The future is here,” blockchain could help property owners “improve [the] property search process, expedite pre-lease due diligence, ease leasing and subsequent property and cash flow management, enable smarter decision-making…[and] enable more efficient processing of financing and payments.” It could also lead to “transparent and relatively cheaper property title management.”
An immutable digital record of all these processes would reduce human error, increase transparency and cut down on all the paperwork investors hate. Of course, blockchain will not only benefit investors involved in direct and complete property ownership. It could also benefit indirect investors interested in fractionalized investing.
Crowdfunding and Tokenization
In their post “Blockchain Crowdfunding Real Estate – How To Crowdfund Real Estate Projects Through Blockchain Technology,” US-based commercial real estate investment fund REI Capital Growth or REICG notes that “the capital-intensive nature of real estate development or investment is a big barrier for many people.” As outlined above, direct investment is out of the question for most everyday Americans, but fractionalized investment offers a less expensive, more flexible alternative.
Through blockchain-enabled tokenization, industry experts argue that both financing and investing in commercial real estate will become simpler, less expensive and more widely available. As REICG puts it, “blockchain technology is making the entry barrier lower than what it used to be in the recent past.”
What is Tokenization?
Most readers will have heard of NFTs or “non-fungible tokens” but might not know what “tokenization” actually means in the context of commercial real estate investing. Writing for NASDAQ.com, Managing Partner and CEO of A-Labs Doron Cohen explains. Cohen writes that tokenization “means taking any asset (as illiquid as it may be) and virtually encapsulating its value and existence to be represented by a digital Token that can be traded like stocks of companies.”
Note: While an NFT typically represents an entire property, digital tokens used in fractionalized investing represent equal shares of ownership in that property.
When commercial real estate assets – from data centers to luxury resorts – are “broken into tokens that represent a fraction of their value, they become liquid for the first time.” This new structure benefits both “investors and asset owners alike.” But how does tokenization benefit beginner investors? Christina Mkrtchyan explains in her article “Tokenization of Real Estate: Revolutionizing Real Estate through Digitalization and Reduced Market Barriers” in the December 2021 issue of USC Gould’s Business Law Digest.
How Does Tokenization Benefit Investors?
Tokenization benefits developers by providing a constant yet flexible flow of fresh capital. It benefits CRE companies by limiting redundancy and making operations more efficient. For investors, tokenization lowers barriers to entry. Writing for the USC Gould School of Law, Christina Mkrtchyan explains how “tokenization uses fractionalization to reduce the high costs of traditional real estate.”
Referencing a Parisian villa that was divided into a million tokens – some costing less than $10 USD – back in 2019, Mkrtchyan notes that tokenization “allows everyday people to invest in smaller portions of the same property, thereby increasing accessibility to investment with lower costs.” Tokenization not only makes commercial real estate available to investors across economic classes. It also makes CRE available to investors all around the world. As Mkrtchyan writes, “whereas traditional real estate is limited mainly to regional investors during local opening hours, real estate tokens can be traded at any time across borders.”
Some industry leaders suggest that tokenization could even help community members — even those with minimal financial means — take ownership of their neighborhoods. Referencing Meridio’s 2018 Troutman Street pilot project, Stuart Miller explains in his article “A Blockchain Building in Bushwick” for The New York Times. Quoting Meridio co-founder Corbin Page, Miller writes that tokenization “could allow communities to band together to battle gentrification.” Fractionalized investing “could help coordinate neighbors’ efforts to buy up small chunks of apartments or houses, or even commercial real estate,” thus enabling them to guide the direction of growth in their communities.
CRE Companies Paving the Way for Wider Adoption of Blockchain in Commercial Real Estate
Meridio’s multifamily rental building in Bushwick, Brooklyn stands out, but there have been many real estate blockchain projects over the last five years. In 2022, development of new projects is ramping up. For example, the Houston-based brokerage RedSwan CRE just introduced their model. According to the May 2022 press release “How RedSwan CRE Is Using Tokenization to Improve the Commercial Real Estate Marketplace” published by Yahoo!, RedSwan “allows investors to purchase part of a piece of commercial real estate for as little as the company’s minimum investment of $1,000…by creating tokenized CRE investment options.” In doing so, the company hopes to open CRE investing to an “underserved group of non-institutional investors.” Alongside Meridio and RedSwan, SolidBlock, LoftyAI, RealT, AKRU, and MarketSpace Capital are all paving the way for wider adoption of blockchain in commercial real estate.