Thursday, January 18, 2024

Blockchain Real Estate: Some Things to Consider

There has been a recent movement toward marrying blockchain technology with real estate transactions. As a result, tokenization has been offered as the solution for everything real estate from investment to document execution. Companies like RealTManageGoRepublicBlocksquare and others now offer a variety of different real estate services based on blockchain technology. Although this wave of innovation is seemingly ubiquitous in today’s real estate market, there are still a number of legal and logistical issues that must be considered before fully integrating blockchain technology into your real estate endeavors.

What Is Blockchain Technology?

Stating the obvious, blockchain technology is extremely complex. Going into even a cursory explanation of what a blockchain is and its multiple applications would not only make this article very long, but also would it take far beyond its intended scope. Investopedia has a great introductory explanation of the blockchain that offers a great deal of background. It can be found here. In its most simple form, a blockchain is a centralized record of information and transactions that is stored on multiple servers and cannot be altered. Blockchains offer an unalterable or, as industry insiders call it, immutable record of transactions between anonymous parties.

Smart contracts are digital entries on to a blockchain that have conditions. These entries take the form of scripts and can essentially function as an autofill for documents that have a physical counterpart. Smart contracts can also serve as a means of seamless transfer of ownership upon the execution of certain conditions or actions. If done correctly, smart contracts offer a streamlined solution to the multifaceted ritual of closing a real estate transaction and could even produce a record that could be publicly recorded. For a deeper understanding of smart contracts and their various applications, feel free to check out this article by

The best way to explain how smart contracts can affect a real estate transaction is the following an example. A buyer and seller agree on the price of a house and enter into a contract. This contract takes the form of a token containing a smart contract that references the buyer and seller, but also is dependent on certain actions, including the inspection, the appraisal, the obtaining of a mortgage commitment. The smart contract will update in status as each part of the transaction is completed and will terminate upon the determined failure of one or more of these milestones. Upon the completion of all of the predetermined transaction milestones, the smart contract will be fully executed and the token will be transferred from the seller to the buyer, thus transferring ownership. As an added step, a physical deed referring to the smart contract will be printed and recorded. This physical document will refer to the blockchain with the understanding that the true chain of title will be continued on the blockchain through subsequent token transfers, as necessary.

What Role Can Blockchain Technology Play In the Real Estate Market?

There are number of ways that real estate companies are using blockchain technology. Companies like Republic and RealBlocks use blockchain technology to facilitate real estate investment. This can take the form of using a blockchain to record fractional divisions of a property or issuing tokens to represent fractional property interest, but it can also mean providing blockchain-based technologies that help manage real estate funds. Closinglock and StreetWire are among the companies that use blockchain technology to ensure the security of closing data for real estate transactions. These companies rely on the blockchain’s immutability and decentralization, which makes it less vulnerable to hacker attacks. Companies like CPROP and Figure run exchanges in which tokenized real estate is exchanged. There are companies that seek to streamline real estate transactions using blockchain technology and smart contracts, such as SmartRealty and Propy. Finally, the record keeping function of the blockchain can be pared with adaptive artificial intelligence to enhance property management. Blockchain real estate management companies incluce ManageGo and Blocksquare. For a more extensive list of blockchain real estate companies and their subcategories, feel free to check out Built In’s list of 17 companies that are shaping the Blockchain Real Estate Industry.

Why Don’t We Make the Blockchain a Part of Everything Real Estate?

The Blockchain does indeed have the potential to revolutionize the real estate industry, but it is not a cure-all. The increased security that comes with blockchain technology makes it a natural fit for companies seeking to secure real estate transaction data. Also, the pairing of blockchain technology with adaptive and predictive AI will certainly revolutionize property management. Such technology could manage building supplies, recommend preventative maintenance, predict maintenance issues, and analyze and anticipate the payment habits of tenants. In these cases, blockchain technology is merely an update to existing technology and offers added efficiency and functionality.

The more problematic areas for blockchain technology extension come from its use in real estate transactions and investment strategies. Whenever a blockchain company involved in real estate chooses to facilitate investment, the bottom line is that investments via cryptoassets are still somewhat undefined by the Securities Exchange Commission (SEC). At first glance, this may look like a great opportunity for many investors and indeed the last twenty years in cryptomarkets have looked like the Wild West. For an asset as illiquid as real estate, however, clarity the SEC's opinion of cryptoassets is essential to the outcome of the investment.

Thr SEC's view on cryptos is evolving. For many years, it chose not to employ a heavy hand when considering cryptocurrency. Six months ago, however, that all changed. In June 2023, the SEC initiated a major lawsuit against Coinbase for illegally offering securities. For those who may not understand, the goal of most securities is to be exempt from the SEC’s regulations. This is because the disclosure requirements of the Securities Acts of 1933 and 1934 and the Investment Companies Act of 1940 are typically costly and can render most small investments unprofitable. Although there are many ways to avoid the federal securities regulations, one commonly used way is to demonstrate that the investment is not considered a security. Without going into the details of the Howey case, which is a great read, the SEC has a specific way of defining a security that is further outlined by a number of SEC guidance papers. For many years, cryptocurrencies were able to operate as if they were not securities, but the SEC’s new direction calls into doubt the offering costs that any blockchain real estate investment company would endure when offering its services to the public.

Beyond the public offering disclosure laws, there are various requirements that the SEC enforces for more esoteric investments like cryptocurrencies. These “Know Your Customer” requirements exist to ensure that investors have the capacity to fully understand the risks of these less traditional investments. Although there has been some guidance from the SEC on how to navigate these requirements, they are required of all companies involved in blockchain real estate offerings. The consequences of not collecting this data can be costly, depending on the type of violation. 

The most important aspect of KYC compliance for blockchain real estate companies is the ability to estimate compliance costs. Although the SEC has provided guidance in this area, the path forward remains unclear, with the looming reality that cryptocurrency may be considered a security in the future.

Real Estate Blockchain and Real Estate Law

Despite whatever lack of clarity maybe present in the world of blockchain real estate investment, it pales in comparison to how murky the water is with concern to real estate blockchain companies and real estate law. This difference results from the way securities law and real estate laws are drafted and enforced. Securities laws are largely federal laws, made by the federal government and enforced by the SEC, a federal organization. This legal centralization makes change more rapid and likely, as the market becomes more familiar with the way blockchain technologies and cryptoassets. Moreover, securities law is primarily concerned with the public and businesses. Change for these laws moves at the speed of the market. Real estate law, in contrast, is made and enforced locally. Moreover, its legal practice is an amalgamation of many customs that date back centuries and have been updated over time.

An example of a legal real estate scheme that blockchain real estate companies will have to navigate is document recording. Not only do these companies have to deal with the thousands of different real estate recording practices across the nation, but they must also contend with the fact that the process for recording chain of title was created at a time that far predates digital interactions. As a result of this incongruity, blockchain companies looking to streamline the real estate transaction process or transfer real estate via smart contracts face an uphill battle.

Smart contract companies in particular may face opposition with the production of recordable documents. Every municipality that records real estate records requires that it be done in a specific manner called “recordable form.” The requirements of recordable form ensure that every document in each area have the same format, so that they can be compared, catalogued and searched easily. The variations of recordable form differ wildly amongst different local governments. The challenge for any blockchain company would be to produce a document that could be converted into recordable form in many different municipalities in a manner that is cost-effective. As technology improves, there will most certainly be a move toward a uniform digital method of recordable form, but this is not the current state of matters.

Another issue that may arise with smart contract companies that wish to transfer ownership is the legal validity of a digital transfer of ownership that does not have a physical counterpart. Most legal decisions regarding real estate ownership are built upon the concept of notice and the clarity of the public record. Any reference in the public record to an external record of title, such as a blockchain, could muddy the chain of title. The validity of blockchain title has not developed enough of a precedent in the courts to establish any reliable expectations of the legality of tokenized ownership transfers in real estate. Beyond the legality of the transfer, the issues of whether these transactions provide notice to the public and the rights that any future buyer may have regarding any lack of proper notice have yet to be fully addressed by the courts. 

With the legality of several real estate title issues not fully established, any blockchain real estate transaction that takes place is subject to being overturned by any subsequent court at any time. This state of affairs makes tokenized real estate transfers and blockchain chains of title legally nebulous and very risky. One way to seemingly mitigate some of the legal risk present with blockchain real estate transfers is to find a way to translate what is happening on the blockchain into a more traditional form of real estate documentation. Efficiency and cost concerns may arise in employing this solution, but the determination on whether the expense of mitigating legal risks arises to the level of being prohibitive must be made on a case by case basis. Eventually, if blockchain companies continues to persist in real estate for an extended time, the law will catch up with the technology. Given the granular process of changing real estate law, however, one can expect that these changes will not come soon.

Blockchain technology seems to indeed be the next wave in real estate. It is a clear technological upgrade and can work wonders for real estate property management and transaction information security. The ease of access and its decentralized nature seem to make blockchain perfect for streamlining real estate transactions. When it comes to investing in real estate and transferring title, however, the legality of its usefulness of blockchain technology is still unclear. 

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