We’ve all heard that tokenization is the wave of the future. According to an article by Deloitte, tokenization will “fundamentally change” the investment world. And those who aren’t prepared, they warn, “risk being left behind.”
Most articles make tokenization sound as exciting as taking vitamins – something you should probably do, even if you don’t want to.
That’s a shame, because tokenization is so much more than just taking vitamins to stay financially healthy. Tokenization is like taking a pill that gives you superpowers. Awesome, twenty-first century superpowers like liquidity, transparency, and democratization.
Who wouldn’t love that?
One reason real estate is the killer use case for security tokens is that its value is relatively easy to appraise in the real world. But the value of a real estate asset isn’t static – there are so many factors that can drive it up. And tokenization is one big boost most of us haven’t considered.
The unexpected bonus of a security token offering (STO) is that the property’s value could increase with tokenization. A million-dollar home today could increase in value well over one million following tokenization.
How does tokenization boost liquidity?
There are a few reasons for this. There are four major factors that can increase property values. Here’s how tokenization could boost each one:
- Supply and demand – obviously, investors won’t want to invest in real estate, tokenized or otherwise, that isn’t in demand. This factor must be carefully considered before initiating an STO. However, thanks to new algorithms and machine learning mining the data from thousands of transactions, tokenization platforms will soon gain the ability to gauge both current and future demand with a much higher degree of accuracy and granularity. In areas with a very high demand and inadequate supply we may see another effect of tokenization – a vibrant secondary market for properties and much quicker investment turnaround.
- Location – to some extent, this factor is out of our hands. However, because tokenization is relatively new on the market and will attract interest, it’s entirely possible that the presence of multiple projects being tokenized in the same geographic area will drive up interest in properties there, increasing values.
- Property market drivers – many of these are also external factors that are out of the owners’ hands, like municipal transportation lines. But some are entirely within reach, like plans for development and redevelopment. With a ready infusion of investment into a property asset, owners can undertake projects that will drive up the value of the underlying property.
- Cost of borrowing – when borrowing cost is high, property values go down. Typically, the cost of borrowing has been in the hands of banks and large institutions. But because blockchain-based investment has the potential to democratize investment and can help determine a fair market rate for borrowing, there’s a very good chance that the cost of borrowing on a tokenized property will go down, driving up property values in turn.
While some of these factors are speculative, there’s also already evidence already out there in the real estate industry to indicate that these estimates are not an exaggeration.
Proof #1 – Asset values for REIT properties
One factor not yet discussed, but also pointed out in the Deloitte article, is the “liquidity premium.” Greater liquidity gives investors more freedom, which is also likely to boost the value of the underlying property. Talk about a win-win.
We can already see this happening today in REIT-based properties, where asset values tend to go up due to the properties’ liquidity. According to the investment guide Fisher Investments on Financials, “Due to REITs’ more liquid nature, they often have an associated liquidity premium relative to property prices—investors are generally willing to pay more for a more liquid investment.”
And in case you think it might be a coincidence that the value of properties associated with REITs is consistently higher, recent academic analysis has shown both that REITs are significantly more liquid, proving their status as a preferred investment vehicle. Concretely, this translates to a premium of a 12-22% increase in the firm value of a property simply by turning relatively illiquid property assets into a more liquid type of security, such as a REIT.
What that means, practically speaking, is that the value of the stock – and in the case of a REIT, the value of the firm itself – are heavily dependent on the liquidity of the real estate itself.
This makes sense if we look at it from the other direction: when real estate assets are illiquid, investors are only willing to come on board if they are offered some type of discount or added benefit for doing so.
This demonstrates clearly that investors care deeply about liquidity vs. illiquidity and expect to be compensated for investing their money in ways that will lock it in for any period of time. Investors pay less and demand greater returns from illiquid assets.
Therefore, by increasing the liquidity, these penalties for illiquidity can be eliminated and the value of any digital security based on the property will very likely experience a corresponding rise in value as well.
Proof #2 – Asset values in more liquid markets
The more liquid local real estate markets are, the more liquid shares will be in REITs based on assets in those markets. To follow up on the liquidity premium mentioned above, demand for assets within a specific sector or geography greatly influences the asset value: how fast the underlying asset can be sold for optimal level of profit is an important factor in determining asset valuation. Thus, when assets get additional avenues for liquidity, either through placement on online platforms or exposure to new investors, these value-determining factors may place the asset in a different, more liquid ‘market.’
Proof #3 – Attractive loan-to-value ratio
The loan-to-value (LTV) ratio describes what percentage of a property’s value is leveraged in a particular loan. Real estate is usually highly leveraged, yielding a higher LTV. The sum total of all loans on a particular property is known as the capital stack. The largest component of the capital stack is usually taken up by lenders – institutions grabbing the biggest piece of the pie.
However, it’s in property owners’ best interests to replace high-interest lenders wherever possible. With the introduction of liquidity through tokenization and the possibility of faster repayment of the debt, the higher turnover could attract investors and ultimately drive up the value of the asset.
With increased liquidity many wonder whether the potential downside would be the increased stability. FIBREE Israel co-chair Yael Tamar’s recent article published in Propmodo, titled No, Tokenizing Real Estate Won’t Make It Less Stable, examines various evidence including volatility of public REITs concluding that what makes real estate a stable asset is the inherent features of the asset class rather than its lack of liquidity.
Beyond that, the vastly greater transparency and accessibility of tokenized investments will undoubtedly drive increased real estate investment. This includes micro-investments currently impossible today.
There’s a very good reason tokenization is the next big thing. These are changes most of us have been dreaming about for years. Right now, we’re on the threshold of creating something great, making this literally the most exciting place in the fintech space. Yet most articles about STOs still sell the potential of this technology short.
Embracing tokenization isn’t just about keeping up – it’s about getting ahead. Getting much more out of existing assets. Tokenization isn’t just another way of investing, it’s a way of making what you already own more valuable than ever. And there’s not a speck of kryptonite in sight.
Up, up, and away!