DeFi: The Future Of Real Estate Financing

DeFi: The Future Of Real Estate Financing

Real estate is an extremely important aspect of the global economy, and when things go wrong with it there can be very dire consequences. Unfortunately, we've had a taste of what can happen if real estate is left to centralized banks and traditional finance. The 2008 economic crash led to a global recession and showed everyone that the future of real estate financing wasn't in traditional finance.

As expected, countries began to bail out the erring banks and corporations instead of getting to the root cause of the problem. Thankfully, the growth of DeFi means there's now a viable alternative to traditional financing of real estate.

Web3, The Perfect Tool For Funding Real Estate

Web3 is mostly defined by three things; a decentralized ledger, a native currency, and the blockchain that powers it all. It so happens all these elements would reduce a lot of the uncertainty in real estate.

By creating a transparent and trustless system for funding, Web3 eliminates the possibility of illegal and unethical behavior. Since there will be no centralized authority to take secret and damaging decisions, consensus building will lead to a more transparent and trusted system.

One innovative way to use DeFi in real estate financing is through real estate tokenization. Tokenization in this sense is merely a decentralized twist on traditional fractionalized property ownership. However, because this fractionalization is facilitated by Web3, it's called tokenization.

Just like traditional fractionalization, real estate tokenization refers to a process where a physical product is converted into several digital tokens. For example, a 5-bedroom duplex in New York may be converted into 100 XY coins. The people who purchase those coins will, as a result, own a part of the building.

In most cases, these owners are awarded a portion of rental payments in proportion to how many tokens they hold. For example, someone who owns 40 tokens out of a hundred would be awarded 40% of the rental profits.

The first big problem that DeFi tokenization solves is that of liquidity. For many retail investors, real estate is merely a luxury too much for them to invest in. The barrier to entry into the sector is so high that many people just give up on it entirely. The sad thing about this dynamic is that real estate investments have extremely good returns. However, since only wealthy people can play the game they end up enjoying the spoils alone.

Thankfully, tokenization allows three or four more investors to be able to pull funds together to purchase a property. This doesn't just change the game in terms of buyers of real estate. It also changes the game in terms of sellers. With Web3, sellers can easily tokenize their properties, sell them, and maybe even keep a controlling share of the table to themselves. And there are already examples of people doing this.

Asides from that, tokenization also cuts costs massively. Through smart contracts, a lot of document verification and trading done in real estate can be done at the push of a button. It also makes the market even more liquid, as investors can always easily sell their tokens — something which isn't always easy in traditional real estate.

One more reason why more people will start looking at real estate tokenization as the future of real estate financing is the ease it provides. Since people won't have to deal with a property manager, they get to earn passive income in the form of rent. In essence, the burden of finding a property manager, or finding a cost-efficient property is passed on to the platform. For investors who want to own large property portfolios without doing the needed legwork, real estate tokenization would be a dream come true. It means they can buy as much real estate as they want without doing any property inspection.

Potential Bottlenecks

However, it's not all sunshine and rainbows. As with many Web3 use cases, there are some limitations to how the blockchain can transform real estate financing. While these obstacles may not exist in ten years due to ingenuity and innovation, they do exist today. And it's important to acknowledge them.

The  most obvious limitation is the regulatory stranglehold that regulatory agencies have on real estate. For one, security tokens don't have legal leeway in many parts of the world. Even the most liberal economies still have some sort of regulation on what can be sold as tokens.

What makes this even more complicated is that the idea of real estate tokenization needs regulatory oversight to scale. At the very least, one would require a trusted market to ensure that people aren't being sold duds as tokens. However, since Web3 is quite anti-regulatory, it's difficult to see how markets can become trusted in the ecosystem. The fact that investors don't have to interact with a physical product ensures that there will be many attempts at fraud by mischievous players. It's vital that these attempts at fraud are unsuccessful, and the only way to ensure that is by building a true trustless system.

Another obstacle that investors will have to contend with is lower returns. Unlike traditional rental payments, the interest that will accrue to tokens will be a lot smaller due to several factors. For one, a lot of investors will only own a few tokens. Since the rental payment accrues proportionally, they may not get a huge share of the payments. Secondly, investors may have to outsource the management of the property to managers who may or may not be competent, which could affect the number of rental payments that accrue to them.

In any case, real estate tokenization is an emerging aspect of the Web3 economy. The benefits of real estate being driven by this sort of decentralized funding are too obvious to ignore, and the next few years will certainly see a lot of innovation that makes tokenization easier. Therefore, it's only a matter of when decentralized finance will take over real estate, not if.

But before then, startups like Bricktrade are already taking the bull by its horns by building a system that allows investors to invest in real estate at scale. Initiatives like this are definitely necessary, as they will be the springboard to a real estate ecosystem funded by decentralized finance.