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Digital Transformation

Digital real estate transactions: Digital diligence

Tokenisation on the blockchain can standardise, simplify and economise some of the more fragmented, complex and costly elements of the real estate transaction process. First, we must bridge the knowledge gap.

Charles Kerrigan, Partner and Global Head of Fintech, CMS Law
7 June 2021

When looking at fintech use cases, it is important to consider not just the product, but what in the relevant industry either services or underpins it.

There are two sides to this. First, the type of things that everyone talks about – servicing the product by bringing customers to it, and by improving the product as it is used. Second, the type of things on which the industry relies, but which have become so embedded that market participants take them for granted. For new entrants into established markets, it is possible to miss elements the market participants assume that everyone knows all about. The real estate industry has been around forever and that makes it susceptible to having some hidden foundations (pun intended!).

Let’s start with the part that everyone talks about. One of the clearest market opportunities in the fractionalisation part of the blockchain business world is in real estate. The market opportunity is clear for two reasons: one – it is an analogue market; and two – it is huge. The global real estate market is worth US$2,687billion and forecast to grow to over US$3,717billion by 2030.

The real estate tokenisation market opportunity is clear for two reasons: one – it is an analogue market; and two – it is a huge market.

The benefits of tokenisation in private markets are also well rehearsed. Improvements in price discovery and liquidity should be easy to make when applied to real estate transactions. The benefits of fractionalisation in real estate, in particular the further democratisation of the asset class, are also well rehearsed – not least by the various crowdfunding platforms that have gone before us with these business models.

Real estate transactions have a well-established workflow behind the scenes. The digitalisation of the real estate industry will remain reliant on this. However, unlike exchange traded securities, trading real estate requires due diligence by a transacting party. That means a transacting party will engage a professional team to do checks before entering into the transaction. I say transacting party, rather than a buyer, because this applies to more than just buyers. A lender, insurer, lessee, etc. will engage the same work. Anyone relying on recourse to the value of the underlying real estate or relying on the fact that they can continue to occupy it, needs to have these checks done.

Outside the industry this may raise the question of why this is needed. There are two main reasons for this: one – real estate assets exist in the real world as tangible assets susceptible to all the vicissitudes inherent in that status; and two – the legal principle of caveat emptor (buyer beware). There is no automatic recourse to a seller if what you buy is not what you expected. So, you need to know that you are buying what you expect. The next question is: what are these checks? In the UK they include checks on entries at the Land Registry, at Companies House, of copies of leases, of information held by local authorities, of construction contracts, of planning documents, of health and safety information - all among other things. All of these things have something in common. They are all analogue processes. The UK Land Registry runs a “Digital Street” programme, but it is not a digital registry. It is knowledgeable and sophisticated, but becoming digital would be a big, and expensive, IT project.

These questions come up in all jurisdictions, of course. Every country has real estate and real estate transactions. There are other ways of approaching these issues. In the US, it is customary for a buyer or other interested party to buy title insurance rather than engaging a lawyer to do a review of the title registry and documents. If insurance costs less than having lawyers do their checks and is quicker (and the insurance market is prepared to sell cover), it is a logical approach. So as far as real estate is concerned, the tokenisation platforms and fractionalisation businesses have done the job of digitalising the front office of real estate transactions. But the overall workflow still has a lot of room for improvement. The platforms know this and, of course, are great advocates for it.

This leads us to an analysis of how we would digitalise the diligence process for real estate. This is easy to say – that is, integrating land and corporate registries, making information available in digital form, establishing systems that produce structured and machine-readable information; essentially, to digitalise the work in each of the paragraphs above. Of course, any information held on blockchains can be updated automatically and made available for use by public and private systems. Some of this is relatively easy to do. Private information, transactional information and even data collected from buildings can be, and is being, digitalised now. Public bodies will get there in their own time, but they are certainly well-aware of the issues and the opportunities for the market and for their home jurisdictions as places to do business. And of course, any of this work that is completed would be equally valuable to insurance businesses, allowing them to offer more and better products and better pricing.

Any information held on blockchains can be updated automatically and made available for use by public and private systems. Private information, transactional information and even data collected from buildings is already being digitalised. Public bodies will get there in their own time.

Are there any collateral benefits to doing this work? I’m glad you asked. Tokenisation and related innovations allow real-time onboarding and trading and have brought genuine breakthroughs – adoption is evidencing that. And imagine the improved functionality as we add, bit by bit, real-time diligence to their systems. Onwards!

  • This article was taken from Digital Bytes, a weekly analysis of developments in the blockchain and digital assets sectors, taking real examples of how, why and where blockchain technology is being implemented around the world.
  • For more information, please email: WBEF@rics.org