Dangers of Tokenized Real Estate Investing
January 30, 2023
While many have heard about real estate tokenization, not a lot of people are aware of what exactly it involves. Real estate tokenization is a process of fractionalizing real property into tokens that are stored on a decentralized database. This database is known as a blockchain and it functions like a digital ledger for information storage.
It can verify, synchronize as well as share the distributed ledgers with all the network participants on which the tokens are recorded. This is an accurate ledger that is available to the public.
Investing in tokenized real estate might sound interesting at first but it is not without dangers. Let’s take a look at them.
Securities law implications of Tokenization
Tokenization of real estate is considered security but an analysis of every specific token must be considered at the outset. When the token is a security, it has to be issued in accordance with the requirements of the prospectus or with the help of an exemption, like the accredited investor exemption. The issuer should consider both the registration requirements and prospectus requirements.
Poor Management of Tokenized Property
Poor management is one of the top dangers of any type of real estate investment. However, it is more so in tokenization. Anyone can tokenize a property since it is much easier than REIT investing or selling property in an alternative way.
Whenever someone invests in a property but does not take due care of it, its price and value will fall, making it unattractive. This happens with junk properties since it is not worth the money in terms of realization possibilities. In order to avoid making a non-cost-efficient investment, you must always look into the STO and issue company details.
Weak Business Model
When it comes to real estate investment, the business model will always matter. You need to understand how the company plans to make a profit and divide it amongst investors. If you want to tokenize the property, decide on a business model and explain it to potential investors.
Low Liquidity of Tokenized Property
The advantage of tokenized real estate is high liquidity as compared to non-tokenized assets but the risk of liquidity still remains. Investors might consider real estate as a long-term investment and would not be willing to sell tokens. This is where the sale of real estate becomes tough since there is no active buying and selling market. Due to low liquidity, there could be low trading or low funds in the pool and the value of the asset will be easily impacted by the exit of a big investor.
Risks Associated with Market Fluctuations
The real estate market is always affected by macro and microeconomic conditions. Consider the financial crisis of 2007-08 when the real estate market rose and fell. Even during the Great Recession, several mortgage-backed securities and derivatives dropped in value.
There is no certainty that such crises will not happen in the future and they could lead to a significant loss to the investors. Hence, investors as well as issuing companies have to be aware of the news and understand the trends before jumping into the market.
These drawbacks can make investing in tokenized real estate highly risky for investors which is why it is recommended to invest with more reliable and established teams that have a solid record and generate consistent returns.