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Legal Aspects of Real Estate Tokenization

Tokenization represents fractional shares of ownership, allowing investors to purchase smaller shares of highly valuable assets. This opens up real estate investing to a wider range of participants, increasing accessibility and potentially increasing liquidity. Below we will look at the main legal aspects that are associated with real estate tokenization and how exactly the idea of tokenizing certain objects can be implemented.

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Legal Considerations in Real Estate Tokenization and Regulatory Framework

Projects can remove geographical restrictions using blockchain technology and allow people from all over the world to participate in real estate opportunities. When determining business methods, projects should carefully consider the legal system of the country in which they intend to issue tokens. Different countries may impose different requirements for issuing tokens, including licensing obligations and other regulatory requirements such as data governance and security, compliance requirements, and illegal monetary means circulation (AML) reporting.

Real estate tokens issued in the European Union may be subject to the obligations and requirements described under the Markets in Crypto Assets Regulation (MiCA) regulation. Certain jurisdictions may classify issued tokens as securities or financial instruments, subjecting them to securities requirements. Projects can then take advantage of the opportunity to obtain an exemption, such as Regulation D in the United States. In addition, the country may have additional regulations that apply to the project regarding real estate ownership, advertising standards, or data protection regulations.

The benefits of real estate tokenization are next-mentioned.

  1. Reducing barriers to entry into the market. By using digital tokens that represent ownership of real estate, tokenization allows for partial ownership. Instead of purchasing the entire property, investors can purchase tokens representing a smaller portion, significantly reducing the initial capital required to participate.
  2. Increased liquidity. Tokens can be traded on secondary markets or specialized exchanges. This provides greater liquidity compared to traditional real estate, where finding a buyer can take months. Investors can sell their positions faster at will, providing financial flexibility.
  3. Ensuring diversification. Tokenization makes it easier for investors to build a diversified real estate portfolio, particularly, including possibilities of NFT usage. By purchasing tokens representing different real estate properties, investors spread their risk across different assets, locations, and types of markets.
  4. Reducing management costs. Many of the real estate tokenization platforms take on the responsibilities of property management, including tenant selection, maintenance, and rent collection. This relieves investors from the direct responsibilities of a landlord, especially those who do not have the time or experience in property management.
  5. Addressing market volatility. While real estate tokenization does not eliminate market volatility, it can reduce risk through diversification. In addition, increased liquidity may reduce some of the extreme price fluctuations associated with illiquid real estate assets.

Process Peculiarities: Compliance Requirements and Documentation

Token issuing provides the real estate industry with fractional ownership, liquidity, accessibility, and global scalability to a degree that was previously unattainable. Real estate tokenization involves representing physical real estate as digital tokens on a blockchain network. Typically, each token represents a fraction of the value of the object.

Projects can use various methods to tokenize real assets, such as creating a company where tokens serve as a digital representation of ownership or para-rights to real estate. Projects may also choose to issue tokens representing ownership of shares in the register of title deeds (a tokenized written document of value) confirming ownership of real estate.

The real estate tokenization process includes the next-mentioned aspects.

  1. Formal initial steps: First of all, it is necessary to select a suitable jurisdiction, create a legal entity, open a bank account, and perform other steps so that the company can operate within the chosen jurisdiction.
  2. Formation of a legal structure.
  3. Selecting the right technology: To create a token, you need to choose the right blockchain technology.
  4. Creation and distribution of tokens.

One of the factors influencing the tokenization process (including the legal structure) is the purpose of its implementation and securities regulation mechanisms. In this article, we will consider the tokenization of real estate in specific cases for selling, attracting investment in a finished property, or attracting investment in a property under construction.

Real estate tokenization is a rather interesting area, but it is worth noting that for its widespread implementation, technical and legal problems must be solved. The technical problem is the high energy consumption of blockchain technology. And the legal one is gaps in the legislation of many countries.

When using real estate tokenization or smart contracts, the investor and owner should first of all be guided by the next-mentioned legal principles.

  1. Take into account an important fact of who is the owner of the property.
  2. Know exactly what rights the token owner is entitled to.
  3. Is there additional profit and in what form will the investor receive it? Bear in mind all asset ownership agreements in a particular case.
  4. Be sure to take into account the specifics of the chosen jurisdiction.

The whole range of factors that influence real estate tokenization includes next-mentioned:

  • type of real estate for tokenization (real estate for generating income, building plot, luxury real estate, etc.);
  • type of equity participation, relevant structure (fund, special purpose vehicle, hybrid legal entity) and choice of jurisdiction;
  • license getting if needed;
  • percentage of tokenization;
  • the presence of an encumbrance on property rights;
  • smart contracts necessary to determine the rights provided for by tokens and implement the token sale;
  • federal and state securities laws;
  • security mechanisms implementation in the realization of escrow option;
  • federal and state reporting requirements;
  • accounting of token owners, fulfillment of obligations when reporting and resale;
  • ownership registration confirmation;
  • compliance with the requirements for conducting AML/KYC checks and accreditation of investors during the token sale, as well as during the secondary circulation of tokens in appropriate cases.

Insights into Emerging Trends: Possible Risk Management

We can find ways to mitigate the potential risks associated with this process.

  1. Thorough check. Due diligence is a mandatory step before investing in both tokenized and traditional real estate. Your company should be prepared for any audit: you should open data about your team, work experience, property management, business model, and so on. You should also be prepared for the fact that the investor will want to study all the conditions of a potential investment and will not rush to make a decision.
  2. Regulatory compliance. In preparation for real estate tokenization, you should study the regulatory nuances in your region. This issue is one of the biggest obstacles for companies. Consultations with experts who are involved in the tokenization of client real estate will help avoid problems with licensing and reporting. It is also necessary to comply with KYC/AML points and ensure that mortgage lenders and other counterparties understand what asset tokenization is and do not oppose it.
  3. Value proposition. As with other types of investments, tokenized real estate should be of interest to potential investors. A clear business model, good condition of real estate, an anti-crisis plan to support the value of the token in the event of a crisis, as well as competent marketing; all this will make you more attractive in the eyes of investors.

Tokenized real estate has the potential to revolutionize the way real estate assets are financed, acquired, disposed of, generated, and sold.

Our company is ready to help you in the process of tokenization of any real assets, providing full support throughout the entire procedure. We will become your reliable legal support, which will be able to cope with any difficulties and nuances. Contact us right now.

The article’s author is Denys Chernyshov – founder and CEO of the globally-famous organization Eternity Law International.

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