Selling 1% of a 5-year office lease. Anyone interested?

May 25, 2018 Articles Selling 1% of a 5-year office lease. Anyone interested?

The blockchain: a business truth machine

Recent transactions will provide, in most valuation exercises, an anchor point for pricing. Available data on cap rates, vacancy and lease terms, among other variables, will be systematically scrutinized as this becomes the basis of a seemingly endless DCF pricing spreadsheet.

The analyst will go at great lengths to derive a reliable relationship between observed data points and bring that insight in the valuation exercise of the considered property.

But what happens when different sources in the market tell you different things about the property’s vacancy rate? Or about the actual cap rate? Whom should you trust?

Perhaps the data was faulty entered in the database. You would need to pay for a second subscription to check this against another data provider. Maybe there was a strategic reason for misreporting the data in the first place, something no data seller can fully insure against. A myriad of different reasons may act as probable causes for the observed discrepancy.

Blockchains are designed to tackle exactly these problems. To understand what they are and how they transform information sharing, think about them in the first stage as a database. What makes them special, are several innovative features.

Blockchains are databases stored on several computers simultaneously, this is also why they are called distributed ledger technologies, or DLT in short. All participants hold equal rights with respect to how information is written and read, no party can unilaterally change the functioning principles of the ledger (decentralization).

The blockchain can be accessed by anyone, anonymously, if we consider for example permissionless blockchains such as those powering Bitcoin or Ethereum. Entries in the database are allowed only according to a pre-specified rule, known to all participants (consensus mechanism).

The rule specifies the action required from participants willing to write data in the blockchain. It represents a mechanism which primarily insures that the common goal of the members in the ecosystem (insure only honest transactions go through, for example) is not hijacked by private interests of any one participant (someone willing to unlawfully claim ownership of an asset).

Depending on the architecture of the DLT, a digital token may be issued to agents validating the transaction. Bitcoin is such an incentive, embedded in the working of the blockchain to insure the ecosystem is functioning according to its original blueprint.

The last important feature is immutability. No participant can alter transaction already registered in the ledger.

It is important to stress the general meaning of transaction: it may refer to a monetary exchange, the transfer of an asset title or more recently, the purchase of virtual cats. Anything can be traded on the blockchain, even crypto kitties.

Not all blockchains are created equal. They differ among each other, for example, in how consensus is reached among participants, if they permit anonymous or require identified agents or whether smart contracts may be deployed to execute specified actions such as title transfer conditional on payment.

Real estate, the new kid on the blockchain

Suppose now that the data registered on the blockchain, rather than representing transfer of cryptographic tokens between different parties, represent information related to an actual sale or, to keep with our introductory example, a commercial lease.

Contractual rent and how it’s related to sales or revenue, use and term clauses, how costs associated to maintenance are split among tenants and landlord, all can be stored on the blockchain, hidden behind cryptographic keys.

The data is validated by several parties, who through their involvement in making the deal happen, have intimate knowledge with the transaction. They may be brokers, lawyers, accountants and notaries who jointly backup the data submitted to the ledger. The design of the blockchain may be such that only registered parties are allowed to write and only those permitted can read the data.

As a small detour, consider the strategic implications for real estate data providers. In our case, our truth machine offers an unbiased, collectively reinforced view of the transaction data.

Blockchains are technologies that turn truth into trust. If our building is also a sensor-loaded smart building submitting data to the ledger, then welcome to real-time pricing based on actual daily space usage.

A portfolio manager, sitting in her London office, no longer needs to worry if the vacancy allowance of 10% of a building on the other side of the globe is fact or fiction. The sensors in the building will broadcast live usage patterns.

Understanding any commercial property as a portfolio of leases, secured on the blockchain, opens new business models. Blockchain powered marketplaces can allow any interested party to browse a multitude of rental income profiles, with different durations and volatility. Landlords can relieve themselves from leases which imply too much risk, yield-hungry investors can buy slices of a building, fit to their risk profile.

Going further, a cryptographic token representing partial ownership of one or more leases, may be issued and transacted on any of the existing public blockchains at costs several orders of magnitude smaller than traditional products. By reducing issuance and management costs, tokenization established an investment market to a much larger base of investors than before [1].

Building owners can then sell the tokenized lease to a multitude of small or large investors. Once the lease is tokenized and all income and exposes are available online, additional investment demand will come from any party, interested and able to judge the value of the lease.

The model stands in stark contrast to the current setup. This type of deal is usually structured over the counter by a bank who matches the buyer and seller, keeping in the process a hefty fee.

But breaking a rock in many small pieces won’t automatically produce small golden nuggets. A tokenized 3% cap rate property in an increasing interest rate environment may well lead to investment losses, blockchains or not. Could this be the kickstarter increasing demand of property derivatives?

This overly simplified example highlights one of the many new avenues possible for the real estate industry. How business models will adapt will depend on regulation and speed of adoption by market participants.

The re-bundling of different real estate functions will nevertheless accelerate and reshape property markets down to their molecular level.

[1] For more details on tokenization of real estate assets, see also

Posted on May 25, 2018 by

Mihnea Constantinescu

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