By Yael Tamar, CMO & Partner, SolidBlock
As we have seen over the last several weeks, nothing makes the global market volatile like a pandemic. It is clear that fear, panic and hysteria exacerbate the natural economic volatility. While this is bad news for the majority of businesses and many investors who got into the game when things were going well, it is good for anyone looking to jump into the market and make money, provided they have liquid assets to invest.
The current pandemic, or any global crisis that creates a disruption on this level, highlights the need for tokenization. Tokenization breaks up an asset into many smaller and less expensive parts, which are called security tokens because they are secured by the underlying asset. Tokenization lowers barriers to investment and opens new funding opportunities for asset owners. In theory, almost any asset could be tokenized: artwork, jewelry, gold, etc., but the greatest potential lies in real estate security tokens.
Tokenization has only become possible within the last five to 10 years, thanks to the development of blockchain technology. A lot of people throw this word around, but not everybody is clear on what it means. Blockchain is simply an online ledger system that stores multiple copies of records, locked with cryptographic security so nobody can read them but the owners. Because every user has a copy, blockchain records cannot be deleted or tampered with, making it an ideal framework for the purchase, sale and trade of security tokens.
Tokenizing a real estate asset can offer businesses a “breather,” along with the opportunity to gain the liquidity they need. And in general, the more liquid an asset is, the more accurate its price will be, and the more likely they are to find investors or lenders at a time of need.
Let’s look at three key predictions about what is likely to happen to the real estate market over the near and more distant future. Then we can explore how tokenization could help solve some of the problems in this kind of scenario, whether it is caused by a pandemic or any other natural or human-made disaster or downturn.
(1) Real Estate Remains the Best Asset to Survive the Slowdown
Real estate investment is widely known to provide the highest and most stable return over the long term. While stocks and bonds have shorter bursts and cycles of prosperity, they also carry more risk, making investing in real estate the best way to get through any downturn. The below graph shows inflation-adjusted returns from various forms of investment from data in 16 advanced economies over the past 145 years:
While the majority of high-tech projects seeking funding have hit the snooze button for the time being, real estate projects must continue. The nature of the business does not allow developments that have already begun to be put on hold for very long. With fewer options for investment in the market, developers may resort to more expensive capital in order to finish their projects.
(2) Rental Income Will Prove Vital in the Short Term
Rental income makes up half of real estate investment returns. Even in an economic downturn, people and businesses continue to pay rent, while appreciation may experience a hit. That is why yielding real estate is likely to survive this period. Food and essentials-related retail and warehousing will thrive as consumers are stockpiling on supplies. Existing shopping malls and much of the hospitality industry will suffer. However, new projects in these subclasses have an opportunity to make good profits because they will likely be up for sale when the economy recovers.
(3) High-Risk Investment Products Are Much Riskier
News of the market crash produces hysteria, causing markets to plunge even further. That creates a great profit opportunity. People are selling off their stocks at a very low price in an effort to recoup some of their investment. If you are troubled by the idea of earning profit from the misery in the market, think of this as putting on your own oxygen mask first in a crisis. But in contrast to this steep drop, real estate returns (the ones depicted above are for residential projects) are much more stable.
Real Estate Has Intrinsic Stability
Looking at all the factors mentioned above, it is clear that real estate is a life raft that can provide an essential element of stability during times of economic downturn. And that is true whether investing in real estate via conventional methods or through tokenization.
That is a pretty audacious claim, since tokenization is much less tested over the long run. So I will go ahead and address the elephant in the room: isn’t it possible that real estate returns are so stable precisely because real estate assets are not as liquid as stocks? Maybe their stability comes from the fact that they cannot be sold off quickly during times of mass hysteria. And if that is the case, isn’t it also possible that tokenization could reduce mass hysteria and eradicate the stability of returns from real estate?
While simulation models need to be built to provide more concrete proof that tokenization will not prompt a mass sell-off of real estate in times of crisis, this is my assessment: property, as an asset class, is inherently different from equity in a few important ways that make it better able to weather a financial crisis.
What are some of these ways?
- Demand is based on the fact that people exist.
People need a place to live, a location to work, and stores to shop in. The price of stocks, on the other hand, is based on product demand. While companies are in a growth stage, the main demand for their product in development is actually the demand for their stock, and the expectation that it will turn into a successful product. If there is ever any doubt that a company will succeed, the stock plummets.
- Value holds (relatively) steady during a crisis.
Another thing about securities based on company stock: the highest value lies in human resources. And what is the first thing companies do during a crisis? Lay off workers. That drives the actual value of the company down, not just the price of stock. In real estate, on the other hand, even if a project fails, most of the time, there is still land that has value. Post-crisis, that value will likely grow.
- Property has built-in cycles.
This is the nature of real estate. It is often possible to “freeze” a project and wait for the storm to pass. Companies do not have this privilege. They have too much overhead, along with fixed monthly expenses. It is much harder to pivot when you are talking about a company focused on a product, service, or even a range of products and services. As we have seen in the last few weeks, companies can try to continue functioning during a crisis with bare-bones staffing, but in many cases, their ability to meet demand is compromised or fails completely.
Tokenization Keeps Investors and Property Owners Safer
On the one hand, tokenization of real estate will make property more liquid, like stocks. But because of all the properties inherent in real estate explored above, the value of real estate-based tokens is more likely to remain stable during crisis conditions.
However, when markets plummet and someone wants to sell their property, they still have an idea of its value. While company values are highly subjective (yes, despite some methodologies to evaluate companies, a lot of the value is based on both market projections and value of competing companies), property valuation has a very specific globally recognized methodology.
From what I have observed over the last few years with tokenized assets, property prices will fluctuate 5 to 10 percent during economically stable times, and 20 to 30 percent during crises. What we will not see is the kind of huge reduction in property stock prices that we have experienced in stocks.
For example, take a look at public REIT prices over the past 40 years:
As you can see, the worst fluctuation in public real estate financial products was in 2008 during the great recession. But even that fluctuation only rose to 30 percent.
The final reason why we will not see huge runs in the real estate industry is the fundamental difference between real estate investors and stock investors.
Property investors are not day traders. This is the primary reason tokenization will not destabilize real estate, turning it into a property-based version of the stock market with the same inherent highs and lows.
Yes, tokenization will create liquidity in the market, letting owners raise capital more efficiently, and allowing investors to enter a project at any time throughout the development cycle based on their risk appetite. However, property investors understand the nature of real estate: this is an asset class that provides limited yet stable returns. Property investors are choosing to invest in this asset class because they are interested in diversifying and de-risking their portfolio. This means they are less likely to sell off property-based securities in the event of mass market hysteria, partly because they do not want to lose their savings, and also because they will do so only when they truly need the funds.
Good News for Savvy Investors
It turns out that asset returns are not tied to the GDP. If anything, asset return growth rate is negatively correlated with economic growth. Over time, returns on these asset classes tend to grow on average around double the speed of the country’s economy as a whole—measured by GDP (see chart below).”
On average, combined assets like stocks and bonds perform several times better than GDP growth. This is positive for investors who can grow their wealth, and negative for those who work for a living as their wages will not keep up with rising inflation and property prices. The wages are tied to the real economic growth, while income from investment is tied to a variety of factors impacting the rate of return including the expectation of growth. Moreover, most tax systems favor investors over employees.
- So what’s going to happen to my real estate portfolio?
What usually happens? It will bounce back. Be patient if you can. You may still be able to leverage your investment to obtain consumer loans in order to survive the slowdown. Or you may be able to leverage them to obtain loans to invest in new assets that are now available at a reduced price.
Traditionally, the more diversified your portfolio is, the better your chances of surviving the downturn. Tokenization, by enabling fractional investment and lowering the threshold to invest in AAA projects and landmarks, means almost any investor can own a diversified portfolio of property assets, even if they have just a few hundred (or dozens) of dollars to invest.
- What about my real estate project? What can I do to hedge against the risks?
Hedging, or “de-risking,” is done through diversifying. If you diversify your capital strategy, you are likely to stay afloat. Diversifying involves increasing exposure to investors you may not have considered before, possibly lowering your thresholds, increasing transparency, making it easy to invest, and providing new and creative marketing avenues.
As an asset owner, tokenization offers a very appealing way to survive a crisis. Just like shares in a public company, which are initially purchased for a set price (during the initial public offering, or IPO), security tokens may later increase in value thanks to secondary market trading. However, while IPOs are slow and expensive, a security token offering (STO) can accomplish the same thing more easily and quickly, at a fraction of the cost.
More importantly, tokenization opens up the possibility for investors to sell their stakes when they need liquidity. It invites people worldwide to get involved with your project, and gives you better odds of surviving the next global financial crisis.
Yael Tamar is CMO and Partner of SolidBlock, which utilizes real estate asset tokenization – the convergence of real estate investing and blockchain technology – to transform real estate into a tradable financial product. Tamar is a blockchain strategist with a decade-long track record as an entrepreneur, as well as a successful career leading marketing and business development in executive roles. SolidBlock is a partner company of BuiltUp Ventures, which invests in innovative, early-stage proptech startups.