The current private real estate market is dominated by a handful of large incumbent real estate companies who have the power to quickly divide a market and make it harder to compete. Usually, these large companies have the advantages of having deep market penetration, having better access to capital, and being able to get the best customer data. However, with the advent of online real estate platforms and digital securities, a new wave of new players is entering the market and challenging the incumbents at their own game.
In the last couple of years, a new business model has emerged that is disrupting the private real estate market. This new model is called blockchain based digital securities. In the last year, many new real estate startups have emerged from the blockchain space. These startups are all focused on disrupting the private real estate market by providing more transparency and security for all parties involved in the transaction process.
Overview: Real estate as asset category
Globally, real estate has historically had a similar performance to government bonds (7.05% vs. 6.89%). Not only does this asset class offer stable returns with less volatility, but in recent years it has become relatively common for real estate investments to generate returns in excess of 10%. Real estate in general tends to be cyclical – it goes up in good times and down in bad times. On a more granular level, however, multifamily properties are often considered a protective investment, as opposed to the more volatile commercial real estate segment. The current environment of low interest rates also creates an ideal environment for stable fixed income, similar to the cash flows of this investment. Historically, this asset class has been reserved for property developers, high net worth individuals and institutional investors. But as fund managers and developers seek to raise capital from a broader group of investors and platforms, and as opportunities arise for individual investors, real estate markets are becoming more prominent in the private equity space. The biggest barriers to entry into the world of real estate investment are high ticket prices and high legal and transaction costs. Investing in physical real estate can be very exclusive, especially in today’s economy. People looking to finance their investments often have to undergo extensive credit checks and demonstrate tangible income or assets. Moreover, the real estate market is relatively opaque and information asymmetries can often lead to significant valuation distortions. REITs were the first iteration of the solution to the above problems. These funds primarily pool capital from the public markets and distribute property income to investors in the form of dividends. Investors can also benefit from capital growth. But investors cannot choose which properties and projects to invest in – their returns and risk appetite are left to the discretion of the fund managers. Essentially, REITs limit investors’ options. However, the private real estate market allows individuals to be more selective in constructing their own portfolios and to have more options for fund allocation and property selection. Over the past decade, the largest private real estate markets have achieved an average annual return of 12.16%, compared to 10.88% for the S&P 500. In terms of risk level, real estate is known to generate reliable and steady cash flows, as most of the dividends come from rental income. Development transactions can be a little riskier, but generally provide higher returns. Debt offerings are also common in real estate crowdfunding, although more than two-thirds of offerings are classified as equity or income shares. Some of the largest real estate markets in the United States have raised over $1 billion and paid significant returns to investors. See below: The total online real estate market is estimated at nearly $90 billion, up from $80 billion in mid-2018.
Benefits to investors
With lower minimums and greater granularity, real estate markets are changing the way the average investor can put their money into real estate. This leads to a democratisation of the real estate market. When selecting individual properties, investors can better weigh their risk appetite. Because individuals have direct control over the properties in their portfolios, risk-averse investors can choose low-risk transactions, while risk-conscious investors can seek higher risk profiles in exchange for higher returns. See below: With each additional unit of profit, the utility of the risk-averse investor increases less and less (diminishing utility). For the risk-averse investor, it is gradually increasing. Since a public REIT falls somewhere in the middle of these two concepts, neither investor will be happy with the level of risk in the fund. A risk-averse investor will not be properly compensated for the risk taken, while a risk-seeking investor will want a higher return than the fund can offer. In the private real estate markets, investors receive a menu of projects and can select the ones they find interesting at their own discretion. This allows for a more efficient allocation of risk tolerance, as investors can choose the transactions they are most comfortable with based on their specific situation. Although real estate markets allow participants to invest in individual transactions, investors may face single-asset risks (i.e., their investments are too dependent on a single project). To address this problem, trading systems should encourage investors to build highly diversified portfolios. For example, Crowdstreet offers investors the opportunity to buy a portfolio tailored to their risk appetite. It is also important that transactions are as complete as possible to minimize counterparty risk for investors. However, it is difficult to find the most effective way to streamline this particular investment process. Real estate markets should screen participants from multiple jurisdictions and ensure full disclosure of transactions to investors. Moreover, dividend payments and settlement of transactions are almost always done manually, as they are usually done through outdated financial channels. So there are huge opportunities for real estate markets to benefit from digital securities.
New Market: Real estate markets with digital titles
There is no doubt that the real estate investment platform of the future must be based on distributed ledger technology. These platforms can offer investors the same benefits as traditional real estate markets, with the added value of digital securities. Currently, there are about 16 real estate investment platforms using digital securities. They are concentrated in the United States and Europe, but few of them have their assets listed on secondary markets. Some of these markets (particularly in the Middle East and Europe) are multi-functional digital securities platforms that also offer real estate. Some of them are exclusively engaged in the issuance of digital securities backed by real estate. As more issuers begin to tokenize multifamily real estate, the proliferation of digital securities in the real estate market is expected to increase significantly over the next year. Digital effects offer an innovative solution to an outdated mechanism. By digitizing real estate, issuers can simplify the process of viewing inventory and analyzing asset performance. The concept of an online platform where transferable digital assets can be securely stored aims to change the way people own fractional capital. Broker networks are at the heart of what makes digitalization so important. Blockchain and distributed ledger technology provide the underlying infrastructure to enable the transfer of digital securities. By creating a system that allows for seamless securities trading across platforms, broker-dealers can interact and offer investors a wider choice of assets. This improves the spread of transactions by increasing market transparency and reducing barriers between players. Since the investments are made on the internet, the overall opportunities for investors are much greater than with traditional private securities. In addition, greater transparency through more accurate pricing and risk assessment and lower intermediation costs can lower barriers to entry for investors. In the future, investors will be able to obtain liquidity through authorized trading systems, which will significantly increase the speed at which these private securities circulate and become available to investors. Real estate markets are at the heart of the trend to broaden access to real estate investment, and digital securities are an ideal vehicle to expand and accelerate this trend. * * * Warning The information presented in Atlas One’s surveys, social media channels, website, webinars, blog, emails and support materials (collectively, the Information) is for informational purposes only. It does not constitute an offer, invitation or other solicitation or recommendation to purchase any securities. This information should not be construed as financial or professional advice. You should consult a specialist to determine what is best for your individual needs. The information comes from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed and Atlas One accepts no liability for the provision of this information. Atlas One assumes no obligation to update or advise on future developments in these areas.
- Source: Federal Ministry of Education and Research (BMBF) and Institute for New Economic Thought (INET), The Rate of Return on Everything, 1870-2015, p. 13, https://economics.harvard.edu/files/economics/files/ms28533.pdf.
- Source: Investopedia, real estate crowdfunding websites, https://www.investopedia.com/best-real-estate-crowdfunding-sites-5070790
- Source: Macroeconomic trends, S&P 500 historical annual performance, https://www.macrotrends.net/2526/sp-500-historical-annual-returns
- Source: EY, Real Estate Crowdfunding, https://www.ey.com/Publication/vwLUAssets/Real_Estate_Crowdfunding/%24FILE/EY-Real%20Estate%20Crowdfunding-March%202019.pdf
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