Foresight Ventures: Will On-Chain Real Estate Reshape Traditional Markets?
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Author: Jeff@Foresight Ventures
TL;DR
- On-chain real estate can disassemble and recombine asset structures. Property rights, rents, and occupancy can be separated and traded independently on an existing basis. Particularly, on-chain real estate can also be partitioned into multiple portions in the scale of time.
- How to solve the issue of scenario disconnection is pivotal for the development of blockchain real estate projects at this stage. Platform tokens, DID (Decentralized Identifiers), and blockchain-based streaming payment platforms hold the potential of solving the “black box” problem.
- The prevailing regulatory framework poses potential risks, with an absence of a concrete right confirmation between the property NFT holders and the SPV companies.
- It is suggested to attempt bridging uncommon asset classes, such as extremely cheap troubled assets and extremely expensive scarce assets. By fractionalizing property rights and binding them with equity NFTs, the actual transactional needs of buyers and sellers could be catered to.
- It is suggested to refine usage scenarios, such as catering to the rental needs of digital nomads, leveraging the web3 native genes of this group, and creating small but beautiful business models.
In the competitive landscape of the RWA track, the cornerstone of innovation lies in the disassembly and recombination of asset structures. The total market value of the real estate industry reached $11 trillion in 2022. Bridging such a colossal market onto the blockchain and fostering a new market ecology is a matter of keen interest. This article collates the blockchain real estate projects in the market, identifies common problems of them, and proposes corresponding hypotheses.
Blockchain Solution for the Korean Jeonse Issue:
The real estate crisis prompted by the Jeonse system in South Korea starkly uncovers numerous issues in the traditional real estate business model. Jeonse is a unique system where tenants pay a lump-sum deposit amounting to 60–70% of the total property value to the landlord, allowing them to reside in the property without monthly rents for a fixed term (typically 2 years). However, the lack of a transparent regulatory mechanism leads landlords to invest the tenant’s deposit in new properties, cashing it out through the Jeonse system. The real estate market, being highly leveraged, becomes precarious in the face of significant drops in housing prices, disruptions in loan supply, and other financial chain disruptions. Consequently, numerous landlords abscond when they are unable to return the deposit. Since the deposit paid by the tenant only represents the landlord’s personal debt, the tenant receives only a minor amount from debt liquidation after the property is auctioned off with lower priority.
Could the real estate crisis instigated by Jeonse be averted through blockchain real estate projects? Let’s consider the main market problems alongside corresponding blockchain solutions:
1. Deposit breach problems.
Tenants can effectively track landlords’ capital flow and debt situation by making deposits on the blockchain, promptly alerting situations where “liabilities exceed assets”. They can also specify the date of fund unlocking through smart contracts, automatically returning the deposit to the payer.
2. The absence of a background investigation platform for landlords and tenants. Especially for tenants who cannot assess risks like the mortgage status of a house.
If property rights are put on the blockchain and converted into NFTs, tenants can distinctly trace the mortgage status of the property NFTs, effectively avoiding “high debt” landlords and mitigating unnecessary troubles.
3. When a landlord defaults on their debt, tenants have a lower priority for compensation as they do not hold property rights.
If the property right NFT is further fractionated on the blockchain, then tenants can obtain a proportionate amount of property right NFTs when paying the deposit and return the corresponding NFTs after receiving the deposit. In case of a landlord’s default necessitating liquidation, they can also receive proportionate compensation based on the corresponding property right NFTs.
4. The real estate transaction market has regional limitations.
When auctioning off default properties, minting property rights on the blockchain into NFTs can effectively mitigate regional restrictions on property transactions, expanding the user base from local neighbors to all blockchain users.
5. Amount restrictions of trading real estate.
Most Jeonse properties are concentrated in prime locations in Seoul, and their high individual prices deter retail investors. By fractionalizing property right NFTs, buyers can purchase only a portion of the fractionalized property right NFTs, significantly reducing the limit on investment amounts.
Critical Pain Points Targeted by Blockchain Real Estate Projects and Key Aspects
Considering the above examples, we identified potential market pain points and problems related to the real estate market. We classified its blockchain solutions and existing blockchain real estate projects, distilling them into the following three crucial aspects for discussion: transaction phase, rental phase, and mortgage phase.
In the transaction phase of real estate, the buyer’s needs are often prioritized. Current blockchain real estate projects primarily separate property rights and usage rights, recomposing transaction content over time. They aim to address potential market problems through blockchain payments, blockchain identities, property right NFTs, and their fractionalization.
1. By eliminating regional transaction limitations and instituting blockchain property background investigation, property information becomes more credible.
Understandably, blockchain platforms offer a free investment window for global investors. Platforms like Tangible bundle property rights into the SPV (Special Purpose Vehicle) where the property is located and mint all property certificates and property information into property right NFTs. Global traders can directly purchase the NFT of the property through their portal site, which implies they have acquired the property rights of the corresponding property. In this process, the Tangible platform initially pays a 10% deposit to the seller and then opens a public sale to the buyer. After reviewing the property rights and information, the buyer decides whether to purchase.
2. To prevent deposit refund default, blockchain payments ensure fund security.
Paying the house purchase deposit on the blockchain can set a smart contract and time limit, making the defaulting party automatically bear the loss. Blockchain payments can also enhance fund transparency and give early warnings to risks. As illustrated earlier, if the subscription is not completed within the agreed period after Tangible paid the deposit to the seller, the deposit will automatically be returned to the Tangible platform.
3. By eliminating property transaction amount limitations, the purchase threshold is lowered.
Users can customize the investment amount. To lower the entry threshold for cross-border property purchases, platforms like RealT further split property rights. Some fractionalize property rights, allowing small investors to voluntarily subscribe to quotas; others separate property rights from rental income, allowing users to only purchase the rental income for the future N years. In addition, CityDAO fractionalizes land rights by registering a DAO company, allowing buyers to not only own property rights but also governance rights.
4. Eliminating payment limitations.
Regulatory issues facing fiat currency transactions also trouble global traders. Therefore, platforms like Smart Reality and ManageGo have specially opened virtual currency payment channels that can hold down payments and even settle directly in virtual currency based on the agreement of the buyer and seller. Transaction platforms like Closing lock monitor the safety of funds as an intermediary and extract corresponding commissions.
Issues in the rental phase mainly revolve around rent collection and property security. Current rental platforms on the market have not completely moved rental activities on the blockchain, and without exception, Tangible, BinaryX, and Reental all use web2 outsourcing companies to ensure tenants pay rent on time. However, there is much more space to explore in managing property rentals on the blockchain.
1. Blockchain rental bilateral background checks of tenant’s rent-paying ability and landlord’s property background.
Through blockchain leasing, landlords can observe the tenant’s on-chain activities, judge their asset balance and repayment ability, and propose corresponding deposit payment plans. Tenants can also judge whether the property is reliable through on-chain property information. Currently, StreetWire is working on a series of features in this direction.
2. On-chain payment of deposits ensures asset safety, streaming payment platforms make rent payments compulsory.
After paying the deposit on the blockchain as mentioned in the Korean Jeonse case, tenant interests can be protected by fractionalizing property rights. For the traditional monthly rent mode, rent can be paid on time compulsorily through on-chain streaming payment platforms, and deposits can be promptly returned after rent is due. We’ve already seen successful cases of on-chain timed rent payments on the Sablier platform.
3. Fractionalized property right NFTs make rental income divisible and combinable.
Fractionalized property right NFTs can distribute collected rent to each landlord according to property rights through smart contracts. Simultaneously, external regulatory factors can be introduced to dynamically adjust rental conditions according to market demand. Thus, property right NFTs have composability, and users can freely sell “lease contracts” with time restrictions. The aforementioned platforms Tangible, etc., have already developed functions to split rental income. In addition to this mode, platforms like Vairt are trying to move short-term rental models on the blockchain to deal with vacancy periods.
The real estate collateral loan phase is still in a market gap. Only RealT and FIGURE are trying to provide mortgage loan functions for fractionalized property right NFTs. However, due to immature market pricing feed mechanisms, unbalanced supply relationships, and other objective factors, it has not been widely recognized by the market. Also, platforms for reducing the cost of housing funds are in a market gap, and the market temporarily lacks Buy Now Pay Later (BNPL) functionality.
Regulatory Framework and Asset Security
Ensuring the legality of blockchain property rights is the issue I paid the most attention to in this research. Currently, almost all blockchain real estate projects use offshore entities to control SPVs as a means to bypass market supervision. I don’t consider this method to be entirely safe and effective.
Let’s take Tangible’s regulatory solution as an example here. The UK properties for sale on the Tangible platform are each held by separate UK SPVs. The offshore entity of the Tangible platform directly controls each SPV company. The fractional property right NFT of the house is issued by the SPV entity and sold to the buyer. To some extent, the transaction safety and legality of the house are protected. However, strictly speaking, the fractional property right NFT of the house does not directly represent the equity of the corresponding SPV. If a debt dispute arises in the parent company or SPV, since the fractional property right NFT cannot directly confirm the property right of the house and does not directly correspond to any shares of the offshore company, buyers are highly likely to end up empty-handed. The asset security problem that was hoped to be solved by going on the blockchain has all been bet on the trading platform itself, indirectly adding additional risks. In addition, if the fractional property right NFT of the house is issued by the SPV company, everything circles back to the regulatory dispute of whether the Token should be defined as a security.
As can be seen, the only solution that aims to bypass regulation and ensure asset security is to strengthen the supervision of SPV companies. CityDAO provides a good example in this direction. Ensuring the interests of each NFT holder through the registration of DAO-form companies. We look forward to CityDAO’s performance after breaking geographical limitations in the future.
So, is there a risk of debt disputes in SPV companies? Yes, especially the risk of default in the house rental phase is very high.
- Reserve risk: Still using Tangible as an example, the platform deducts a total of 7% of the total property value as a vacancy reserve and maintenance reserve. If the reserve is lower than the above ratio, 20% of the rental income will be withheld or the payment of rent will be suspended for replenishment. As an off-chain asset, the reserve is not transparent in actual operation. Since the SPV company has the right to dispose of the reserve, it is very likely to pay the deposit for subsequent house auctions using the reserve, or even use it for other purposes. Once the property cannot be rented for a longtime, and the funds from the sale of other properties have not been returned in time, the SPV will face a risk of default.
- Collateral risk: Because all property rights belong to the SPV company and users can’t monitor it in real-time during actual operation, the SPV company may mortgage the property for a loan, lend out funds for other investments, increasing the risk of default.
What problems are still unresolved? What might be the solutions?
The black box issue of the blockchain process, in my opinion, is the most critical one to be solved. The fragmentation between on-chain and off-chain scenarios leads to uncertainty in blockchain transactions and leasing. This uncertainty directly leads to the following issues:
- The scarcity of quality assets: Good houses are not hard to sell offline, and blockchain properties need background checks before going on the blockchain. This extra step may lead to transaction efficiency lower than offline property agents, and the property resources users can see on the blockchain are often properties that are not easy to sell off-chain; or they need to bear costs higher than the market level as a whole. Improving the efficiency of going on the blockchain and continually replenishing property sources according to customer demand is also an issue to be resolved.
- The actual investment return is far lower than the expected return: When calculating the expected investment return, the platform considers both the potential increase in property value and rental income as expected returns. However, in actual operation, because house renting and management are all outsourced, issues such as leasing duration and tenant default can’t be controlled. Specifically, tenant default is a very difficult issue to deal with in Europe. If a tenant refuses to pay rent, the landlord can only enforce it through litigation, which can take up to six months. This also means that rent income for half a year is zero.
- Property liquidity is confined on-chain: Because of the fractionalization of property ownership, holders can only wait for buyers willing to purchase equivalent fractional property rights when they resell it. Liquidity is relatively restricted and even confined on the blockchain. In the market, mortgage loans for on-chain properties are also in a vacuum phase, desperately needing to fill the gap.
Apart from the black box issue, the business form of blockchain real estate platforms is not very web3 native, and the platform Token is basically not empowered. The entire industry can only be considered as a web2.5 platform on the blockchain.
- Most tokens on blockchain real estate platforms are not empowered with functionality, and we hope to enhance user stickiness and stimulate the participation demand of non-investment users by adding usage features to these tokens. For example, besides users who trade real estate, users browsing the website can also be participants and content contributors to the platform.
- The rental process overly relies on outsourcing companies, which prevents users from forming stickiness to the platform. The rental process should try to incorporate pure blockchain transaction steps. By integrating user DID and credit accounts, it can be determined how much security deposit users need to pledge. At the same time, combining smart contract-controlled locks or power switches can prevent users from not moving out when the term is up. Also, processes like maintenance can adopt crowd-sourced token incentives to increase user stickiness.
- Platforms overly depend on regional resources, with 90% of the existing blockchain real estate platforms concentrated in the United States, while the rankings of global real estate transaction volume in 2022 are the United States, Japan, the United Kingdom, and Germany. Few platforms can tap into the trading or rental markets in these later countries and regions. The author believes that the rental market is a native scenario very suitable for web3 users and is worth paying attention to. Detailed elaboration will follow in the text.
Open Imagination for Blockchain Real Estate Projects
Although there are many problems with blockchain property projects, and the biggest problem is that they do not practically solve users’ real needs. But we still maintain an actively optimistic imagination for this track, because there are still many niche scenarios and potential user needs that have not been particularly met.
High-quality assets in the real estate market often do not lack liquidity. If we can broaden the category of real estate, and then reclassify it, we will get some more focused categories. We list two categories.
1. Exorbitantly priced scarce real estate.
Those exorbitantly priced rare real estates often deter ordinary investors, such as castles, old Western-style houses, wineries, farms, etc. These assets generally have extremely high individual prices and are not used to meet daily living needs. Middle-class investors can only stop at admiring but do not have a good investment window. And these assets also face an overly long transaction cycle in the trading process, resulting in unsatisfactory liquidity. The blockchain platform is a good solution, which can disassemble the ownership and usage rights of these assets. We take wineries as an example. If you can split the wine production in the winery transaction process, the winery’s property rights represent a fixed amount of wine output each year. After purchasing the property rights NFT, the buyer can sell each year’s wine output on their own, thus forming a new trading market. Through blockchain contracts, property rights and usage rights are dispersed on the timeline, and users can freely combine and trade them, forming a non-standardized innovative market. This not only lowers the threshold for investors but also quickly improves the liquidity of these types of assets.
2. Extremely cheap distressed assets.
These types of assets are usually acquired and restructured by dedicated acquisition companies. For example, unfinished buildings, old houses in need of renovation, etc. These assets often have commercial use expectations after renovation, but likewise, they have no way to open a safe window to ordinary investors. The on-chain platform can also solve this problem, by splitting property rights NFT and rights NFT, it can lower the threshold for investors and provide a reasonable exit path. For example, houses in need of renovation, if they can be planned as guest houses, then investors can enjoy accommodation rights NFT, and then they can be sold or used for personal use in the sales market. Meanwhile, the entire fundraising process is centralized on-chain, and all investors are also convenient to jointly monitor the flow of money, reducing the improper expenditure of the project.
The current on-chain real estate platforms generally do not segment users, and the scenarios are quite rough. Segmenting target users can make the leasing track more precise, align the platform tone with user needs, and increase usage frequency. We list two possible scenarios:
1. Digital nomads are a huge group in the web3 community, and there are currently over 35 million digital nomads globally, and this number is still expanding. Digital nomads travel around the world and often have a strong need for renting, but due to objective factors, they cannot sign long-term rental contracts, and short-term rentals have a very high market premium. The author believes that launching an on-chain rental platform for digital nomads is very effective. They are very knowledgeable about the on-chain ecosystem, and most people can trace the source of assets through on-chain behavior, which is also convenient for landlords to trace. On-chain rental platforms can even lock deposits through on-chain smart contracts. Users can also rate landlords’ houses, and through tagging the DID of tenants and landlords respectively, the on-chain reputation can effectively restrain both parties.
2. Initiate community-based real estate projects, use “human mining”, and use the 2Earn mechanism of the WEB3 platform to create autonomous communities similar to Anaya, CityDAO. Community members control the legal entity through property rights NFT, release rights and benefits through platform tokens, and have reasonable autonomous rights. All property rights and interests can also be sold at the secondary level or mortgaged for loans through the on-chain platform, forming a new community-based real estate format.
Staying Optimistic
Although discussing on-chain real estate projects seems premature at this moment, many problems are difficult to solve in a short time. But facing such a huge market capacity and real market demand, I am still willing to stay optimistic. I believe that innovative market ecosystems can emerge in on-chain real estate projects.
About Foresight Ventures
Foresight Ventures is dedicated to backing the disruptive innovation of blockchain for the next few decades. We manage multiple funds: a VC fund, an actively-managed secondary fund, a multi-strategy FOF, and a private market secondary fund, with AUM exceeding $400 million. Foresight Ventures adheres to the belief of “Unique, Independent, Aggressive, Long-Term mindset” and provides extensive support for portfolio companies within a growing ecosystem. Our team is composed of veterans from top financial and technology companies like Sequoia Capital, CICC, Google, Bitmain and many others.
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