Research

Since 2017, Blocksquare and its team have dedicated their time and resources to find the most lean and effective method of bringing real estate assets on the Ethereum blockchain.

In the course of this journey Blocksquare has also received some awards and recognitions amongst both the PropTech and Blockchain communities:

• Best blockchain solution for real estate — 2019 winners at Crypto Valley Summit (first prize 100,000 USD)

• Builtworld PropTech competition finalists 2019

• One of the winners at 2020 Proptech Innovation Awards by German Tech & Union Investments

While developing the real estate tokenization protocol the team researched various tokenization models including debt and equity, concluding that neither of the two are currently suitable for the purpose of tokenizing real estate assets.

Findings: Debt and equity tokenization

Tokenizing either debt or equity of the capital stack presents challenges — debt is already serviced very well traditionally by banking institutions, while equity tokens have no real on-chain settlement of rights in most jurisdictions around the world. What's more, tokenizing equity hits so many established regulations, that the risks greatly outweigh the benefits.

In the real estate context, tokenization of debt is easier to implement and also easy to understand, banks already serve this avenue very well. As long as the project is of a certain quality, the borrower has a good balance sheet and is able to provide 20-30% of the required capital to execute the real estate investment, banks will green light the senior loan. Tokenization of debt will thus predominantly attract projects that are unable to secure financing through traditional and well established routes — in short, projects that most probably shouldn’t be offered to investors publicly.

On the other side of the capital stack we have equity. The tokenization of equity was highly expected with the rise of STOs, however, it never really took off. The main challenge of tokenizing equity is transferability. While tokens can settle instantly on a blockchain, to actually transfer the ownership of private companies or real estate is a much more complex process that includes notaries and banking institutions to get involved.

We thus conclude that as long as these core players do not become an integral part of Ethereum, the actual transferability of shares will remain limited and provide investors more uncertainty than traditional investment routes.

Solution: Revenue based asset tokenization

As mentioned above, tokenizing either debt or equity of the capital stack presents challenges — debt is already serviced very well traditionally, while equity tokens have no real on-chain settlement in most jurisdictions around the world.

Is there anything else out there? A solution that would offer both asset owners and investors something new?

Economic right deriving from asset ownership

In the real estate context it is fairly easy to estimate the revenue a particular property can generate. Most common revenue streams for real estate properties are:

• cash flows from lease contracts, and

• resale of the property to a 3rd party buyer.

In the context of commercial real estate, the revenues a property generates also highly impact the valuation of the property as investors look predominantly for a target return.

Revenue based investing is not by any means a new concept, and is mostly used for financing companies through royalties. A royalty is a defined share of the royalty issuer’s revenues. Royalties have been used for hundreds of years where one party wished to share revenues with another party who was doing something useful to the royalty payer or issuer. Royalties were traditionally used in commerce where the definition of profit was either difficult to determine or not chosen to be revealed.

To put it simply, the issuer is telling investors that every month they will receive X% of the issuer’s revenues until they receive Y times their cash back and the issuer expects it to be happening in a period of Z years.

The advantages over buying shares or lending a company money? An investor is not concerned with or impacted by the issuer’s profitability for so long as the issuer meets royalty payment obligations. The royalty owner also benefits when the revenues of an issuer increase, but on the flip side there is also the risk of revenues declining.

But don’t take our word for it — Investment banker, financier, management consultant, author, lecturer, and inventor of the Lipper Index, Dr. Arthur Lipper, is the main advocate for revenue based investing.

Feel free to Google him!

Top-line revenues vs. bottom-line profits

Revenues are found on the top line of a balance sheet and are easier to understand and project than the profits we find on the bottom line of the balance sheet. Grasping one set of factors that affect revenues is easier than grasping the multi-dimensional factors that affect profit, so risk and reward of revenue investing can be quantified in a more straightforward manner.

This is the principle behind royalty finance and provides a greater degree of certainty to the investor; returns in the form of current income begin to flow immediately, and they grow as revenues grow. The investor’s natural skepticism is decreased because he has better information, though it can never be eliminated (nor should it be).

The company must still credibly justify its revenue projections, and provide a failsafe mechanism to report, sequester and pay a percentage of revenues to investors. But the investor is now on more solid ground in quantifying his risk, and his reward. Therefore, raising capital may become easier, and the decision to green-light the investment becomes more straightforward. Everyone benefits.

Real estate revenues & tokenization

Real estate is a specific asset class that offers an investor both steady cash flow and value appreciation over time. Although volatile for traditional markets, in comparison to the crypto market it looks like a safe and steady investment that appreciates in value over time. Additionally, the revenues from lease contracts offer a steady inflow of capital to the investor — in crypto terms it is much like rewards you receive while staking, but without the risk of holding an unstable asset.

By tokenizing the real estate asset’s revenues, investors are focused on the growth and performance of revenues. The rest of the balance sheet is less relevant to the investor’s direct interest, and unlocking its mysteries is less of an obstacle to making an informed investment decision.