by Jon Haahr and Jon Haahr Jr.
Location, location, location. For years, this phrase has been repeated as the cardinal rule of real estate. Location is immutable, something that cannot be changed. Developers can improve a vacant lot by building a new asset and skilled operators can increase the quality and finish of construction, but they cannot change the physical location.
For investors, the same phrase would be: liquidity, liquidity, liquidity. Sam Zell, renowned real estate investor and operator, stated, “You can have all of the assets in the world, but if you have no liquidity, it doesn’t matter. Liquidity equals value.” The historic difficulty of providing liquidity for many types of real estate securities and most individual properties has made the asset class cumbersome at best and impractical at worst for a large segment of the population to own and limits capital that might otherwise be available for new investment. If this and other inefficiencies of the asset class can be adequately addressed, there is the potential to radically reshape this $200 trillion sector of the economy, broadening ownership and wealth distribution globally.
Multiple piecemeal solutions have been presented to the market over the past few years in an attempt to address the issues of capital formation, liquidity and the paper-intensive documentation process — but none with a holistic vision. Efforts to date have included solutions to important but isolated problems such as e-signatures, and crowdfunding platforms that have proven to be a non-scalable source for real estate capital. Those funds that do exist to provide “liquidity” for select securities and properties fall far short of investor expectations. The sites are isolated — disconnected from the institutional or broader trading community — and offer limited transparency and lengthy settlement processes, which result in large discounts to fair market value.
Fortunately, we have reached an inflection point within the industry where the benefits of change and the opportunity for change have intersected. Using technology specifically targeted to real estate and provided through a single platform solution offers benefits to all key industry players. Sponsors can increase their access to capital at decreased costs; financial advisers can broaden their distribution capabilities and enhance their fiduciary role on behalf of clients; and all participants can benefit from decreased time and costs related to the paper-intensive shareholder services process.
Instead of struggling to make incremental/marginal improvements to the current system, trading technology combined with the blockchain provide an avenue to reshape the way real estate securities and properties are bought, owned and traded. The focus is not on displacing people, but rather improving the operational aspects of the market to enhance the investment process — providing ease of discovery, distribution, after-market liquidity, real-time pricing, cost savings and transparency.
RESHAPING OUR VISION
We do not have to limit our vision of the future. Secondary market liquidity, while an important objective, does not need to be the only, or even ultimate, goal. The power of technological application can be employed across the sector, from initial issuance through settlement, to create a market that reflects fair value and significantly expands ownership of the asset class. As such, we can address the critical issues of each constituent.
- Sponsors and operators: Receive access to a much larger pool of potential investors while minimizing distribution and shareholder services costs.
- Financial advisers and market makers: Receive broader access to information and direct real estate investments as well as the ability to rebalance/trade assets in a liquid aftermarket.
- Investors: Receive increased transparency and discovery capabilities along with access to the same high-quality securities and properties that institutional investors have historically enjoyed, and fair market value through a true secondary market.
To achieve these goals, the technology platform needs to provide solutions to three key areas in a comprehensive fashion:
- New issuance: Sector lacks a scalable, automated issuance and distribution platform, leading to inefficient capital formation.
- Secondary trading: Lack of a true secondary market results in billions of dollars of “stranded paper” and wide bid/ask spreads, as well as unacceptable gaps between net asset value and fair market value.
- Clearing and settlement: Listing, selling and closing on these securities and properties is inefficient, costly and time consuming.
THE BLOCKCHAIN BENEFIT
The implementation of blockchain technology has the potential to entirely reshape the real estate industry, providing a key component for addressing traditional problems and acting as a catalyst to broaden ownership, facilitate investment and streamline documentation. Blockchain is a decentralized, continuously growing public ledger of records, called “blocks,” which are linked and secured using cryptography. Each block is comprised of information that sits below a distributed ledger, acting as a way to verify transactions submitted by producing a new block to the chain. The technology is designed to record transactions between two parties efficiently and securely in a verifiable, permanent fashion.
The blockchain distributed ledger is typically managed by a network, which collectively adheres to a protocol for validating new blocks — that is, any new piece of information, such as a trade, new account, or dividend payment. Once recorded, the data in a given block cannot be changed retroactively without the alteration of all subsequent blocks, requiring collusion of the network majority, which protects the integrity of the data. In short, blockchain technology provides common access to a master copy of original data, allowing an integrated platform to create an ecosystem of informed, motivated users.
In order to become the central marketplace for illiquid real estate, the platform needs to attract sponsors, advisers/investors and market makers for more than just transactional purposes. Individuals and market participants need to be incentivized to adopt the technology and leverage the platform on a daily basis, like Bloomberg Markets for example. Creating this network ecosystem is, in many ways, more important than the site’s technological underpinnings (as demonstrated by the crowdfunding industry’s inability to raise capital in scale). Critical mass of participants is accomplished by providing significant, quantifiable benefits in the form of transparency, discovery and real-time pricing. These attributes can be applied to a breadth of real estate assets, including securities such as nontraded REITs and Delaware Statutory Trusts, as well as individual properties and portfolios, all on a global basis.
By leveraging blockchain technology, this platform can bring together the currently dislocated network of real estate sponsors, inter-dealer brokers and investment advisers into a dynamic, competitive and transparent trading marketplace, providing access to a sophisticated multi-dealer electronic trading infrastructure, designed to facilitate efficient capital formation, price discovery and ease of clearing and settlement.
Once the ecosystem has been created, real estate sponsors and distributors are able to market liquidity in this previously illiquid market, giving investors confidence that they can monetize their holdings at fair market value should circumstances or market factors dictate. Marketplace liquidity also provides financial advisory firms and distributors with an efficient and investor-friendly manner to recycle capital locked up on client balance sheets. Not only will this benefit investors by providing them with previously unavailable financial flexibility, but it will help sponsors increase initial sales and recycle capital into new offerings. Whether the DOL Rule is legally mandated or not, a transparent, liquid market enables financial advisers increased flexibility to manage client accounts.
A NEW PARADIGM
Importantly, creating a single platform ecosystem for real estate — supporting sales, trading and settlement — is achievable today. Leveraging available technology (blockchain, automated trading and clearing/settlement) to create an integrated trading platform exclusively for illiquid real estate securities and properties has the potential to meet the foundational objectives of all industry constituents. Issuance and trading is possible through an operating platform that includes: a proprietary trading exchange, a FINRA/SEC regulated alternative trading system (ATS), and a blockchain matching engine for clearing/settlement and trade reporting. Trades can be settled on the blockchain and reported immediately to the general ledgers of all involved parties.
Creating a single solution platform would provide the industry with access to a Bloomberg Markets for illiquid real estate that delivers asset education/discovery, capital formation/distribution, fair market pricing, secondary trading and settlement — a one-stop solution for all industry participants with an ecosystem of users that grows organically. This scalable ecosystem ensures a critical mass of participants on a platform in support of new issuance investment and secondary market pricing, reflecting fair value.
While the real estate sector is often opaque and inefficient compared to other asset classes, these historic characteristics also provide opportunity: a leverage point for technology to benefit sponsors/operators, advisers and investors alike. Blockchain technology augments this potential by solving the problem of secondary market liquidity and clearing/settlement. The self-sustaining ecosystem described here will provide participants and their clients with a single integrated platform, creating the opportunity to significantly broaden participation in the $200 trillion real estate industry.
Jon Haahr is founder and senior managing partner of Silver Portal Capital, and Jon Haahr Jr. is vice president of the organization.