Can real estate on the chain revolutionize the traditional transaction leasing market?

Author: Jeff@Foresight Ventures

Summarize:

1. Real estate on the chain can split the asset structure and rights and interests of real estate for a second time. On the original basis, property rights, income rights and use rights can be stripped out. All three can be traded separately. In particular, on the time scale, on-chain real estate can also be split into multiple layers.
2. How to solve the problem of scene fragmentation in the process of chaining is the core of the development of real estate projects on the chain at this stage. Platform Token, DID, and on-chain streaming payment platforms have the opportunity to become a tool to solve the black box problem.
3. The compliance framework at this stage has potential risks, and there is a lack of a solid relationship between the NFT in the hands of the buyer and the SPV company.
4. It is recommended to try to bridge uncommon asset classes, such as extremely cheap non-performing assets and extremely expensive scarce assets, and bind equity NFT while fragmenting property rights to solve the real transaction needs of buyers and sellers.
5. It is recommended to try to subdivide the user circle and refine the usage scenarios, for example, to serve the renting needs of the digital nomads well, and to use the web3 native genes of this group to create a small and beautiful business model.

In the siege of the RWA track, the core of innovation is the split and reorganization of the asset structure. The total market capacity of the real estate industry will reach 11 trillion US dollars in 2022. How to bridge such a huge market and form a new market ecology deserves attention. This article sorts out the real estate projects on the chain on the market, puts forward the common problems of real estate projects on the chain, and puts forward the corresponding assumptions.

1. On-chain solutions to South Korea’s full rental housing problem

The real estate crisis caused by South Korea's full rental housing system has fully demonstrated to us many problems in the traditional real estate transaction chain. The full rental system refers to the system in which the tenant can use the house without rent for a fixed period of time (usually 2 years) after paying a one-time deposit of 60-70% of the total value of the house to the landlord. Due to the lack of a transparent supervision mechanism, the security deposit used by the tenant to cover the rent is fully invested by the landlord in the new property, and then continues to use the full rental system to cash out in a circular manner. **The real estate market is very fragile in high-leverage conditions. Once there are problems such as a sharp decline in housing prices and a break in the supply chain of loans, it will become precarious. **As a result, a large number of landlords choose to run away quietly when they cannot return the security deposit. Since the security deposit paid by the tenant can only represent the landlord’s personal debt, they can only get a small amount of compensation from the debt settlement with a lower priority after the auction of the house.

Is it possible to avoid the real estate crisis caused by full rental housing through real estate projects on the chain? The main market problems are listed here, and the corresponding on-chain solutions are given.

1. Fund breaches such as security deposits (deposits).

The tenant pays the security deposit on the chain, which can effectively track the landlord's capital flow and debt situation, and timely warn of "insolvency"; the security deposit or deposit can be automatically returned to the payer by specifying the unlocking date of the funds through the smart contract. 2. Landlords and tenants lack a back-to-back platform, especially for tenants, unable to assess risks such as housing mortgage status.

If the house property rights are chained and NFTs are generated, tenants can clearly trace the mortgage status of the property rights NFTs, which can effectively avoid "high debt" landlords. Reduce unnecessary trouble. 3. Once the landlord defaults on the debt, the tenant can only wait for compensation with a lower debt priority because they do not hold the property rights of the house.

If the property right NFT continues to be split into fragmented NFTs on the chain, then the tenant can get the corresponding proportion of property right NFT when paying the deposit, and return the corresponding NFT after receiving the deposit; once the landlord defaults and needs to be liquidated, he can also rely on the corresponding property right NFT to get the corresponding proportion of compensation. 4. The real estate transaction market has local limitations.

In the liquidation auction process of defaulted houses, by putting the property rights on the chain and casting NFT, the geographical restrictions on house transactions can be effectively reduced, and the range of users participating in the transaction is expanded from local to all users on the chain. 5. Restrictions on bulk transactions of real estate.

Most of the fully-rented houses are concentrated in prime locations in Seoul, and their high unit prices deter ordinary investors. By fragmenting the property right NFT, buyers can only purchase part of the fragmented property right NFT, which greatly reduces the investment amount limit.

2. The targeted pain points and core links of real estate projects on the chain

Referring to the above examples, we combined the real estate chain to supplement potential market pain points and problems, and classified its on-chain solutions and existing on-chain real estate projects into the following three core links for discussion: transaction link, lease link and mortgage loan link.

Figure: Market Pain Points and Chain Solutions

In the real estate transaction process, the buyer's needs are often given top priority. Existing on-chain real estate projects mainly split property rights and use rights, recombine transaction content in combination with the dimension of time, and try to solve potential problems in the market through solutions such as on-chain payment, on-chain identity, NFT of property rights and its fragmentation.

1. Eliminate the limitations of local transactions, on-chain housing background adjustment to make housing information more authentic and reliable.

It is not difficult to understand that the on-chain platform gives global investors a free investment window. Platforms such as Tangible package the property right into the SPV (Special Purpose Vehicle) where the house is located, and mint all the property title certificates, house information and other content into the house property NFT. Global traders can directly purchase the NFT of the house through its portal, which means they own the property rights of the corresponding house. In this process, the Tangible platform first advances 10% to the seller as a deposit, and then opens the subscription to buyers. Buyers decide whether to buy after reading the property title and its information. 2. Prevent asset deposits and deposits from being refunded in case of breach of contract, and on-chain payment guarantees fund security.

By paying the house purchase deposit on the chain, you can set up a smart contract and set a time limit, so that the defaulting party will automatically bear the loss. On-chain payment can also improve financial transparency and give early warning of risks. In the previous description, after Tangible advances the deposit to the seller, if the subscription is not completed within the agreed time limit, the deposit will be automatically refunded to the Tangible platform. 3. Eliminate the limitation of housing transaction amount and lower the purchase threshold.

Users can customize the investment amount. In order to lower the entry threshold for cross-border housing purchases, platforms such as RealT split the housing property rights twice. Some fragmented the property rights of the real estate, and small investors can voluntarily subscribe for the quota; some split the property rights and rental income of the housing, and users can only purchase the rental income of the next N years. In addition, CityDAO has fragmented land property rights by registering a DAO company. Buyers not only own property rights, but also have governance rights. 4. Eliminate payment channel limitations.

The regulatory issues faced by fiat currency transactions also plague global traders, so Smart Reality and ManageGo platforms have specially opened virtual currency payment channels, which can host down payment funds; on the basis of both buyers and sellers agreeing, they can even settle directly in virtual currency. Closing lock and other trading platforms act as intermediaries to monitor the security of funds and draw corresponding commissions.

The issues in the lease link mainly revolve around rent collection and house security. At present, the rental platforms in the market have not fully chained the rental activities, and without exception, the three platforms Tangible, BinaryX and Reental have adopted the form of combining web2 outsourcing companies to ensure that tenants pay rent on time. But on-chain managed home rentals have more room to explore.

1. Two-way background adjustment of on-chain leasing ** rent payment ability of tenants ** and ** landlord housing background **.

Through on-chain leasing, the landlord can observe the dynamics of the tenant on the chain, judge its asset level and solvency, and propose a corresponding deposit payment plan. Tenants can also judge whether the house source is reliable through the property right information on the house chain. Currently StreetWire is doing a series of functions in this direction. 2. The deposit is paid on the chain to ensure the safety of assets, and the stream payment platform makes rent payment mandatory.

As mentioned in the case of full rental housing in South Korea, after the deposit is paid on the chain, the interests of tenants can be protected by fragmenting property rights. For the traditional monthly rental model, the on-chain payment platform can be used to force the tenant to pay the rent on time through smart contracts, and the deposit can be refunded in time after the rent expires. On the Sablier platform, we have seen successful cases of regular rent payment on the chain. 3. Fragmented property rights NFT enables house rental income to be split and combined.

Fragmented property rights NFT can distribute the rent collected to each landlord in accordance with the proportion of property rights through smart contracts. At the same time, external adjustment factors can also be introduced to dynamically adjust the lease conditions according to market demand. In this way, the property rights NFT will be composable, and users can freely sell the "lease contract" with a time limit. The three rental platforms mentioned above, such as Tangible, have developed the function of splitting rental income. In addition to this model, platforms such as Vairt are also trying to move the short-term rental model to the chain to cope with the vacancy period of houses.

The mortgage loan link of real estate is still in a blank stage in the market. Only RealT and FIGURE are trying to provide mortgage lending functions to fragmented property rights NFT. However, due to objective factors such as the immaturity of the market pricing and price feeding mechanism and the unbalanced supply relationship, it has not yet been widely recognized by the market. In addition, the lending platform used to reduce the capital cost of buying a house is also in a blank stage in the market, and the function of BNPL is temporarily lacking in the market.

Figure: Disassembly of the core link of the real estate project on the chain ## 3. Compliance structure and asset security

How to ensure the compliance of property rights on the chain is the most concerned issue in the research of the author. At present, almost all real estate projects on the chain adopt the method of holding SPV by offshore entities to bypass market supervision. The author believes that this method is not completely safe and effective.

Figure: Schematic diagram of the SPV architecture of real estate projects on the chain

Here we take Tangible's compliance solution as an example. The UK properties for sale on the Tangible platform are held by independent UK SPVs. The offshore subject of the Tangible platform directly holds each SPV company. NFTs of house fragmented property rights are issued by SPV entities and sold to buyers. To some extent, the transaction security and legality of the house are protected. However, strictly speaking, the NFT of housing fragmentation property rights does not directly represent the equity of the corresponding SPV. **Once the parent company or SPV has a debt dispute, because the NFT of the fragmented property rights of the house cannot directly confirm the property rights of the house, or even directly correspond to any shares of the offshore company, the buyer is very likely to get nothing. The asset security issues that were originally hoped to be solved through the chain were all bet on the trading platform itself, which added additional risks in disguise. In addition, if the house fragmented property rights NFT is issued by SPV, everything will go back to the regulatory dispute over whether Token should be defined as a security.

It can be seen that the only way to bypass supervision and ensure asset security is to strengthen the supervision of SPV companies. CityDAO has given us a good example in this direction. Guarantee the interests of every NFT holder by registering a company in the form of DAO. Looking forward to the performance of CityDAO after breaking through the geographical limitations in the future.

So does the SPV company have the risk of debt disputes? Yes, especially the risk of default in the housing rental segment is high.

1. Reserve fund risk: Still taking Tangible as an example, the platform deducts a total of 7% of the total property value as the vacancy reserve fund and maintenance reserve fund. If the reserve fund is lower than the above ratio, 20% of the rental income will be withheld or the rent payment will be suspended for supplement. As an off-chain asset, the reserve fund is not transparent in real operation. Since the SPV company has the right to control the reserve fund, it is very likely to use the reserve fund to pay the deposit for subsequent auction houses, or even use it for other purposes. Once the property cannot be rented out for a long time, and the funds for the sale of other properties are not paid back in time, the SPV will face the risk of debt default.
2. Mortgage risk: Since all the property rights of the house belong to the SPV company, and users cannot monitor it in real time in actual operation, the SPV company may mortgage the house property and lend funds for other investments, which also increases the risk of debt default.

What problems have not been resolved? What could be the solution?

In the author's opinion, the black box problem in the chain-up process is the core that needs to be solved. The fragmented scene on the chain and off-chain leads to the uncertainty of on-chain transactions and leasing. This uncertainty leads directly to the following questions:

1. The problem of scarcity of high-quality assets: Good houses can be sold offline, but real estate on the chain needs to be adjusted and then uploaded to the chain. This extra step is likely to result in lower transaction efficiency than offline real estate agencies. The real estate resources that users can see on the chain are often properties that are not easy to sell offline; or they need to bear costs higher than the market level as a whole. How to improve the efficiency of uploading to the chain, and continuously replenish housing resources according to the needs of customers is also a problem that needs to be solved.
2. The actual investment income is far lower than the expected income: When calculating the expected investment income, the platform takes the house value upside and rental income as the expected income. However, in the actual operation process, since the rental and management of the houses are managed by outsourcing companies, problems such as frequent leasing and tenant breach of contract cannot be controlled. In particular, tenant breach of contract in Europe is a very difficult problem to deal with. If the tenant refuses to pay the rent, the landlord can only enforce it by suing and other means. This process may take up to half a year. This also means that the rental income for half a year is zero.
3. The liquidity of real estate is locked on the chain: The ownership of the real estate purchased on the chain is fragmented. When the holder conducts a secondary sale, he can only wait for buyers who are willing to purchase the same amount of fragmented property rights. Liquidity is relatively restricted, and even liquidity can only be imprisoned on the chain. On the other hand, real estate mortgage lending on the market is in a vacuum stage, and there is an urgent need to fill the gap.

In addition to the black box problem, the business form of the real estate platform on the chain is not native enough to web3, and the platform token is basically not empowered. The entire business format can only be regarded as an embarrassing web2 platform on the chain.

1. Most of the Tokens of real estate platforms on the chain are not endowed with usage functions. We expect to increase the user stickiness of the platform and stimulate the participation needs of non-investment users by increasing the usage functions of Tokens. For example, in addition to real estate transaction users, users who browse the web can also be participants and content contributors of the platform.
2. Leasing relies too much on outsourcing companies, which makes it impossible for users to form stickiness to the platform. The leasing process tries to join the link of pure on-chain transactions. By combining the user's DID and credit account, the amount of security deposit that the user needs to pledge is judged. At the same time, by combining door locks or power switches controlled by smart contracts, it is possible to prevent users from moving out when due. At the same time, maintenance and other processes can also use crowdsourcing Token incentives to improve user stickiness.
3. The platform is overly dependent on regional resources. 90% of the existing on-chain real estate platforms are concentrated in the United States, and the global real estate transaction volume rankings in 2022 are the United States, Japan, the United Kingdom, and Germany. Few people are interested in the latter countries and regions, and there are few platforms that can open up the global trading market or leasing market. The author believes that the rental market is a native scenario that is very suitable for web3 users, and deserves attention, which will be elaborated below.

4. Open ideas for real estate projects on the chain

Although real estate projects on the chain have many of the above-mentioned problems, the biggest problem is that they do not solve the real needs of users in a practical way. But we still maintain a positive and optimistic imagination for this track, because There are still many subdivision scenarios and the needs of potential users have not been particularly met.

High-quality assets in the real estate market often do not lack liquidity. If the real estate categories can be relaxed and then reclassified, we can get some more focused categories. We list two categories.

1. Scarce real estate with super high prices.

The rare real estate with super high prices often discourages ordinary people, such as old castles, old bungalows, wineries, farms, etc. This type of asset generally has a super high unit price and is not used to meet daily living needs. Middle-class investors can only stop at viewing, but there is no good investment window. Such assets also face an extremely long transaction cycle during the transaction process, resulting in unsatisfactory liquidity. The on-chain platform is a good solution, which can dismantle the property rights and usage rights of such assets. Let's take a winery as an example. If the red wine production can be split during the winery transaction, the property rights of the winery represent a fixed amount of red wine output each year. After purchasing the property rights NFT, the buyer can sell the red wine output every year by himself, which forms an innovative trading market. **Through the contract on the chain, property rights and usage rights are dispersed on the time axis, and users can freely combine and trade to form a non-standardized innovation market. **It not only reduces the threshold for investors, but also rapidly improves the liquidity of such assets.

Figure: Winery property rights and rights and interests NFT concept

2. Non-performing assets with extremely cheap prices.

Such assets are often acquired and reorganized by specialized acquisition companies. For example, unfinished buildings, dilapidated old houses to be repaired, etc. Such assets often have the expectation of commercial use after renovation, but similarly, there is no way to open a safe window to ordinary investors. The on-chain platform can solve this problem. By splitting property rights NFT and equity NFT, it can lower the threshold for investors and provide a reasonable exit path. For example, if a house to be repaired can be planned as a homestay hotel, then investors can enjoy the NFT of accommodation rights, which can then be sold in the sales market or used by themselves. At the same time, the entire fundraising process is concentrated on the chain, so that all investors can monitor the flow of funds together and reduce improper expenses of the project.

The current on-chain real estate platforms generally do not subdivide users, and the scenarios are relatively rough. Subdividing target users can make the rental track more precise, and the platform’s tonality fits the needs of users and increases the frequency of use. We cite two possible scenarios:

1. Digital nomads are the largest group in the web3 community. There are currently more than 35 million digital nomads in the world, and the number is still expanding. Digital nomads live around the world and often have a strong demand for rental housing. However, 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 leasing platform for digital nomads is very effective. **They have a good understanding of the ecology on the chain, and most people can track the source of assets through the behavior on the chain, which is also convenient for landlords to trace the source. The on-chain leasing platform can lock the deposit through smart contracts on the chain, and users can also evaluate the landlord's house. By tagging the DIDs of the tenant and the landlord, the reputation on the chain can effectively restrict both parties.

Figure: Schematic diagram of the global distribution of digital nomads

2. It is also a new direction to launch community-based real estate projects and use the 2Earn mechanism of the WEB3 platform to create autonomous communities like Anaya and CityDAO through the "Human Mine". Community members control legal subjects through property rights NFT, release rights and benefits through platform Token, and have reasonable autonomy rights. And all property rights and interests can also be sold through the chain platform for secondary sales or even mortgage loans, forming a new community-based real estate format.

remain optimistic

Although it is too early to discuss real estate projects on the chain at this moment, many problems are difficult to solve in a short time. But in the face of such a huge market capacity and real market demand, I am still willing to remain optimistic. I believe that real estate projects on the chain can have an innovative market ecology.