The tokenized real estate market has developed an innovative approach offering fractional owners liquidity and investment avenues. Indeed, this method has enhanced accessibility in comparison to traditional real estate; it has also come up with unique risks that fractional owners should be aware of.
So, what are the potential risks related to tokenized real estate and what effective risk management strategies to deal with them?
What is tokenized real estate?
By tokenizing real estate, you can understand converting your property ownership into digital tokens that work on the basis of blockchain technology. Each token shows your fractional ownership or shares on the property or asset that allows you to buy, sell, or trade them on different digital sites.
This tokenization in real estate or property business has brought transparency, eliminated transaction fees and showcased this market to a global audience. However, it introduces challenges and risk factors such as market volatility, regulatory challenges and other technical issues.
Understanding the key risks
Technological risks
Cybersecurity is one of the major concerns; many recent analyses stated an increase in cybersecurity attacks on blockchain-based platforms. A Chainalysis report found that the hackers stole around 1.7 billion from cryptocurrency platforms in 2023, about 54.3% less than they did the previous year. Thus, a robust security measure is necessary in the real estate tokenization market.
Risk related to smart contracts
Despite advancements and transparency in blockchain technology, smart contract vulnerabilities remain a great concern in the tokenization real estate market. Crypto scams have become more prevalent, according to a recent report by Chainalysis.
There was an overall decline of 77% from $3.3 billion to $1.1 billion in the first half of 2023, but a worrying trend emerged: ransom attacks are on the rise, with 62.3% more loot being collected than in 2022. Thus, smart contract audits and security protocols should be maintained on a daily basis when dealing with tokenized real estate.
Regulatory risks
The legal blockchain and cryptocurrency market is continuously evolving, and regulation changes can greatly impact tokenized platforms. For example, the U.S. Securities and Exchange Commission (SEC) increased scrutiny in 2023, resulting in penalties for non-compliant platforms.
Thus, compliance with anti-money laundering(AML) laws, local laws, and tax regulations is vital. However, some find it complex in different jurisdictions, which demands investors stay constantly updated about legal developments and their impact on market stability.
Market volatility
It is one of the major issues in the tokenization real estate market. The value of the tokenized market can fluctuate due to certain factors, such as changes in the interest rate, investors’ sentiment or the economic condition, as we see in any land-based real estate market.
What are risk management strategies for fractional owners in tokenized real estate?
Diversification is one of the most fruitful risk management strategies, where investors can spread their investments across different assets, eliminating the risks of a single asset.
There are multiple ways to do that.
- Geographic diversification: You can avoid regulatory changes or economic downturns in local markets by spreading your funds in various regions and countries.
- Property diversification: Depositing your funds into different property types, such as commercial, residential, or retail, can help mitigate the risk, as the economic conditions for each property type are different. Thus, it helps balance the overall risk. For instance, during the COVID-19 pandemic, the commercial real estate market suffered greatly, but real estate in suburban areas showed significant growth and demand.
- Analyzing the market condition: Staying updated about the market condition can help fractional owners or stakeholders make informed decisions.
- Monitoring economic indicators: Tracking economic indicators involves fluctuating interest rates, employment rates and inflation. For instance, in 2023, the U.S. Federal Reserve hiked the interest rate, affecting the mortgage rate and slowing the market growth.
- Following the real estate trends: Staying informed about the real estate trends will help you understand market data properly, including property price movements, occupancy rates and rental yields.
- Due Diligence: When you plan to invest in tokenized real estate, conducting thorough due diligence is vital.
- Accessing the property: Evaluating the location, market value, and physical condition benefits investors. For example, in June 2023, U.S. real estate reached a new high of $47 trillion, an all-time high for the US housing market.
- Reviewing legal documents: Always examine the documents related to the tokenization process or property; this includes factors like zoning laws, title deeds, or other existing liens. The legal soundness will help you avoid facing any future disputes.
- Liquidity management: Managing liquidity is an important consideration in the real estate market. There are many ways to boost your liquidity, including,
- Staggered investments: Ensure that not all assets are illiquid at the same time by investing in properties with varying lock-in periods and liquidity provisions.
- Secondary money trading: Look for platforms that offer secondary money trading for tokens that ultimately help investors buy and sell their assets more seamlessly.
- Reserving liquidity: To take advantage of investment opportunities, reserve liquid assets to manage your cash flow needs.
- Smart contract audits: Regular smart contract audits can provide security and trustworthiness in the tokenized real estate market. Experts conduct these audits by thoroughly examining the code for bugs or other compliance issues. According to some reports, in 2023, unaddressed smart contract flaws caused significant losses in several blockchain platforms.
Thus, it is necessary to address and mitigate these issues through auditing before the deployment so that it can safeguard your assets. Moreover, regular audits can boost transparency and thus develop confidence among investors to find stability in the real estate market by eliminating the technical risks.
Final Say
Fractional owners can manage the overall risk in the tokenized real estate business by analyzing data-driven insight and monitoring market trends. By utilizing these data and continuously working on risk mitigation measures, investors can better navigate the difficulties of this market and uncover the full potential to maximize their returns.
