Real estate, blockchain and the quantity theory of money

10 min read

The concept of illiquidity discounts, how it relates to markets such as commercial real estate and the benefits that tokenization could bring to the industry are topics that I have already discussed in previous articles. In this article I will elaborate on the relationship between liquidity preference and the future demand for tokenized real estate investments.

See also: Tokenizing commercial real estate and the promise of liquidity

Illiquidity discounts reflect the reduction in the price applied to an asset because of a shallow market and are particularly pronounced in real estate, sometimes up to 30% to 50% of the asset's actual value. This occurrence is due to a number of factors such as cumbersome regulatory oversight, the uniqueness of many assets, and the fact that most transactions take place in shallow private markets and that real estate is often priced when needed.

Blockchain technology offers the potential to address the sources of illiquidity discounts by speeding up efficient markets and price discovery, streamlining the transaction process and facilitating immediate payments. The effects of these benefits are likely to be further accelerated when it comes to commercial real estate, since the traditional formation of syndicates and other capital structures can be cumbersome.

If this is indeed the case, then the next question is, how will the demand for real estate – especially at the commercial level – change based on these more liquid markets?

John Maynard Keynes and the quantity theory of money

In 1936, the famous English economist John Maynard Keynes articulated his quantity theory of money in his book The General Theory of Employment, Interest and Money, dividing the liquidity demand factors into three primary categories:

  • Transactional demand – high liquidity for daily expenses.
  • Precautionary requirement – liquidity to cover unforeseen expenses, such as an accident or a health case.
  • Speculative question – ask to take advantage of future changes in interest rates or bond prices.

Popularly, Keynes described how people need access to cash to cover their daily expenses, to fill a rainy daily fund and to keep some strictly to see if it can appreciate in value.

From this perspective, Keynes theorized that governments could adjust the level of monetary demand based on interest rates in an effort to manage inflation and support broader economic goals. This is an interesting insight, and perhaps worthwhile, of future research because blockchains want to build a more sophisticated monetary policy.

It would be interesting to consider how Keynes' quantity theory can influence the real estate sector and corporate finance in general.

Principles of business financing

At a very basic level, it is the task of chief financial officers to ensure that their organizations have sufficient liquidity to cover daily and monthly expenses and to invest the remaining money to maximize returns.

In fact, this requirement falls neatly into three question categories that are very closely aligned with Keynes's theory of 1936. Specifically, business entities need access to liquidity for:

  1. Daily expenses.
  2. Repayment of short-term debts.
  3. Invest in long-term investments.

Explain working capital management

The specific term often used to describe this balance is working capital management. Working capital usually consists of assets that can be converted into cash within a 12-month period. It is described in both gross and net conditions – gross is the total value of all relevant assets and net is the remaining amount after deduction of current liabilities, such as the creditor accounts of a company.

Typical short-term assets that qualify as working capital include cash on hand, debtors, inventory (provided that this is not too unique or not liquid), and certain highly liquid short-term investments. It is important to focus on what I mean by short-term investments, as they are considered to be & # 39; tradable securities & # 39; which can be converted directly into cash in a time frame of 3 to 12 months. These investments are generally listed on public exchanges and their sale does not have a major effect on the spot price of the underlying asset.

Real estate investment trusts

Today, there are many types of real estate investments and funds that want to take advantage of tokenization, and one of the most relevant use cases are real estate investment companies (REITs), some of which are listed on the world's largest stock exchanges, while others are public but non-public. listed or private.

In general, a REIT is an entity that combines the capital of many investors to acquire or provide a diversified portfolio of investment property under professional management. REITs can qualify for the federal income tax as a property investment according to the Internal Revenue Code of the United States. REITs are therefore generally entitled to deduct the dividends they pay and are usually not subject to US federal corporation tax on their net income distributed to their unit holders. This treatment essentially eliminates the "double taxation" (taxation at both company and unit holder level) that is generally the result of investing in an enterprise. REITs generally pay dividends to investors of at least 90% of their annual regular taxable income, making some types of REITs an ideal short-term investment. In addition, they focus on a wide range of industries related to real estate (commercial, residential, healthcare, forest, shopping centers, etc.).

According to the National Association of Real Estate Investment Trusts (NAREIT), there are approximately 1,100 REITs that have filed tax returns in the US and collectively hold more than $ 3 trillion in gross real estate across the country. About 20% of these are public REIT & # 39; s, who are registered with the SEC and trade on one of the major stock exchanges – the majority are on the New York Stock Exchange (NYSE). The remaining 80% is represented by public but unlisted REITs, which are not traded on a national stock exchange but are registered with the SEC, and private REIT & # 39; s, which are not traded on a national stock exchange or registered with the SEC and often can only be sold to institutional investors.

The fundamental difference between unlisted REITs and listed REITs is the available daily liquidity with a listed REIT. Although some unlisted REITs traditionally offer limited redemption plans, listed REITs are traditionally considered to be a better alternative for investors with a short-term horizon.

On the other hand, non-listed REITs can serve as a way for investors to invest capital in a diversified pool of real estate assets, with a lower correlation with the general stock market than listed REITs. In addition, listed REITs are subject to more demanding disclosure and corporate governance requirements than non-listed REITs.

The total listed REIT sector has always been traded at the highest level, with the FTSE NAREIT All REIT Index yielding less than 5% from January 1, 2015 to December 30, 2018. Such prices suggest that a significant portion of the price of listed REIT & # 39 ; s is attributable to a built-in liquidity premium, since recent non-levered capitalization rates on private property real estate transactions have averaged between 4% and 6%, according to the most recent publicly available CBRE report, the U.S. Cap Rate Survey H1 2019 Advance Review.

Although REIT & # 39; s are just one of many types of investment vehicles, and there are a whole range of real estate companies and investment funds that want to take advantage of distributed ledger technology, I believe that specifically non-listed and private REIT & # 39; s can have the greatest benefits provide tokenization.

Returning to blockchain technology

What does tokenization mean for the real estate sector? This industry is, more than most, the victim of the illiquidity discount, which can invalidate the sector for investment companies that need a certain amount of liquidity in their investments.

There are two general reasons why blockchain technology could be an important factor that opens up a new set of opportunities for investment firms that want to maximize the upside potential of their working capital.

First, through the use of blockchain technology, conventional and highly regulated real estate investment vehicles (such as REIT & # 39; s) can operate at unprecedented levels of efficiency by allowing programmable governance and built-in compliance on the platform and / or security token levels, as well as by automation of cap table and investor management processes. This will, at least in theory, reduce management costs and increase the profit that is returned to investors.

Secondly, the symbiotic rise of digital security issuance and secondary trading platforms entails not only the possibility of significantly reducing (if not eliminating) traditional counterparty risk and transactional friction, but also making the underlying assets more liquid. This suggests that in the future, unlisted and private real estate investment vehicles (such as private REITs) – which once formed a very illiquid part of the market – can no longer make that unfortunate distinction.

It remains to be seen when – or if – tokenization will help to classify traditional types of private real estate investment instruments as viable short-term investments, but there is a good chance that they could get this distinction, especially in local economies, thereby reinforcing overall demand for real estate investments.

One thing is certain: the timing for this opportunity is favorable. The outlook for the real estate sector in the US, Europe and other regions & # 39; s abroad remains positive. As long as the demand for residential and commercial real estate remains strong, it is reasonable to speculate that, at least at the macro level, the demand for tokenized real estate investments will only increase compared to other types of private equity.

The opinions, thoughts and opinions expressed here are the authors only and do not necessarily reflect the views and opinions of Cointelegraph.

Nothing in this article may be construed as legal advice, and all content is for informational purposes only. You may not act on the basis of anything herein without seeking appropriate legal advice about your specific situation.

Alexander Kanen is a New York City lawyer, speaker and entrepreneur, specializing in real estate, private equity and blockchain. He is chairman of the Real Estate Working Group at the Wall Street Blockchain Alliance, member of the Legal Working Group of WSBA, member of the New York board of directors of the International Real Estate Federation and has a special consultative status with the Economic and Social Council of the United Nations. Since early 2013 involved in distributed ledger technology, Alexander pioneered with the concept of "Bitcoin closures".

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