Real Estate Tokenization: Myths and Truths

This summary highlights key insights from providing legal counsel to companies involved in the tokenization of real estate projects, noting that while many projects may appear similar on the surface, they often differ significantly in their underlying structures and legal frameworks—therefore a thorough legal analysis is essential when considering such investments.

What exactly does tokenization mean?
Tokenization refers to the digital representation of a real-world asset, typically using blockchain technology to ensure security. A real asset may be a real estate, or the rights related to property (such as the right to a deed once the project is over, or to the use of a unit). Blockchain allows investors to access its public data to check the assets with no need for intermediaries, extra costs or delays.

What is the difference between one token or another?
The difference lies in “quality” and content; like how a $100 Monopoly bill differs from a $100 US dollar bill. While all tokens are created by code, each token represents something different. 

It may be a financial asset (offering a yield), a digital representation of an agreement, a real estate right, economic rights, political rights, a combination of several rights and obligations…there are endless possibilities. It is recommended that investors become acquainted with the project in hand, to find out what they are buying behind the token (because the token itself has no value, but value lies on what it represents).

Regarding quality, we are not referring to programming quality or to blockchain safety. In this case, it refers to the legal backing of the represented asset. It is important to check that whoever issues the token has the right to the underlying asset, is authorized to tokenize it, cannot sell it several times, and that the asset exists, etc. As example, Casa Token, a product from our client Pala Blockchain, brings enhanced security and trust by using a notary public as validator. This means that the notary public intervenes in the whole process before the project goes on sale and tokens are only issued upon approval of the pertinent documentation by such professionals.

How does it affect the real estate market?
Real estate tokenization emerged approximately 5 years ago, starting a new era in property management. The purchase of housing and other real estate (mostly in markets with underdeveloped mortgage loans) is nearly impossible for people depending on their current income. Tokens emerged as a solution since they allow to fraction the rights over properties, offering a lower investment ticket, helping more people to access this market.  

On one side, save for some exceptions, the real estate market tends to move “in block,” where those properties of similar level and location go up and down in price at the same time. This fact may hamper investors’ prospects due to the economic or financial situation they may be going through. In fluctuating markets such as in Argentina, buying property can be challenging. 

Let’s suppose an investor can buy 50% of a property he likes and plans to save for the balance. By the time he manages to gather the money, he is unlikely to be able to buy 100% of the property due to price fluctuations (exchange rates, new market values, etc.). The token brings a solution to this issue since, unlike cash, its value should rise and drop according to the property’s value. 

On the other hand, developers and real estate companies do have the option to sell their property with lower tickets to broaden their target audience. Tokens can be quite attractive for those aiming to diversify their investments or for someone who rents and has some extra money (though not enough to buy 100% of a property).

Does this mean that you can buy a property without having the total amount to carry out the transaction?
Yes. Tokens are issued based on the guidelines of the issuing entity. In some cases, parameters are defined by the software company and, in others, by the developer itself. This means that an investor could buy “the 12% of the 4ºC apartment of a particular building” if permitted by the conditions of the tokenization project. 

What about the legal framework?
This matter is controversial and subject to legal rulings and opinions. It is essential to understand what is being purchased since conditions vary according to the type of asset that has been tokenized.

Rules shall apply according to the type of transaction that is being represented by the token. To explain, tokenization is like “uploading” a transaction onto blockchain, but the legal framework will be governed by the underlying asset and transaction.

Whenever a legitimate and existing business is being tokenized, tokenization shall be valid and legal. It is important to bear in mind that, according to the type of transaction, tokenization could be subject to specific regulations such as those governing stock exchanges, tradable assets, financial investments, exchange regime, etc. It therefore always depends on the regulation applicable to the underlying business.

But real estate in Argentina is traded in cash today. How will this paradigm shift be achieved?
The change will be achieved (or not) by the market. We believe that this model will mostly benefit potential clients/buyers, thus resulting in a successful business model, and bringing more transparency to the real estate market and democratizing access to real estate ownership. Developers are looking to finance their ventures and to profit from them. If more clients/buyers invest, developers will have achieved their goals (whether through cash or new technologies). Across many platforms, tokens can even be purchased with credit cards or cryptocurrencies.

The” spread effect” is an important factor as well. If developers start offering tokens to those with little to invest or who are unable to afford the value of 100% of a property and accepting all means of payment, two things may happen (not necessarily exclusive): a) the market wins because it is the only one; or b) competitors start offering the same thing to avoid being excluded. The third alternative is that nobody trusts the tokens and refrains from buying them, but we believe this is not the case.

What happens if the property is sold for a lower value than originally planned?
It depends on the type of token. In the case of financial tokens (also referred to as debt tokens since they work as a loan and pay an interest rate for a fixed term), risk and return are allocated to the buyer. In the case of real estate investment trusts at cost or for development (the majority of cases), the risk is to the investors. If the property price is higher than the invested amount (all cases), investors win. On the contrary, if the price is lower than the amount invested, they lose. It works in the same way as the underlying transaction.

What happens if the property is not sold?
Again, it depends on the type of token. Let’s exclude financial tokens from the answer because developers must pay when conditions are met. In tokenized transactions, their aim is not the property sale itself but rather the deed registration.

The registration of deeds can be achieved in several ways: if one investor purchases the remaining tokens from the other pool investors or if deeds are registered in everyone’s name, then the pool of investors can agree on the sale of the venture and/or the venture can be registered as a condominium. This does depend on the conditions set out in the trust (which shall be reflected in the token) as defined by the developer. “The exit” is another important aspect consider before making an investment.

How are those contracts related to real estate tokens considered fully valid?
It is essential to gain professional advice, either from a lawyer or a notary public or both. The professional involved must be well acquainted with tokenization to be able to explain to investors how it works, and the duties and obligations involved.
In this sense, tokenization operates like any other transaction and is linked to the validity of the underlying contract. That is why we support the approach Pala Blockchain took by appointing notaries public to their staff to work with token issuance and documentation revisions.

What are the legal implications of tokenization in the ownership and transfer of real property?
In the context of development trusts, tokenization applies to the trustee’s rights, excluding any registration or special regime with the Real Estate Registry. It is simply registered in the name of the trust until further deed registration is transferred to the name of the buyers.

How is data protection and privacy managed in real estate tokenized transactions?
Tokenization platforms and/or developers must maintain all data in relation to token holders since it is essential for deed registration. Data will be protected in accordance with the data protection policy of these companies and with the regulations in force in the countries where transactions are conducted. Obviously, there will be public and private data.

What are the legal requirements of valid real property tokens in different jurisdictions?
Tokenization is subject to local legislation in the same way as the sale and purchase of real estate. Tokens must be backed by a legally enforceable asset and comply with jurisdiction-specific regulations. We recommend you use an expert professional to check the legal aspects in terms of compliance.

How is the issuance and trading of real estate tokens regulated within the current legal framework?
Regulation varies according to different jurisdictions but there is no specific regulation “for tokens” in terms of issuance and trading. Tokens associated with financial transactions must comply with the regulation stipulated by the corresponding enforcement agency. Tokens representing warrants, collective financing, negotiable obligations, and virtual assets service processing must also adhere to applicable financial and securities regulations and particularly, if traded in the open market, with public offering, etc.

How are legal disputes connected to the trading of real estate tokens resolved? 
In law, there is a principle that says that “the accessory follows the principal.” Since tokenization is the representation of a more traditional transaction, the applicable rules regarding jurisdiction are the rules applicable to the underlying transaction. The technology of tokenization also provides far more information than in a traditional transaction, supported by an unalterable, transparent and traceable chain.

What are the tax provisions in real estate tokenization?
This aspect should be clarified by an expert accountant but, in principle, the same provisions apply as if you were joining a trust (following our analysis of trust at cost). We strongly recommend you seek expert advice before making any investment due to the impact it may have in terms of return.

In a few words, what are the benefits of real estate tokenization?
Tokenization streamlines the real estate market by transforming it into a broader and more democratic market for the middle classes (in Argentina) with more agile, solid and transparent instruments than the traditional ones.

For more information please contact Diego J.Nunes, Partner at dienunes@estudionubnes.com.ar

About Estudio Nunes & Asociados:

As Alliott Global Alliance's legal representative in Argentina, Nunes & Asociados Abogados specialises in offering corporate, commercial, civil, labour and administrative legal advice.

Striving to offer comprehensive legal consulting to clients, companies and individuals, the team provides technical professional and innovative solutions, all tailored to each client's complex requirements.

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