If you want to feel like a king/queen of New York you buy a skyscraper. You can let your oddities shine through on your instagram and on the New York Post, you can buy a building on Madison and re-enact the bonfires of the vanities. The lifestyle of a titan of the towers is available only to a select few. The rest of us (including myself) own real estate through our portfolios. But imagine if you could own a piece of a skyscraper in New York? Well, you can sort of do that now by buying SL Green’s stock - a Real Estate Investment Trust (REIT) that ultimately distributes 90% of its earnings to shareholders. This is a unique opportunity to have exposure to Madison, Park, 6th Avenue and more. What if you have conviction about Los Angeles’s real estate market resiliency but you’re soured on New York’s prospects? You could short SL Green and buy Douglas Emmett (DEI). Essentially, there are strategies available to you to get alpha exposure to all sorts of markets across the world through direct investments, REITs or some esoteric structures that exist in the illiquid world of private securities. Until recently though, the private security market remained just that - private and esoteric. Unable to truly understand the options out there, controlled by closely held syndicates and the “who’s who” of real estate, private securities have been the portion of your investment portfolio that you buy and forget about until there’s a long-awaited exit. It's 2018 however, and we are at the precipice of a shifting landscape for what inevitably will reshape the private security.
Enter stage left: Tokenized securities. With the advent of the decentralized smart contracts, entire asset classes are looking at tokenization as a new way to not only provide fractional interest in assets but also create liquidity across global exchanges that didn’t exist before. The root of this all stems from the Jumpstart Our Business Startups Act (JOBS act) in 2015 in which the SEC opened up Regulation A+ to allow for private companies to effectively launch mini Initial Public Offerings (IPOs)for any asset. Markets are two way streets though. As the JOBS act gave the ability for companies to securitize their assets and sell them to a broader set of investors (accredited), the question then became whether or not there were interested investors on the other side of the table. In the real estate world, a rush to syndicate and securitize as many assets as possible ensued and companies like Crowdstreet, Fundrise, RealtyShares and Cadre popped up and appealed to the masses.
These companies would essentially buy capital stack positions in real estate assets and then offer them on the backend to their pool of accredited investors on the retail side of the house. The investors showed up in droves. With increasing demands for liquidity and shorter term holds, these same companies created secondary markets for their investors.The problem to that business model was that they created a “walled garden.” Investors didn’t have liquidity beyond those sites as Cadre members could only sell to other Cadre members. So how would tokenized shares solve that walled garden problem?
With smart contracts on the ethereum blockchain, companies looking to securitize their assets to sell to a broader set of investors have the ability to program in the parameters of the investor (i.e. I only want 25-50 year old women, who live in Los Angeles and has a net-worth of 5MM or above), create a self-compliant token and then standardize it to re-trade on any exchange that accepts ERC-20 tokens. That standardization of tokens to be traded on any exchange is what creates this newfound liquidity that didn’t exist in the previous private security markets. Imagine now, you can buy a fractional interest in an asset in Culver City and then sell it to a buyer on a Turkish exchange that’s accessing it in Miami yet wants exposure to Los Angeles real estate, but can’t afford to buy a building themselves. Imagine you own and operate a building in Marina Del Rey. Your equity has doubled and now you want to get some value out but still want to maintain operating control. You now could issue a security of a portion of your equity, maintain operating rights and collect fees on asset management, property management, etc. and begin to float those tokens on a decentralized exchange.
Now that you’ve created these highly liquid private securities, you can take it one step further. Large institutions can now begin to buy these tokenizied securities in droves and customize them into baskets of fractional interest (similar to a REIT) that provide targeted exposures. For example, imagine buying into a share of a basket of goods that holds fractional interest in assets in Echo Park and Silver Lake, Los Angeles, Williamsburg and Fort Greene, Brooklyn to create a basket of fractional assets that are the “eastside warriors” of the major metropolises. Mo Shaikh, CEO Meridio, did just that. Merido created these digital shares in mid 2018 with the help of Cushman & Wakefield.
Meridio is not alone in this pursuit. Dozens of companies are popping up and partnering to educate, facilitate and create a future infused with highly liquid partial asset interests.
“The Harbor platform will help change the way traditional assets like commercial real estate are securitized,” said Mike Belshe, CEO, BitGo, and advisor to Harbor. “BitGo and Harbor share a commitment to transforming capital markets by creating ways for more people and institutions to participate. We have worked closely to create a seamless experience for issuers and investors, from the provisioning of digital wallets to the custody of funds.” - Josh Stein, CEO of Harbor
Imagine these institutions could then market these newly targeted securities to entirely different and motif-driven investor bases. Imagine the New York City office of Amazon allowing 401K allocations to the Long Island City real estate basket via Fidelity. The possibilities and flexibility here are endless. It’s a new era. It’s the wild wild west of securitization. As long as the SEC continues to respect the needs of the issuers and protects the interest of investors, we’re going to continue to see some incredible innovation around securitization. We can now create a healthy and varied new set of capital markets from which to raise capital as long as investors remain vigilant and understand the underlying financials.
Disclaimer: This is in no way shape or form investment advice and should not be misconstrued as such.