FRACTIONALISED & TOKENISED – THE NEW OWNERSHIP MODEL?

The trend worldwide appears to be moving towards selling property in smaller fractions or shares instead of in its entirety and using tokens in the transactions via a tech platform.
Text by Jan Yong

How would you like to own a stake in a luxury island in the Great Barrier Reef off the coast of Australia, or an Aspen ski resort managed by St Regis, or a 12-storey Manhattan building, or a luxury student residence or a hotel booking platform? These are all available for sale to any accredited investors around the world. You can either buy a single share or as many shares as you can afford using the US dollar, or tokens such as Bitcoin, Ethereum or a coin unique to the initial coin offering (ICO) itself.

In the case of the Great Barrier Reef namely Great Keppel Island, there are plans to create a futuristic luxury resort complete with a Greg Norman-designed golf course, 750 villas, 300 luxury apartments, and a 5-star beachfront hotel which are projected to be worth billions upon completion. Unlike many ICO proposals, the tokens on sale will be backed by the developments on the island itself.

The tokens including the Great Keppel Island (GKI) tokens can be traded on the existing digital asset exchanges thus ensuring its liquidity while the progress of the development will ensure its appreciation in value, says its proponents.

The GKI token sale is not the only example of real- estate developers fractionalising their development and seeking funding through the use of digital tokens or simply referred to as ‘tokenisation’. Since October 2018, Aspen Digital, the owner of the St. Regis resort has been offering shares in St. Regis Aspen which are represented by Aspen Coins. Each Aspen Coin will represent an equity stake in Aspen Digital. Facilitating the token sale is the well- established crowdfunding platform, Indiegogo.

The St. Regis Aspen hotel is seeking USD12 million in investment for redevelopment of a luxury ski resort in Aspen, Colorado. It has earlier ditched a Real Estate Investment Trust (REIT) Plan as its funding source.

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Selling tokens as a means of fundraising boomed in 2017 with many projects receiving tens of millions of dollars for little more than an idea. Since 2018, real estate developers have caught on and a few have been using ICOs to raise funds and sell their developments.

Experts are optimistic that if these offerings succeed, more developers will sell their properties in fractions through shares or coins.

“Not just in the US, Australia, Japan or Singapore, this trend is also catching on in various other parts
of the world including Malaysia,” says Elizabeth Siew, advocate and promoter of ‘fractional ownership’ in Malaysia.

Experts are optimistic that if these ICOs succeed, more developers will sell their properties through shares or coins.

She cites the example of Malaysian developer Ho Wah Genting which has launched 2 projects through fractionalising and tokenising it, meaning it is offering 500-sq-foot hotel rooms to a maximum of 12 owners each who will each pay a one-time payment of RM125,000 for an undivided share in the room. They can pay for the Goldmen Suites, a proposed 60-storey hotel project with 600 rooms a prime area in Kuala Lumpur with hard cash or cryptocurrency.

Its other project, HWG Resort is a seafront development in Port Dickson featuring a cruise entertainment hub, hotel town and water chalet. It also has a similar sales strategy as Goldmen Suites.

The fine print is that you need to fork out RM700 per month maintenance fees and in return, you get 30 days of free stay a year, whether for your own stay or rental.

The interesting part is that the exit procedure is super easy as all you need to do is to inform the developer who is one of the owners by default.

The company uses a smart contract which utilises blockchain technology and a conventional contract to record ownership and benefit entitlement. This way, every stage of the transaction is transparent and investors can sell to worldwide buyers using their blockchain platform.

WIN-WIN ARRANGEMENT

It seems like a win-win situation for developers and investors. Developers get to sell to a worldwide target market by slicing up their development and selling fractions of it to buyers while investors don’t even need to get a bank loan as the one-time entry payment is very low for a luxury development.

Furthermore, using blockchain opens up a new level of transparency never before possible, for example, you can check if there had been some violent incidents at the property, provided the blockchain is connected to the police, notes Siew.

More significantly, there is no real property gains tax as your share is only a right to the property with benefit entitlements such as rental or dividend.

Siew adds that the contract does not need to be a smart contract although that could give you better protection. “Smart contract means coding the contract so it can execute itself, for example, auto crediting a certain amount into your account. You would need a bank account or e-wallet to pay by coins or cash as long as the buyer agrees to the mode of payment. All of these is of course subject to the applicable law of contract,” Siew explains.

Tokenisation which basically combines fractional share in the property and funding with tokens (usually through an ICO) is not legal yet in Malaysia although the Securities Commission is expected to come out with guidelines to regulate ICOs soon, says Siew.

But fractionalising the property itself as in splitting one property into smaller shares (or 10 properties together then fractionalising them into undivided shares) by a developer is legal.

When tokenized with the promise of a return, the underlying asset is considered a security. As such, it is subject to the Securities Commission regulations as it becomes more like shares or unit trusts which are governed under their relevant laws.

It is differentiated from crowdfunding where the latter is usually looked upon as project funding by the developer while timeshare is governed by the Interest Schemes Act 2016.

Landbanking strictly refers to shares in undeveloped land with a long time horizon for future development while REITs allow small-time investors to own shares in a slice of an otherwise impossibly expensive piece of commercial real estate in Malaysia. An example is the IGB REIT which owns the Mid Valley Megamall valued at RM1 bil.

FRACTIONAL OWNERSHIP

In comparison, in fractional ownership arrangements, the investor actually owns a part of the property or an interest in the property.

“The developer is considered to have sold the property to you. Fractional ownership is a concept, not so much a method. Whether it’s legal or not depends on how you structure it,” explains Siew.

“If I am a developer and sell my development in fractions, it’s legal. But if I use a third party platform like Indiegogo (crowdfunding), then a license is required.

“And if I am a developer and I sell to you and promise to give returns, then it becomes an interest scheme, in which case the government would
need to regulate it as I am running a financial scheme. I will have to go to the SSM (Companies Commission of Malaysia) to apply for approval of the scheme. I must hire a licenced property manager to manage the property as well as appoint a licenced trustee. This will eat into costing (expenditure).

“On the other hand, if I just sell to you and recommend a third party operator who then pays you the return, then this is legal. The operator
who is under a management contract will hire a manager to manage the arrangement. The net profit from the revenue will be passed on to the owners in the form of dividend or free stay, or can be anything else if agreed upon. This ‘two- contract’ arrangement is considered legal, although developers are advised to appoint trustees to manage the funds,” Siew elaborates.

The investor’s ownership is secure as it is evidenced in the Sale and Purchase Agreement and the Trustee’s register which contains the names of all the beneficial fractional owners. In the Land office, only the trustee’s name is stated in the title but the beneficial ownership is clearly given to each individual owner.

Siew, a long-time blockchain enthusiast further says that there are more than 10 ways of structuring the fractional ownership concept – in creative yet legal means.

Meanwhile, in America, the trend is slowly moving towards mainstreaming blockchain despite heavyweight detractors such as Warren Buffett.

In February, JP Morgan announced it is launching its own “digital token.”

This is in addition to IBM, American Express and even NASA which have all started to implement blockchain into their operations. The signal to the market can’t be ignored – that blockchain is now ready for mass adoption. This is largely because the core issues of regulation, insured and secure storage, and price volatility – are being solved.

With the entry of institutional mainstream players with their deep balance sheets, it would seem that the adoption of blockchain in fintech will become so widespread that it will eventually spill into real estate.

But markets don’t always move in predictable ways hence the jury is still out though it’s only a matter
of time before every transaction goes cashless and tokenised and property ownership becomes more of ownership of a fraction of the property or an interest in the property.

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