Digitalisation is increasingly disrupting the real estate landscape today. Recent years have seen an upsurge in the adoption of technology in various aspects of the business. From digitizing paper-based tasks to the automation of payments, the ubiquity of ‘touchless’ digitalisation is conspicuous, especially after the COVID-19 crisis. Driven by the need to gain competitive advantage and customer satisfaction, real estate firms are now reimagining their archaic deal management to outlive the pandemic. However, the Altus group reports that over 45% of CRE teams are spending 15% to 25% of their time just managing and organizing their data.
Blockchain is one digital tool that is largely disrupting and revolutionizing commercial real estate deal management. With smart contracts, digital identity and other paraphernalia, Blockchain is delivering sustainable solutions to the arduous challenges in the real estate industry. Hence, this is encouraging efficient streamlining of the complex, multi-layered process of commercial real estate deal management.
Unravelling the steps of a commercial real estate transaction
A Commercial real estate transaction is the process of transferring the rights of commercial property like office space, industrial multifamily rentals or retail etc, between two parties mainly for business or income-generating purposes. This process primarily moves in five phases:
1. Identifying Investment opportunities
Ibisworld reports that the global size of the commercial real estate market $3.2tr in 2021. It is a major asset class that offers investors the potential for an attractive return on investments. For this reason, it is important to develop an investment thesis through extensive research. The criterion for zeroing in on a suitable property must include analysis of property type, location, purchase price, risk profile, etc. This way, investors can easily curate the list of lucrative properties and rule out the depreciative ones.
The underwriting process involves an extensive analysis of a property in terms of its financial aspects. At this stage, the current data like rental income, occupancy, property taxes, utilities etc are combined with future performance estimations. Therefore, underwriting is extremely crucial for addressing sponsor questions relating to the reason for the property sale, rental limits, maintenance costs, locational relevance, occupancy status and exit strategy.
The next step involves constructing a pro forma analysis that aligns perfectly with the price value expectations and underwritten returns. However, incorporating a suitable underwriting process is a complex process. It involves the creation of numerous financial models with different assumptions that scrutinize potential profitable as well as unrewarding scenarios. Hence, the management of the large volumes of research data generated in the process becomes hectic and cumbersome.
3. Making an offer
If the underwriting process shortlists a suitable property for the investor, in terms of price and returns, the acquisition teams make an offer to the seller. This involves the following stages:
- Preliminary due diligence
This involves acquiring maximum information about the shortlisted property without incurring significant due-diligence costs. This step is extremely important for gathering every little detail of the property and providing the best initial offer.
- Communicating interest in the deal
This is the stage when buyers communicate their interest to the seller’s representative or the owner, and confirm a possibility of deal execution. This is what piques the confidence of the seller in the buyer‘s commitment. The sellers becomes certain that the buyer is interested in closing the transaction at or near the contracted price. Hence, conveying certainty of execution plays a key role in this stage for acquiring the property at the best price.
- Walk-in tour of the property
Walk-in tours of the property serves as a win-win situation for both the buyer and the seller. The buyers can ensure that there is no informational gaps, and whether the property meets the seller’s description or not. On the hand, sellers get a further confirmation of the buyer’s serious interest in the transaction.
- Meeting with submarket lease brokers
A meeting with the submarket leasing brokers serves as a way of receiving an informed third-party opinion regarding the asset’s rental potential and its rates.
- Comparing with competitive set
After acquiring the advice and opinions of experience lease brokers, buyers generally tour the competitive properties. Touring these properties help the buyer in comparing the properties and make an informed decision regarding their shortlisted property.
- Submitting the first round bid
When the buyer is satisfied with the property after the underwriting and due-diligence process, the buyer makes an offer to the seller. This initial bid replicates the Letter of Intent (LOI). Herein, the buyer addresses the major points of interest , and this stage is often the starting point for further negotiations.
4. Pre-closing stage
At the pre-closing stage, the seller eliminates most buyers. Generally, this is either because the bid price is too low or the buyer does not meet the seller’s terms. Here, the seller wants to identify the ideal buyer who has the ability to close the transaction at the highest price. The seller then shortlists the buyers among the remaining ones.
- Best and final round bids
The best and final round bids are among the narrowed down number of buyers. At this stage, sellers are confident that buyers will push higher on pirce to close the deal. Strong buyers gain a sense of the competition and tend to bring down the price of the seller, while other bidders stretch to the desired number. Hence, the seller has conducts buyer interview to get the best bidder.
- Buyer Interview
The seller narrows down the pool of buyers even further and he/she conducts a buyer interview for the last two standing candidates. Here, the seller wants to determine which buyer is most committed to sealing the transaction. Further, the seller or his/her representative interviews the buyer. Here, they try to analyse the extent of their due diligence and the status of their capital stack (equity and debt).
On the other hand, the buyer tries to convince the seller regarding their intent in closing the transaction. After the interview, the seller usually selects the best candidate based upon their representative’s recommendation.
- Purchase and Sale Agreement (PSA)
The next step involves the formulation of the Purchase and Sale Agreement. The PSA is the contract created between the buyer and the seller. This documents every necessary information about the subject property exchanging hands. Further, it also specifies both the parties’ rights, obligations and liabilities, and also lays out the closing process. Legal counsels of both parties then review and revise the PSA.
5. Closing Stage
This is the final stage of the transaction process, and it brings the deal to a close.
The buyer and seller hire a third-party escrow agent to manage the closing process with utmost transparency. The escrow agent holds deposits and all other funds in a neutral account until all the preconditions set in the escrow agreement are met. This process enxures that both the parties comply with their agreed upon obligations. After the preconditions are met, the escrow agent releases the fund.
- Signing Authotity Verification and Closing due diligence
The legal counsels for the buyer and seller provide each other with proof of the signing power for the legally enabled individuals. These individuals sign on behalf of each party and executing the transaction.
Finally, the buyer also ensures the accurate transference of property rights, and that there are no outstanding due diligence issues. After the fulfilment of every requirement in the PSA, the buyer receives the assignment documentation, which grants the ownership right to the buyer over the lease. In closing, a transition memo is issued to Asset Management, Property Management, Accounting and all other relevant internal parties notifying them of the closing of the transaction.
Blockchain in CRE deal management (use cases)
As evident by the process mentioned above, the commercial real estate transaction process is convoluted and lengthy, to say the least. The involvement of multiple entities and long trails of paperwork makes the process time-consuming, disorganized, costly and prone to opacity and inaccuracies.
Blockchain, however, has the potential to optimize commercial real estate deal management. The distributed ledger ensures a secure digitalization of various aspects of the process, namely the predominantly offline due-diligence process, paper-based agreement and record-keeping and slow finance mechanisms, and costly third-party intermediaries to name a few. Therefore, Blockchain reduces fraud and restores transparency and accuracy in the overall process.
1. Due Diligence
Due diligence involves the verification of a property’s history of ownership, maintenance, occupancy etc. This process as discussed above is generally conducted manually and is largely reliant on paper based documents and third-party service providers. Thus, due diligence increases administrative tasks and becomes notoriously time-consuming. Further, the involvement of multiple entities and physical documents results in tendencies of frauds, errors and high cost incurrence.
However, Blockchain stores digital identities of a property that stores every current and historical record of the property. It digitalizes the physical, financial and legal records of the property is and consolidates them in the blockchain ledger. It also securely stores the entire verification process and distributes it on a single unified platform. In addition to this, blockchain also grants each stakeholder a unique digital identity. Herein, by using smart contracts participants can sign, verify and send official documents to each other. The decentralized nature of the database allows all the parties to access and view these documents. Hence, it offers increased accuracy and transparency in commercial real estate deal management.
Further, Blockchain-based digital identities also validate crucial information like the financial and legal status of the property, tenant profile, occupancy/vacancy etc. Every participant in the network can access and validate the record, including the financial advisors. Therefore, it eliminates the need for third-party intermediaries. As a result, it accelerates the validating process.
2. Property Management
CRE transactions involve the presence of multiple stakeholders like landlords, tenants, investors, property managers, and various other vendors. Thus ensues a long list of payment and service transactions that need secure storage and tracking. However, these tasks are conducted manually and a lack of coordination and organization exposes the entire property management process prone to inaccuracies and chaos.
On the contrary, Blockchain-based smart contracts automate property management. Blockchain morphs the paper based lease contracts into digital smart tenancy contracts. These smart contracts optimizes the entire skeleton of property management ranging from lease agreement signing and payment automation to maintenance clauses. The digital protocols of the smart contracts obligates the stakeholders to perform in accordance to the agreed upon terms and thereby restores transparency and accountability in the operation.
Moreover, the parties involved sign mutual agreements regarding rent collection, mortgage, maintenance etc. Based on the bonds, the smart contract automatically releases lease payments. On the occasion of lease termination, the contract adjusts damage repair charges (if any) and pays back the security deposit to the tenant. Thus, such legally enforceable contracts simplify the property management and restores instant payment flows.
3. Payment Processing
Payments are financing mechanisms are slow and expensive in CRE transactions. This is predominantly due to the presence of multiple third-party intermediaries and large volumes of documents. The problem gets even more challenging in the cases of mortgage and cross-border transactions. Again, less coordination among the participants, high foreign exchange charges and a scattered database are the primary reasons cited for this delay in the financial operations.
Nevertheless, Blockchain-based smart contracts and digital identities can again save the day in this occasion. In the case of loan application and mortgage, blockchain-based digital identities can alleviate the due-diligence and financial verification time period. This expedites the mortgage and loan approval time. Further, smart contracts is the immutable and secure database of every transaction record. Here, the buyer could trace audit trails and mortgage payments in real time.
In the case of cross-border transactions, the distributed ledger provides a common, shared network for participants to engage without any intermediary. The common distributed ledger shares various information such as sender and receiver details, foreign exchange rates, delivery time etc. Again, every participating node can access this information. As a result, this leads to faster processing and transferring of funds without any settlement risk. Further, payment processing takes place with the utmost transparency.
4. Property Title Management
Land title records in the commercial real estate industry are still paper-based. The manually prepared nature of the records raises serious doubts about the authenticity and accuracy of the title documents. Detection of any error and inaccuracy often halts the property title transfer. As a result, property owners often end up paying exorbitant fees to verify the accuracy and authenticity of the documents beforehand to prevent potential title frauds. Buyers, on the other hand, get title insurance while purchasing a property. This increases the property purchase cost.
According to the American Land Title Association, in nearly all real estate transactions at least one title error is detected that needs correction before transferring the title. Further, Ibid reports that in 25 per cent of transactions, title professionals and property incur high legal fees to fix title defects that could impact the buyers’ ownership. Kyle Torpey, a seasoned bitcoin journalist estimates that that nearly $1 billion is spent annually on title fraud resolutions
For this reason, Blockchain-based digital identities provide sustainable solutions. The digital identity stores property title details, which is immutable since any attempt to alter the data needs consensus among the several participants. The tamper-proof and encrypted nature of the blockchain network further reduces the risk of any fraudulent activities. Hence, there remains no need for third-party authentication for title accuracy. As a result, the property title transfer process is simplified and securely conducted, with no additional charges.
Commercial real estate deal management is another distinct area where Blockchain is introducing its disruptive innovation. The commercial real estate market is of an exceedingly anti-technology nature. However, the unprecedented macro-economic circumstances of 2020, namely COVID 19 has forced the real estate moguls to rethink their modus operandi to continue being the attractive asset class and reaping lucrative returns. The efficient implementation of Blockchain seeks to streamline the more complex transaction operation and instil better transparency and efficiency in the overall business strategies. Therefore, it is safe to say that Blockchain is paving the way for a digital revolution in commercial real estate deal management.