The commercial real estate market today is steadily adopting Blockchain in its operations today. Real estate transactions using blockchain—a market Statista predicts will grow from $339.5 million last year to $2.3 billion in 2021. A notably paper-based industry, the commercial real estate market is using Blockchain-based smart contracts. This helps to automate its transactions, boost investments, bypass middlemen, and streamline payments.
Challenges in traditional commercial real estate transactions
Commercial real estate transactions are a complex process that involve multiple entities, cumbersome paperwork and other redundancies. Here are some of the challenges in the traditional commercial real estate transactions:
- Complex process
Commercial real estate is essentially a complex process. This is because it involves several entities such as brokers, owners and stakeholders alongside multiple steps for transactions. As a result, the process of lease agreements and other property operations scatter. These entities have several contracts to sign between them. Any error or delay in the documents interrupt the transaction proceedings. The commercial real estate transaction also moves in multiple steps that range from site selection to development and entitlement. Right from the start of the lease, a commercial real estate transaction involves various payment, maintenance charges and service transactions. Therefore, there is a constant need for execution and consistent tracking and recording on a real-time basis.
- Cash-flow management
There are also several checks on the same data. As a result, many real estate companies have rigorous accounting, compliance and cash flow management needs and related costs. Since the property is leased not by one entity, but by multiple, managing lease payouts is difficult. According to a study performed by Jessie Hagen of the U.S. Bank, 82 percent of businesses fail because of poor management of cash flow. In the commercial real estate industry, developers often experience cash flow problems. The need to track, check, record and confirm the same or separate datasets result in many real estate companies to undergo strict accounting, compliance and cash flow management.
- Inefficient Financing and Payments
Due to the presence of several partners and lengthy paper-based documents, payments and money transfers, commercial real estate transactions become expensive and unnecessarily time-consuming. Due diligence and financial approval is still heavily reliant on an extensive process of paper-based documentation. Further, in case of mortgages or cross-border transactions, there is a greater amount of delay in financing and payment process. The typical time to close a commercial mortgage is about three months. Moreover payments and money transfers require a large amount of fee. This fee increases to almost twice the rate in the cases of cross-border transactions.
- Data un-accessibility
To finalize a commercial real estate deal, it is always ideal to access the property and transaction data in real time. However, the presence of intermediaries and multiple channel partners lead to the unavailability and obstruction of crucial information and data. Moreover, manual conduction of the due-diligence activities and legal review makes the procedure prone to loss of information or errors.
Transparency in commercial real estate markets is an extremely important component. However, it is improving at a slow pace in over a decade in the market. JLL reports that in 2020, the commercial real estate market showed the slowest improvement in the transparency index since the period following the financial crisis in 2008.
The cause of intransparency is chiefly the presence of multiple parties, intermediaries and the cumbersome paperwork. In case of mortgages and due-diligence, there is a chance that the buyer and lender can fill in false information in the documents. Moreover, they can forge the documents using advanced digital editing, which makes the forgery hard to detect. Thus, such manual verification leaves room for intransparency in the transactions and information. Besides, illegitimate intermediaries can limit information from the buyers to seal the transaction. This often fools buyers to purchase illegal/not for sale properties with a huge investment. Hence, all these factors lead to the decline of transparency in the commercial real estate transactions.
What is a Smart Contract?
A Smart contract is a self-executing contract where the terms of the agreement between buyer and seller are directly written into lines of code. The agreement in the form of code therein exists across a distributed, decentralized blockchain network. Therefore, smart contracts create transparency in transactions and agreements. It also self-enforce the terms without any external third-party or manual involvement.
Read our blog to know more about Smart contracts.
How does Smart contracts help in commercial real estate transactions?
Since, smart contracts are digital codes in a blockchain and do not require manual checks, they simplify the commercial real estate transaction process. These self-executing codes on a blockchain automates the terms of agreements between parties with consensus protocols. Today commercial real estate executives are adopting smart contracts to ease several aspects of their operations.
- Property Title Management and transfer
Smart contracts can simplify Property Title Management and Transfer. Land titles are mostly reliant on paper documents which creates the possibilities of errors and theft. As per the American Land Title Association, title practitioners find 25 percent of titles faults during settlement. Hence, title professionals need to insure the title, which could impact the buyers’ ownership in 25% of transactions. Moreover, an error in the land title interrupts or even stops the transfer of the assets between parties.
Blockchain creates digital identities for land titles which make title management error free and tamper-proof. The distributed nature of the blockchain ledger enables the parties to access the digital identities. However they can make no changes to it without a consensus across the several blockchain nodes. Further, smart contracts can conduct the transfer of the land title digitally. In cases of online property registries, smart contracts can further complete the property title transfer after the parties submit their digital signatures and complete the payment. Therefore, smart contracts save the property stakeholders significant time and expenses. It also enables the permissioned entities to access and verify the title transfer process in real time, which restores transparency.
- Rental agreements
Smart contracts can also create digital rental contracts on a single decentralized ledger. The owner of a commercial property and the buyer or renter can execute a digital contract that contains clauses like selling price, payment frequency, and other property and tenancy specifics. The landlord initiates the contract by specifying the monthly rent and the property address, which the tenant signs which in turn starts the contract. Hence, there remains no need to overwrite the current tenant more than once. The immutability of the contract also disallows the participants to change the terms for their own benefit. Thus, the smart contract collects the money automatically from the renter and sends it to the owner on the pre-conditioned data.
The smart contract also triggers routine maintenance depending on the negotiated terms. Therefore, smart contracts increase the certainty of agreements and streamline the rental agreement, which otherwise involve multiple bureaucratic complex steps and unnecessary costs.
- Lease preparation and payments
Smart contracts can effectively execute real estate lease preparation. A lease is the document that determines and allots the terms of the agreement between the tenant and the landlord. However, in traditional circumstances, negotiating lease terms can often be complex, costly and time consuming. Moreover, it needs manual enforcing once it is agreed upon. Hence, right from the start it involves multiple layers of transaction and tracking.
But, smart contracts insert automation in the process and simplify it greatly. Firstly, blockchain enabled smart contracts streamline communication between the parties. With a single code of agreement,it eliminates the lengthy paper trail of physical documents. Moreover, the distributed nature of the blockchain, makes the lease terms accessible to every permissioned party. It also enables the tracking of payments and the lease-preparation process, which can also be reviewed later at any given time. Such automation removes the need for intermediaries and their associated costs. Hence, this restores auditability in the process.
The contract also pays the rent to the landlord automatically. It secures the ren in the form of a minimum balance bank account or digital wallets. Further, it also stores the record automatically on a blockchain which can be accessed at a later time. In addition, on the termination of the lease, the contract triggers the payment of the security deposit back to the tenant, after adjusting any expense regarding damage repair. Hence, the entire lease preparation remains transparent and accessible in real time to all the stakeholders.
- Land registry
Land registry is the process of recording ownership, possession or other rights in a land to ease transactions and prevent unlawful disposal. Primarily the land registry process is time-consuming and expensive. This is due to the presence of brokers, manual paperwork and other complex steps.
However, smart contracts simplify the entire process through automation.
It utilizes digital signatures of the parties involved which reduce months of paperwork. Further, it eliminates the chances of manual errors in registering the information. This is due to unique digital fingerprints that verifies the information and ensures its accuracy. Unique digital fingerprints also approve the validity of the stakeholders to regulate the transaction, thereby reducing frauds.
For land registry, the sellers approve the land ownership transfer request on the blockchain platform, which is automatically sent to the land inspector. The land inspector verifies the transaction and initiates the transfer, which requires the buyer and the seller to upload their documents with their unique fingerprints and digital signatures on the blockchain platform. The smart contract then matches the hash generated after the signing of the document with the hash generated after the upload. As a result, when the two hashes match the smart contract automatically approves the land transfer to the seller and he/she gets registered as the owner of the property. In addition, the contract also stores the copies of the transaction to its ledger and allows permissioned parties to view the records whenever required.
Therefore, it removes intermediaries, paperwork and dishonest activities from the process completely.
Benefits of smart contracts in commercial real estate
Commercial estate agents SavoyStewart.co.uk surveyed 544 commercial real estate (CRE) professionals to identify how they think smart contracts benefit CRE. While 71% of the professionals viewed an increase in speed of the transactions as the greatest benefit of smart contracts, 66% experts believes that it streamlines the exchange between the buyer and seller. On the other hand, 63% of the professionals state the lack of intermediaries bring down the cost of transactions a lot. Further, 59% believe security to be the greatest advantage of smart contracts. By eliminating the use of paper, smart contracts reduce environmental footprint, which is a definite positive impact that 40% appreciate and 45% believe it will connect buyers and sellers better than ever.
Let’s have a look at the benefits of smart contracts in the commercial real estate transactions:
- Data availability
Smart Contracts acts as the platform for exchanging property information and transaction deals securely and transparently among the stakeholders. It’s distributed nature allows any permissioned party to access the records at any given time. Further, it disallows any party to change the previously entered information without a consensus across multiple nodes. This enables the parties to get access to authentic information without any manipulation by a third party. Therefore, smart contracts restore accountability and make the transaction process tamper and censorship resistant.
Smart contract is a digital program where every clause, terms and condition is written in the form of code. It eliminates the use of paper-based documents that require manual filling in and often has errors and mistakes in them. Hence, the digital codes are generally error-free with no manual intervention which makes the clauses and transactions accurate.
Smart Contracts eliminates the dependency of real estate transactions on wire transfers and costly verification processes by several intermediaries. This usually takes more than at least a couple of days to complete. Besides, it deletes the use of extensive paper based documents that elongate the process further. With smart contracts, the speed of transactions increases and saves days of paperwork and delay due to manual involvement.
- Eliminate Intermediaries
Smart contracts are self-executing softwares that automate transactions in their peer-to-peer network without the need for intermediaries. Brokers and escrow companies are absent which saves their charges and the overall time period of the transaction. Hence, commercial real estate transactions become affordable and swift.
- Secure Data storage
Smart contracts provide the secure storage of property data and transaction records. It also enables the involved parties to access the information at any given time. Moreover, the storage of past transactions and terms of agreement, prevents any potential dispute that may arise between the parties. In addition to this, the encryption technology makes the data immutable and highly secure.
The inherent component of transparency makes smart contracts lucrative for real estate businesses. With no intermediary manipulation and manual errors, smart contracts automatically self-execute transactions upon agreement on all the conditions. In addition, smart contracts enable the permissioned parties to access all the terms of the agreement at any given time. This removes any communication gap between parties and ensures transparency in the transactions.
Smart contracts and blockchain hold tremendous potential for transforming the commercial real estate ecosystem. With automation, speed and transparency smart contracts will create a new way of interaction among stakeholders. Thus, digitalization is the face of the future for the commercial real estate sector.