Building a real estate exchange
Photo by Markus Winkler
I've been thinking about this problem for a long time - how can you make investing in real estate so easy anyone can do it?
Real estate investing requires large upfront costs. I talk about this issue in this post.
While this is the biggest barrier for most people, there are others:
Here is a short list
- Finding a good deal - The best deals are often off market. Finding off market deals often come down to “who you know.” This puts the newcomer at a disadvantage
- Closing a deal - you need to have a good building inspector ($) and a good lawyer ($$$)
- Finding a bank loan - Lots of issues here. Various obvious ones and some more subtle issues like navigating the complexities of loan types/rates and documents required.
- Managing the property - Behind the upfront cost, this is the most significant hurdle to investing in real estate. Most people have day jobs and don't have time to manage a building. There are “turnkey” options, but as this article states: you can’t really have your cake and eat it too.
- Liquidity - Pretty obvious. Your money is tied up in the asset. There is no way to get it out except selling or getting a cash out mortgage. Not great options.
I think this is best explained with an example:
Lets says I own a building. The building makes $10,000 in earnings per year (rent income of $50,000 - $25,000 expenses - $15,000 mortgage).
The building is owned in an LLC. I want to sell “shares” of this LLC. Purchasers of these shares are true owners of the LLC and are entitled to a percentage of the earnings, tax benefits and liquidation value (cash when the building is sold).
So lets say I decide to issue 10,000 shares and each share is guaranteed 1/10,000 of the earnings per year ($1/share for the trailing year). I keep 5,000 shares so I retain 50% of the earnings/ownership.
When I sell the shares I price them initially at $10/share. Anyone who purchases the shares will make $1/year (if the earnings stay the same) or 10% of their investment.
People like this deal - 10% ROI is way more than they can make in a savings account and about the same as the stock market. I list the shares on an exchange and the price of the shares quickly increases to $12. Investors are still making about 8% ROI at $12/share. All 5,000 shares are sold.
Selling the 5,000 shares at an average price of $11 ($10 initially that increased to $12/share) nets me $55,000 cash. I still own 5,000 shares (out of 10,000 total). These shares make $1/share/year or $5,000/year.
What are the properties of these shares? Let's break it down into several components:
The shares can be purchased by anyone (not really - a discussion for another post) at any time. The stock market allows trading during the business hours the exchange is open. You can trade cryptocurrencies 24/7.
Related to accessibility. You can buy or sell your shares at any time. There is no lock out period. Most REIT investments have a lock out period that makes it costly or impossible to get your money out.
This has to be hashed out but the basic concept is that the shares can (and I think should) grant the holder governance rights.
Similar to how owning stock in a company grants you voting rights on certain issues - ownership of the shares of a building should entitle the owner to governance rights. Things like which management company to use or when to sell the building could be voted on by the shareholders.
Most REITs aggregate multiple buildings in a given area in one fund or offering. The benefit of this is more diversity - it limits the downside risk of one individual building failing to generate ROI. This also allows economies of scale. There is significant compliance overhead to issuing a REIT offering so the incentive is to create a large asset.
This model would be atomic - each building would have their own shares issued. The shareholders own only one asset - representing ownership in one building. Atomization allows individual building owners to issue shares without having to join a large asset pool. Investors can also invest in the individual assets that are cherry-picked for maximal return. You can always aggregate assets to create diversification. But you can’t atomize a REIT any further - it is the smallest unit of investment.
Owners of the shares are true owners of the building. They have governance rights as mentioned above.
However, they also receive the tax benefits. They will be issued a K-1 as any partner in a real estate partnership would. The difference would be the length of ownership would have to be included.
For example, if you held the shares for 180 days, you would be entitled to a half year of the earnings and tax pass-throughs.
There are many legal considerations and implementation details to make something like this work. I'll discuss these in a separate post.
I’ll also discuss a minimal viable product (MVP) app that one might build to prove that people want this. After all, the first step to building a successful startup is making something that people want.
Although, as you’ll see in the implementation post, there may actually be execution risk for this idea.
I’m inclined to think “if you build it they will come” and the real question is - can it be built?
If you have any interest in this idea and like to reach out to discuss, you can enter your contact info here: contact form.
People I have specific interest in talking to:
- Finance people - specific those with experience navigating funding portal registration.
- Cryptocurrency enthusiasts (dapps/dao/dex) - lots of acronyms here. If you work in this space you know what I'm looking for.
- Real estate investors - If you like this idea, own real estate and might want to get involved, please reach out.