Blockchain and Real Estate: An imaginary lending network of tomorrow
Blockchain is a decentralised ledger technology. It allows safekeeping of all transactions that take place on this peer-to-peer network. And like all sectors, this technology has the potential to change the way we look at real estate. In this article, I would like to put forward such a network example.
Understanding the Background
The backbone of any real estate project is the lending of funds. A real estate developer (hereafter referred simply as ‘a developer’) generally needs a lender who can provide funds for the project. Here, an Alternate Investment Fund (hereafter referred simply as ‘an investment fund’) helps by providing the initial or last-mile financial support for the developer’s project. Generally, this investment fund is a conglomerate of big banks that have a common investment goal. Any developer’s project, that qualifies within the set criteria of the investment fund, can avail lending.
In an economy, there are multiple investment funds that have different criteria for the qualification of a developer’s project for lending.
A developer also has an army of support, including the funding, for a project to make it a reality. We can safely distribute this developer’s support into two broad categories: a white-collar help and a blue-collar help. A white-collar help can include the project consultants, legal support, project monitoring team, designers, architect etc. and a blue-collar help is the labour force, raw material vendors, suppliers of internal electrical and non-electrical fittings like wires, pipes etc.
Today’s Lending System
For example, SBI bank, HDFC bank and ICICI bank decide to come together for the Affordable and Mid-Income Housing Fund (AMH Fund); with an investment of INR 60 Bn, 40 Bn and 25Bn respectively.
They decide to disburse all of the funds within 3 years and will exit the market after 10 years. They are expecting a CAGR 18% on their individual project investments. The fund also has some ‘special criteria’ that needs to be met, if a real estate developer wants to avail a loan. An example of a similar fund and its criteria is here.
A real estate developer can approach this AMH Fund and request for (let’s say) INR 1Bn. The developer gives a roadmap of how this fund is going to be used in the next 180 days and details of repayment. After sharing all the documentation to the fund, it is realised that this developer also meets the ‘special criteria’. Now, the bank can disburse the loan of INR 1Bn to the developer, but in trenches.
After our developer’s project has been scrutinised on the potential risks, the funds can be disbursed to the developer. As the project work is completed for one stage, the funds to support the next stage of development are disbursed. As the project nears completion, the cash flows start becoming positive and the fund can expect the returns on its investment. Once the Fund’s decided ROI is achieved, it exits the project and the developer continues ahead. If everything remains as planned, funds can exit the real estate project safely in a decided time and the developer is able to complete the project on time. But everything seldom goes as planned.
Let’s say our developer is a little sly. To achieve a lower rate of interest, he shows higher pre-sales of apartments by asking his extended friends and family to ‘book’ some apartments — something that can be canceled later! Our developer also shows higher marketing cost, since the marketing agency partnered is a close friend’s startup. Same is the case with the paints company and the interior raw material company. This would cost the Fund an additional (let’s say) INR 0.1Bn. And delays in disbursements, poor risk assessment, unreliable project monitoring, fake bills and services are part and parcel of the real estate lending business.
Problems in the existing system:
- No one place for the developer to approach multiple (or all) funds. Like Flipkart.
- Real-time monitoring of all the projects is cumbersome for all stakeholders, be it the fund managers, the project monitoring agency and even the developer himself.
- Developers could favour illicit agencies to get raw materials and services. Lots of under-the-table activities. Pick up any real estate project in Gurugram, India and study it.
- Investment funds end up working with too many papers and documentation of too many developers. Losing track of what’s happening is inevitable.
- Funds transfer between parties is slow because of the lack of trust and increased due-diligence.
- Public sector banks end up taking too much risk by sometimes favouring illicit real estate developers.
- …..and many more!
The solution is having a universal consortium blockchain network for real estate lending that spreads across all segments of the project life-cycle to provide a one-stop place for developers, support agencies, customers, investment funds and banks.
The Solution:
A consortium blockchain network for all stakeholders of real estate, managed by strict rules governed by smart contracts. A business needs to be a member of the network to avail lending or to provide services. Strict criteria to maintain membership.
Let’s break the above statement into its 3 major elements:
1: A consortium blockchain network for all stakeholders of real estate
This blockchain network is a shared philosophy of multiple banks. The control on the direction of the network is based on the banks. Naturally, a bank that stakes more investment into the network, gets more voting rights. The network also defines four more sets of criteria for Investment Funds, Vendors, Developers and Customers on the network. Let’s understand all the 5 stakeholders of the network:
- Banks: A bank can be a member of the network by providing a certain stake as funds for investment. The consortium of banks can vote on the criteria for the other four stakeholders to be a member.
- Investment Funds: A professionally managed fund selected or created by the participating banks to disburse funds to the developers.
- Vendors: Verified and registered white-collar or blue-collar agency that fits the criteria of doing business in the network. They are the support system that helps the developer in the completion of his real estate project OR an Investment Fund in the lending process.
- Developer: A registered real estate developer is looking for investments for his upcoming or already under construction real estate projects.
- Customer: A customer is anyone interested to purchase a property in a registered project of a registered developer OR a business for whom the developer is making the project (like a Hotel Operator, Mall Operator etc.)
2. Strict criteria to maintain membership
The Investment Funds, Vendors and Developers must comply with all the rules set by the banks to be a part of the network.
A customer is not an active member of the network. He can view certain details that help him make a decision.
All payments (from customers, vendors, developers or management of the fund) route via only the network.
3. A business needs to be a member of the network to avail lending or to provide services
Vendors registered on the network can provide additional services to the general public like receiving rental income from their fractional ownership of hotels or residential apartments. Rental agreements with the digital identity of the tenant are captured on the network and rentals are transferred from the tenant’s bank account into the registered bank account on the network automatically every month. Distribution of this rental to the fractional owners is automatically calculated and payment is instantaneous.
An Imaginary Lending Network of Tomorrow
In the proposed network, our developer approaches the Investment Fund for a requirement of INR 1Bn. He is immediately asked to join the network and comply with the set requirements. Valuation of the project is done by verified valuers of the network. Investment is approved for only INR 0.9Bn.
All the vendors are informed about the new project and they bid for participating further to ensure completion of the project. Our developer gets to choose who to select from the verified vendors or he can ask his vendors to register on the network.
The developer initiates the work with the vendors and everyone is notified about the initiation of work. The vendor can notify after completion of work and payment is automatically made directly to the vendor after approval from our developer, project monitoring team and the Investment Fund.
All payments are made directly to the verified vendors on the network. Invoices can be generated only from the network. Real-time verification of the invoice is achieved from the GST portal — increasing the credibility of vendors on the network.
Reduced risk and paperwork mean Investment Funds can provide a lower rate of interest on lending and disburse the fund faster. Our developer will have to comply with a lower cost of capital.
Real-time monitoring of the project can be achieved on multiple levels since all stakeholders are a member of the network. Inconsistency from any stakeholder is immediately visible.
Continuing our example, the initiation of the 5th stage of the project is notified by our developer on the network. The 3rd site inspection report and confirmation are received, 4th visit is scheduled, The vendors confirm the delivery of 5th shipment and the internal finance admin team of Investment Fund is notified, the payment is on its way. Feasibility models are continuously re-evaluated by comparing forecasted and real datasets. The legal team has highlighted some concerns, the IF, the Developer and the consultant are notified.
The process of onboarding and receiving funds can be made in a way to provide additional services and support at every stage of development. For example, The developer can apply for requests for proposals from vendors on the network. Verifiable and auditable valuation reports and models can be shared with the relevant stakeholders directly. Pre-sales of projects can be launched on a public channel for potential customers of the project. etc.
Let us discuss one such case: Fractional Ownership
Our developer has received clearance from all the consultants and the Investment Fund. The raw materials for the next stage are about to arrive and the project monitoring team has verified and digitally confirmed on the network that previous works are up to standards. Since the project is on its way of completion, our developer applies for launching pre-sales offers for customers on a public channel. This public channel only shares the information directly available on the network and the general public are rest assured about the authenticity.
Because every detail of the project is tracked on the network, the developer is able to allow fractional ownership of individual apartments to smaller investors. Every owner’s digital identity is captured and attached to the apartment’s profile on the network. Investors are also allowed to re-sell their fractional ownership of the apartment on this public channel, increasing liquidity and easy entry-exit into real estate investment for small investors. The value of this fractional ownership is kept closer to reality with the help of publicly available valuation reports by verified consultants of the network.
And this fractional ownership can be for not only high-value residential apartments but also for corporate offices, hotels or even malls?! Our developer is already planning for his next project — in student housing and investors around the world can have fractional ownership once the pre-sale is launched on the public channel.
What happens in the end?
A registered bank on the network can leave the network by canceling its membership once projects in which it invested are completed. The bank has successfully exited 20 projects in 8 years and now they can leave the network. Other banks can join the network in their place and hence the cycle continues for the banks.
The Investment Fund has also successfully funded 200+ projects and is now waiting for the last few projects to complete, but there are already 3 other Institutional Funds ready to be a part. They all can join in simultaneously.
Our developer has also completed his project and since he is a verified member of the network, his next projects in line are moved faster and his credibility as a real estate developer increases.
The list of vendors across the world keeps on increasing, everyone from around the world can participate. The Italian marbles are quite literally coming from an Italian vendor now. Every vendor automatically receives credibility points on completing work, from the developer and from the Institutional Fund — increasing trust.
Customers from around the world can now participate in this real estate circus and have asset liquidity like never before. More traction is seen from tier-2 and tier-3 cities as people’s fancy dream of owning real estate assets in metro cities are coming true. The asset values are kept in check with publicly available valuation reports.
Advantages in the new system:
- Investment Fund is notified at every step of the project life-cycle.
- Vendors receive payment directly from the network, but only after approval from the developer, project monitoring and IF on the network.
- Reduced time for disbursement for vendors and developers; faster project completion.
- Faster disbursement of funds and reduced holding cost for Investment Funds.
- Automated payments and verification of work by multiple stakeholders mean reduced risk for Investment Funds and a lower rate of interest for developers.
- Customers get enhanced clarity of the project and credibility of the developer.
There can be many other directions in which this network can grow… let me know if you have a trajectory in mind. You can also learn more about blockchain development with our ‘100 days of code’ program! You can also be a part of our community and be in touch with the latest developments and trends in blockchain technology!
