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Tokenization for illiquid assets – In practice

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In part one of this article I shared the basics of tokenization and the technologies behind it, I also touched on some of the applications for these. If you haven’t read it, I recommend you do, you’ll find it here. If you have, then proceed...

Due to the nascent nature of blockchain and tokenization i.e. these are still emerging technologies and regulatory environments are still playing catch up, we haven’t seen mass adoptions in the market. However, tokenization is starting to happen. In this article I aim to describe the basic steps for tokenization, using a large commercial building as an example, and provide the details on a real-life transaction.

Tokenizing a large commercial building

As previously mentioned, the concept of tokenization is more suitable for large assets, large being defined as above USD 10 million or HKD 78 million. A small affordable property might not be the best candidate for tokenization due to a fixed startup cost of several hundreds of US dollars. Below I have outlined the basic steps to potentially make this happen, and it all starts with deciding what to tokenize.

(Do note that the tasks for tokenization process are often done simultaneously or overlapping in timelines.)

Step 1: Decide what to tokenize

For any large asset, not only can you tokenize the ownership, but you can also tokenize the cash flow or net profit from the operation of the building. Let’s assume, for the sake of our example, that the owner has decided to tokenize her ownership of a large commercial building. Step 2: Value the asset to be tokenized A firm like Colliers, or a qualified valuer as myself, can perform a valuation for the commercial building. Let’s assume, once again, the owner wants to tokenize the ownership of the building, and the market value concluded by a qualified valuer is USD100 million. The owner can decide to break it down to 100,000 shares or tokenize it to 100,000 tokens, with each token being valued at USD 1,000 at the time of issuance, which represents 1/100,000 of the building’s ownership.

Step 3: Check the local compliance and regulatory policy

A task that is preferably done by an attorney or consultant familiar with the local landscape and regulatory environment on tokenization. The issuance of tokenized assets will most likely be considered as a private placement, so, a licensed private broker is also needed in most cases. It’s also advised that the owner set up a special purpose vehicle (“SPV”) to hold the asset and to isolate the risk of the SPV from the owner’s other assets.

Step 4: Engage a tokenization platform company for the issuance

The platform company provides the technology and structure for the digital securitization or tokenization of the building. There are plenty of emerging companies competing to deliver platform services, but look for the reputable ones providing a more complete range of services – as always do your due diligence, check them out online, read reviews, talk to friends, etc. Such platform companies might already have the legal, regulatory and compliance, as well as brokerage services built into their platform, hence, making it easier and more cost effective for both the issuers and the investors.

I talked to Jacqueline Kwok at Securitize, a digital securities (security tokens) issuance platform firm headquartered in San Francisco. She mentioned that Securitize’s platform can provide a complete solution for their clients. The service starts with the client’s on-boarding – going through the due diligence of anti-money laundering (AML) and know your customer (KYC), the investor qualification check, creating a digital signature, digital signing, and registering the token wallet. After all these tasks are complete, tokens will be issued at the issuer’s / asset owner’s discretion, and investors are given access to a dashboard as an account management tool for all activities and communications. The initial process can be completed in as little as four weeks. The platform (or Securitize in this case) will then provide ongoing support such as delivery of news and announcements, distribution of cash flows, and transfer of ownerships, etc.

The cost of tokenizing an asset varies on the complexity of the transaction. However, after the cost of the initial setup, the incremental costs for ongoing administrative activities should be significantly lower than a transaction done the traditional way, due to the elimination of third-party agents.

Step 5: Decide on a market or exchange place

The owner has to choose an exchange place for the trading activities of the tokens after the issuance. In practice, the issuance platform and exchange place are often decided at the same time. Just as for an issuance platform, there are many competing providers serving as exchange platforms. The owner should consult with its team of advisors on choosing the most appropriate exchange place for listing her tokens.

Step 6: Terminate the tokenization

The asset can be tokenized forever, also known as an evergreen tokenization. But, most likely, the owner might want to end the tokenization at some point. One way to do this is to purchase the outstanding tokens from other investors, then authorize the platform to eliminate them or burn them. She can also decide at the beginning of the process to setup the tokenized asset with a limited term, which will be appropriate for most of the private equity funds.

And those are the essential steps of tokenizing a commercial building. But how does it look in real life...?

Case study – The St. Regis Aspen Resort Tokenization in 2018

The St. Regis Aspen Resort is a full-service, 179 guest room, luxury hotel located in Aspen, Colorado with an upscale restaurant, a private spa and heated outdoor pool with panoramic views of the Aspen mountainside.

The owner of the resort, New York-based asset manager Elevated Returns, originally planned to sell 49 percent of the equity for USD33.5 million in an initial public offering on the New York Stock Exchange in early 2018. The listing would be through Aspen REIT, a single asset real estate trust owning the St. Regis Aspen Resort. The share price would be USD20 each, and the investors would have to put down at least USD2,000 to participate. The implied equity valuation of the company through IPO is around USD68 million.

Days before the IPO in February 2018, Elevated Returns canceled the sale. The owner instead moved to the security digitalization direction and completed an offering through digital tokens in October 2018. Aspen Digital Inc (“Aspen Digital”) was set up to own the St. Regis Aspen Resort. Soon after which accredited investors in the US were able to purchase Aspen Digital Coins, in the form of digital tokens - Aspen Tokens, which represent the equity ownership in Aspen Digital. Each token had a value of USD1 at the time of offering. Minimum purchase is USD10,000. Investors may purchase using either US dollars or cryptocurrencies such as Bitcoin or Ethereum. The owner sold 18.9 percent of the equity for USD18 million through digital tokens, which implied a total equity value of around USD95 million.

The Aspen Digital transaction is considered as one of the first successful cases of tokenization of a trophy real estate asset. The implied equity valuation of the company from the Aspen Digital transaction is also significantly higher than the equity valuation from the initially planned Aspen REIT IPO, which indicated a greater interest from the investment community in asset tokenization. Elevated Returns is now considering replicating the process on its other real estate asset holdings.

Conclusion

Tokenization is creating a new class of financial assets. And even though the industry is still emerging and the regulatory environment around it is still developing, the trend is that tokenization is becoming an increasingly viable tool to provide liquidity for illiquid assets.

For any investors who are interested in tokenizing on their real estate assets, Colliers International has a dedicated team who can assist you through the process. Just let me know, I’d be more than happy to chat more about tokenization and what we might be able to do.

Sources:
https://aspencoin.io/
https://www.aspentimes.com/trending/in-18-million-deal-nearly-one-fifth-of-st-regis-aspen-sells-through-digital-tokens/
http://www.elevatedreturns.com/