Research, ideas, and leadership for a more secure, peaceful world
Author
Helena Rong
This blog post is an intro to a white paper that details a proposal for decentralized fractional property ownership and collective governance in local development. The original paper can be found directly here.
Since Covid-19, the real estate market in the US has seen a marked increase in the number of properties under distress. According to real estate data provider ATTOM, the foreclosure rate in the US rose 104% in the third quarter of 2022 compared to the year before, counting a total of 92,634 properties with foreclosure filings which include default notices, scheduled auctions or bank repossessions in metro areas (ATTOM, 2022). Another group, CoStar Group Inc,, has estimated that $126 billion in commercial real estate will be forced to sell at distressed prices through 2022 and about $321 billion by 2025 as delinquencies rise (Gittelsohn, 2020). Given the rising number of distressed properties in the current market, there is an opportunity to experiment with novel concepts and technologies of decentralized governance, financing options, and collective ownership.
The current work proposes a model for fractional funding, democratically governing, and community-engaged investing in distressed commercial properties using “Web3” tools such as decentralized autonomous organizations (DAOs) and token engineering. While most Web3 projects today are set to be global and borderless, when it comes to cities, the brick-and-mortar nature and the physical aspects of the built world cannot be overlooked. As such, Web3 for cities ought to balance between a set of dualities: URL vs. IRL; on-chain vs. off-chain; online vs. offline; local vs. non-local.
The proposed framework - described in detail in the full version of the white paper - situates the DAO within the context of a city with its own federation of decentralized units that are locally rooted. While DAO membership is not necessarily restricted to a particular geographical region, locality is preferred and prioritized, and is reflected in the design of the governance protocols.
A presentation of the case and overview of the approach is outlined in this piece below.
“Wherever there is great property there is great inequality.” Adam Smith pointed to this age-old truth behind inequality in his book, The Wealth of Nations. Unfortunately, not much has changed between 1776 when Smith documented this phenomenon and present day. Real estate – the largest asset class in the world and the largest individual component of the economy for many nations – remains the root cause of the “rentier class” and the surge in wealth inequality in recent decades that has resulted from the divergence between rates of income growth and rates of return on existing real estate assets.
To facilitate greater access to property ownership and enhancing liquidity, attempts by developers and asset managers have been made to fractionalize real estate (i.e., dividing a single asset into multiple shares of ownership) through several investment instruments. However, they are neither truly accessible to the public nor transparent and representative. For example, investors have leveraged “special purpose vehicles,” or “SPV,” previously to experiment with fractional ownership of properties. In this model, accredited investors pool resources and form an SPV through which to purchase commercial real estate. However, this model is not accessible to the general public due to the complex and stringent requirements of investment accreditation. Each SPV is also capped at only 250 investors and is thus unscalable.
“Real Estate Investment Trust” or “REIT” is another example of a testing fractionalized real estate model. A REIT is a company that buys, sells, operates, or finances commercial real estate. Investors in a REIT own the REIT’s securities, rather than the actual portion of the physical property. While REITs are known to be publicly tradable, many of them are also privately owned and traded, which means that they are only available to accredited investors. However, in either scenario, transparency for and representation of investors is a problem because investors are excluded from decision-making and governance processes (such as deciding what to invest and what to do with a property) due to the General Partner (GP)/Limited Partner (LP) fund structure.
Today, the so-called “Web3” movement emerges as a reaction against the growing concentration of power to information in the hands of a few and instead proposes an open, trustless, and distributed iteration of the Internet that rests on visions of interoperation, decentralization, democratization, and user-controlled monetization.
Many Web3 technologies such as tokens (both fungible and non-fungible), smart contracts, and new human coordination models such as decentralized autonomous organizations (DAOs)– which I elaborate on below–are laying out the critical foundation to accomplish the cooperative ideal at scale, and to fundamentally address the wealth gap in the real world. These tools can be applied to real world assets, ideally enabling more accessible and democratized forms of fractional ownership at scale.
Popularized as a novel model of human coordination since 2016, decentralized autonomous organizations, or “DAOs” – one of the cornerstones of Web3 technologies– are changing the way organizations collaborate and make collective decisions. A DAO is typically comprised of a (loosely connected) community that is united by a mutual objective. Members of a DAO collectively pool resources and use software protocols enacted by smart contracts on a blockchain to execute collective decisions (World Economic Forum 2022).
DAOs are seen by many as an alternative to traditional organizations,such as corporations, due to their potential in democratizing governance through enabling transparent, adaptable, and decentralized management. Lacking an established definition or operating standards, DAOs define their own constitutions and governance protocols that are unique to their missions and goals. In most cases, DAOs leverage the use of “tokens” to program values and make digital representations of assets. A token is defined by the SEC as “a digital representation of values or rights,” that has an unmodifiable transaction history on the blockchain and can be exchanged between persons or entities without an intermediary (Peirce, 2021). The innovation of “token engineering,” which refers to the design of token systems, is unleashing new possibilities of designing incentivized systems for owning, trading, and governing shared assets in a decentralized yet secure way.
The fractionalization of real estate investing supported by the innovations of transparent tokenization and DAOs thus carries revolutionary significance in reducing the wealth gap and creating collective wealth. Through this approach to property investing, the general public with limited funds will be able to cooperate with each other to directly buy and own a portion of their interested properties. This mechanism enables a greater number of people to enjoy economic benefits such as better investment yields and wealth accumulation that are conventionally reserved for the well-resourced. In addition to the immediate structural and economic benefits, fractionalized property ownership powered by blockchain and DAOs can also exhibit various advantages, including more transparent investing processes, lowered property transaction costs, more urban revitalization sponsored by social capital, and less fiscal burden on municipal governments.
As mentioned previously though, while most Web3 projects are global in nature and DAOs borderless in their engagement, when it comes to the intersection of digital technologies and the real world, location matters. As such, the proposed framework attempts to bridge and balance the online and offline dynamics of a digitally enabled city, taking advantage of decentralized ownership and governance without losing sight of the local relevance of the physical world.
Although the white paper explores distressed commercial properties as a potential use case, the proposed framework for fractional ownership and community-driven development can well extend and adapt to any other types of real estate properties, public goods, and infrastructure in cities. The use of Web3 technologies and principles such as blockchain and token engineering in the paper’s described scenario illustrates a case of scalable economic prototype powered by significantly higher social participation and financial liquidity. And while the ideas of fractional ownership of real estate (i.e., SPVs) and collective governance (i.e., cooperatives) well precede the advent of Web3, the combination of Web3 technologies and cooperative ideals allows for designs of sociotechnical systems that can enable more accessible, transparent, flexible, and secure frameworks for collective ownership and governance of shared resources, while fully taking advantage of network effects that allow for scalability. In the context of collective property ownership and development, collective wealth created within a locale can be more equitably shared and distributed amongst local community members due to increased democratization of decision-making and participation in local development.
References
I thank Finn Xu, Amritha Jayanti, Professor David Wood, Professor Alex (Sandy) Pentland, Zeslene Mao, Connor Spelliscy and Xenofon Kontouris, for their generous feedback on the initial draft of this white paper. Reach out for thoughts, feedback, and potential collaboration through helena_rong@hks.harvard.edu. Stay tuned for updates via twitter.
For Academic Citation: Rong, Helena, A proposal for fractional property ownership and collective governance in local development (February 10, 2023). Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4353724.
Rong , Helena. “Can Web3 help enable fairer distribution of wealth? A proposal for fractional property ownership and collective governance in local development.” February 10, 2023
