Gravel2Gavel Construction & Real Estate Law Blog
Non-Fungible Tokens (NFTs) are changing how we think about asset ownership in the real world and in the digital world. NFTs—unique digital tokens stored on a blockchain ledger that represent ownership of an asset, either real or virtual—have gained significant popularity in realms such as art, gaming and entertainment, as a means to establish authenticity and transfer various rights. As a result, entrepreneurs are searching for new industries to disrupt utilizing the advantages offered by NFTs and blockchain more generally. The traditional real estate industry, together with virtual land in the evolving Metaverse, has been on the radar of many.
NFTs in the Traditional Real Estate Industry
Real Property Ownership
NFTs can be used to represent ownership of real-world property. Currently, deeds serve this function and buyers employ title insurance companies, escrow holders and lawyers to authenticate deeds and search for encumbrances in public title records. NFTs can provide a way to potentially bypass trusted intermediaries because blockchains can verify ownership, identify title encumbrances and settle transactions more efficiently. In May 2021, Propy, a technology company active in this space, helped TechCrunch founder, Michael Arrington, list his apartment in Kiev, Ukraine, as a real estate-backed NFT. The property sold for over $93,000 and Propy touted this achievement as “the world’s first real estate NFT.” On April 12, 2022, Propy sold another property in Hyde Park, Tampa, as an NFT for $215,000.
Examples like this are likely to remain rare in the U.S. for some time because well-established laws and county land record offices do not recognize transfers of ownership with NFTs. The traditional real estate industry and its entrenched stakeholders will likely be slow to adopt this new technology.
Fractionalized Investments and Loyalty Programs
Real estate investments are capital intensive, so some entrepreneurs have turned to NFTs and digital coins to raise funds for their projects. In 2018, the St. Regis Aspen Resort sold an 18.9% ownership stake in the hotel through token sales of “Aspen Coins.” Investors could buy coins with U.S. dollars, bitcoin or ether. Omni-Psi, a real estate investment startup, raises funds from investors to buy properties by issuing ORT tokens. Revenue is distributed to token holders pro rata on an ongoing basis. Lofty AI is a technology startup that has created an online marketplace in which anyone can invest as little as $50 to buy a digital token equivalent to a stake in a single-property rental business. Each token represents a share of ownership in a Delaware limited liability company. Other platforms use art NFTs to attract interest in their real estate offerings. OXO Living, an Indonesian boutique developer, sold NFTs that “represented” the physical homes they were selling in Bali. The owner of a home had a right of first refusal on the NFT that was associated with his or her home. Anyone who had a crypto wallet could make an offer on an NFT. On a smaller scale, homeowners in need of liquidity can use platforms like Vesta Equity to raise equity from their homes by issuing tokens that represent fractional ownership interests.
Loyalty programs are also utilizing this technology. Marriott Bonvoy, the hotel chain’s rewards program, conducted a lottery at Art Basel, Miami, in which NFTs were distributed to three winners. Each winner was also awarded 200,000 loyalty points. AMC Theatres awarded around 86,000 NFTs to select loyalty members during the launch of the new Spiderman movie No Way Home.
NFTs in the Metaverse
In late 2021, Republic Realm (now Everyrealm) paid a record $4.3 million for virtual land in The Sandbox, the largest purchase of virtual land to date. In a 2021 report, Grayscale speculated that “the Metaverse is estimated to be a trillion-dollar revenue opportunity across advertising, social commerce, digital events, hardware, and developer/creator monetization.”
Virtual Land Ownership
Metaverse platforms like Decentraland and The Sandbox sell parcels of digital land by associating each parcel with an NFT and recording transactions on blockchain networks like Ethereum. After a buyer purchases a virtual parcel, the transaction is recorded on the blockchain, and the NFT is transferred to the buyer’s digital wallet. Metaverse platforms can then authenticate land parcel ownership when a user links a wallet to the platform. Users can also participate in governance if the platform is operated as a decentralized autonomous organization (or DAO) that allows token holders to vote on initiatives.
Decentralized Finance
Digital property owners can obtain loans by collateralizing their NFTs on platforms like NFTfi that match NFT owners with entities that have cash to invest. After the borrower and lender agree on terms, the loan is closed using a smart contract without the need for intermediaries. NFT owners can also fractionalize interests on platforms like Fractional and sell smaller stakes or place NFTs on platforms like NFTx and earn interest on the asset.
Tax Consequences and Risks with NFTs
The IRS has stated that tokens are taxable as property when a recognition event, such as a sale, occurs. NFT owners may be subject to restrictions on use in the applicable smart contract or terms of use applicable to a Metaverse platform. Blockchain platforms themselves are subject to scams and hacks. Even though the legal framework for the Metaverse remains in its infancy, NFT buyers and sellers must comply with the legal requirements currently applicable to their transactions. Moreover, an owner that breaches a platform’s requirements could risk losing rights in the NFT hosted on that platform. Determining which laws apply will be much more difficult than in the traditional real estate industry, in part because applicable rules are still being determined, jurisdiction could be asserted in multiple countries, and the enforcement of rights and remedies can be very challenging.
The Future of Real Estate NFTs
In theory, NFTs provide a simplified and more secure way of transferring ownership of real estate or shares in real estate investments, on- or offline. As with any emerging opportunity, any potential investor must perform appropriate due diligence and pay close attention to guidance issued by governmental authorities and rule-makers globally.
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