Tech startups look to blockchains to change the future of real estate
Nate Gipson got a notice back in February that one of his rental homes in…
Nate Gipson got a notice back in February that one of his rental homes in Memphis, Tennessee, needed a new ceiling fan. As a landlord, he thought the request was reasonable enough.
But before the work could go forward, he had to hash it out with a group of other people who, like him, had purchased a stake in the property through a cryptocurrency website called Lofty AI. And some of them needed convincing.
“There was a large discussion of, ‘Is the property manager scamming us?’” Gipson said. “They said, ‘I can go on Amazon and buy one for $35.’”
Like many decisions on Lofty AI, it came down to a vote of the owners, and the bylaws required a 60 percent supermajority for approval.
Welcome to the next phase of the crypto economy, in which ownership of faraway rental properties is divvied up into digital tokens that are sold around the world, and where the token-holders transform the business of being a landlord into a series of online polls — a system that the tenant may not even know about.
Lofty AI is one of several tech startups aiming to use blockchain technology to create a new form of investment in real estate. They add to a growing movement built around shared ownership and cooperation, often called distributed autonomous organizations, or DAOs.
DAOs are often formed around specific projects, such as crowdsourcing money to buy a first-edition copy of the U.S. Constitution, and members get a say if they’ve bought a token online.
The concept of real estate investing for the average person isn’t new. Websites such as Fundrise and RoofStock have for years offered the chance to buy shares of homes and commercial developments in distant places, but they often require a minimum investment of $1,000 or more and restrict how quickly an investor may cash out.
Lofty AI is going further, creating a mostly unregulated online marketplace in which almost any adult in the world 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 the Delaware-based limited liability company.
“Real estate has historically been seen as a stodgy industry that’s resistant to change, and now we’re seeing all kinds of tech and real-estate ventures,” said Desiree Fields, an assistant professor of geography and global metropolitan studies at the University of California, Berkeley.
She said the emergence of new real estate marketplaces reflects how hot the housing market has become, attracting ever more investors while pricing out many would-be homeowners.
“You can’t afford to buy a home yourself, but maybe you can become 1/50th of a landlord,” Fields said.
Lofty AI is still small. Its online marketplace began last year and so far lists about 90 rental properties, mostly in Rust Belt states such as Illinois, Michigan, Missouri and Ohio. Property management companies handle the day-to-day rental operations.
“We just thought, ‘Is there any way we can make real estate investing more accessible, so that anyone with an internet connection would be able to start building an investment portfolio of rental properties?’” said Jerry Chu, Lofty AI’s CEO. The startup got funding from Y Combinator, a well-known Silicon Valley investment firm.
“What we want is to bring the benefit of acquiring these individual properties yourself without having to deal with the problems,” he said.
Gipson, 24, isn’t a typical Memphis landlord. A student in the San Francisco Bay Area, he also owns tokenized shares of rental properties in Chicago, and he regularly votes on subjects that come up for his properties — such as the new ceiling fan, which owners did approve.
“I feel like a landlord making those decisions,” he said. He plans to sell his tokens eventually for a down payment on a home of his own.
The buying and selling of tokens are recorded on a blockchain, a system in which many computers contribute to a shared database or ledger that no single entity controls. Chu said the blockchain ledgers are fit to take the place of old-fashioned record-keeping in real estate because the transactions are transparent.
“The buyer and seller can’t trust each other sometimes, and that’s why you have this whole escrow and settlement process,” he said. “For us, settlement takes four seconds.”
But it’s not clear if the idea of democratizing investment in rental properties will sit well in a tight housing market that’s already seeing huge change thanks to other tech startups.
Gipson said the startup began telling investors not to reach out to their tenants directly after an experience early on when a tenant learned about Lofty AI and thought it was so unusual that it must have been a scam.
“It would be bad etiquette if a tenant was reached out to by 30, 40 different people saying, ‘Oh, I own the property,’” he said.
Single-family home rentals have historically been informal arrangements, as individual landlords rented out their second homes or properties they inherited. But that changed during the Great Recession that began in 2007, when large investment firms started to buy up foreclosed houses.
That has paved the way for small investors to crowdsource their way in, said George Ratiu, a senior economist at Realtor.com.
“The single-family rental is becoming something of a standardized investor class,” he said. “We’re just beginning to sense and see the impact that technology is making.”
Ratiu said investors have been attracted to the rentals in part by low levels of new construction constricting the national supply of housing and pushing up prices and rents. Rising interest rates this year will also keep some potential homebuyers in the rental market longer, boosting demand in the short term, he said.
“The risk is: What happens in a down market? Are their positions going to be hedged well enough that they can withstand that shock?” he said.
The properties on Lofty AI have maintenance reserve funds, and token owners have had lively discussions in online message boards about how to handle evictions and avoid becoming absentee landlords or worse.
“The short-term investors will always pick the cheapest repairs because they don’t want their CoC affected,” one investor wrote this month on Lofty AI’s Discord message board, referring to “cash on cash return,” a measure of investment performance.
Last year, a new investor joked darkly on Discord: “I’ve joined the club and own tokens. I’m uncertain if my business card should be titled ‘uncle moneybags’ or ‘slumlord’. Please advise.”
Fields, the Berkeley professor, said that complex and anonymous ownership arrangements could make it difficult to hold landlords accountable.
“The landlord can be anywhere. There’s this geographically stretched relationship,” she said.
“Absentee landlords are not a new thing, but they don’t necessarily have a stake in Cleveland, Ohio, and the people who live there.”
The conversion of owner-occupied houses into rentals is getting pushback in some neighborhoods where neither renters nor outside investors are especially welcome. The Wall Street Journal reported this month that leasing restrictions are on the rise among homeowners associations.
But the concept of tokenized real estate is still being tried elsewhere, including at competing startups such as Arrived Homes, which offers rental property shares starting at $100, and Vesta Equity, which allows homeowners to convert equity into non-fungible tokens, a kind of unique digital asset. (Lofty AI’s tokens are fungible tokens, meaning they’re interchangeable with tokens in the same property.)
In the mountain town of Aspen, Colorado, the St. Regis hotel is selling ownership shares via a digital currency called Aspen Coin. As of last month, 826 investors held the coin, according to tZero, an online marketplace where the coin is traded.
For investors, the emergence of these marketplaces may address what’s long been a downside of real estate: People usually can’t sell quickly if they need cash for another purpose.
“We think blockchain technology and its gradual introduction provides an important path for facilitating liquidity,” said Alan Konevsky, tZero’s executive vice president. “It’s an open book that investors see.”
But government regulation remains a question mark for cryptocurrency marketplaces. Lofty AI has taken the position that its tokens do not meet the federal legal definition of a “security” and that its marketplace does not meet the definition of an “exchange,” allowing the startup so far to avoid most regulations from the Securities and Exchange Commission.
SEC Chair Gary Gensler has said that most crypto tokens bear the hallmarks of regulated securities, but the commission has so far held off issuing rules while the Biden administration studies various questions around cryptocurrency.
The SEC did not respond to a request for comment on Lofty AI.
But Lofty AI already hit a regulatory wall in California, where state law defines a security more broadly than federal law. In February, Lofty AI stopped allowing California-based investors to buy new tokens.
The California Department of Financial Protection and Innovation declined to comment.
In the absence of government regulations, Lofty AI has been coming up with rules of its own, such as barring anyone from owning more than 15 percent of a property. The company makes 8 percent of the sale price of a property if investors buy all the tokens.
“Our hope is that it gets as large as possible,” Chu said.