Original Article: Real estate tokens: the risks and how to avoid them
Of course, tokenized real estate is a safe and low-risk asset class; however, no investment will be entirely deliberated from any kind of risk, and even merely holding cash contains risks like inflation or robbery. In this piece, we will guide you through jeopardies that can possibly be encountered in this field and explain how to make the best of real estate assets tokenization.
Possible risks of real estate tokens
For starters, it is reasonable to outline the possible risks this type of investing might have. Let’s review them one by one.
1. Poor management or bad property
If a property belongs to a person or a company that is not investing a sufficient amount of money or management or simply doesn’t take duly care about it, it falls in price and generally becomes unattractive. The same issue is relevant for junk properties ― meaning a piece of real estate that isn’t worth its money in terms of realization possibilities. To avoid making a non-cost-effective investment, look into an issuing company and the STO details.
2. Risks suggested by business model
Even if the initial property has good management, the business model of its exploitation ― meaning the way it is used ― maybe not be really widespread. Even renting the property as commercial type, compared to residential, has more spirals in the procedure. For example, while renting out an apartment is a standard business model, setting up a data center in the commercial property takes an additional security resource and puts either an owner or a tenant at a bigger risk.
The other case is leveraging real estate to take a loan, which creates a considerable risk regardless of how safe real estate is initially. For instance, a business may take a loan secured by the property in question; companies may take such a step to raise funds quicker and use it for this same property’s renovation, and while it may actually speed up the process, the risk grows as well. To avoid this situation, investors should pay attention to what is the property is being used for in the context of its business model and evaluate the adequacy of risk based on this data.
3. The market-related risk
Market-related risk is always bounded to global macro-and micro-economic trends. One of the most widespread examples would be the great recession (financial crisis of 2007-08) when the housing market in the United States swung from boom to bust; thus, a large number of mortgage-backed securities (MBSs) and derivatives lost their value. As a matter of fact, the crises like this can happen locally on the markets of different countries at different times, which is why it’s crucial to keep up with news of the global market.
Of course, when it comes to tokenized real estate, an issue of low liquidity is much less probable than it is for non-tokenized assets; yet, it can still exist. It can happen, for instance, if all the investors see the given property as a rather long-term investment opportunity and do not make an exit. Therefore, selling the property becomes quite challenging, as the active market is not formed. However, in the case of narrow liquidity (a low trading volume or small amount of money put in the liquidity pool), the final property’s price will be influenced by a significant investor’s exit.
Real estate tokens risk mitigation
Forewarned is forearmed: being well-aware of risks leaves more space for a proper strategy to avoid them.
Conducting due diligence is the first and foremost rule concerning not only tokenized real estate but all other investments. You should look into the management team and their former track record, as well as analyze the business model along with the adequacy and comfort of its risk. You also have to mind the current market state and get closely acquainted with the conditions of a potential investment.
There’s a saying that briefly describes the point of diversification: don’t put all your eggs in one basket. It’s crucial not to depend on one major investment and, therefore, not to put all of your savings in one asset. If you can choose between one big property and two smaller ones, it’s better to stick to the second option; additionally, investing in a couple of different asset classes (say, equity and tokenized natural resources) is even safer. This way, you will be able to distribute the risk.
If the tokenized real estate you have invested in is falling in price or has liquidity issues, it’s easy to get emotional. Indeed, sometimes selling real estate tokens ASAP is really the best option which will more or less cover the losses, but in particular cases, there can be a different solution. Some companies may have a turn-around plan, which is supposed to grow the token’s value or, at the very least, what investors can do is wait out the crisis: the prices may recover in some time, and your portfolio will be back to normal. Suppose an extraordinary situation is actually taking place; in that case, you need to consider how much, given your risk tolerance, situation nuances, and the planning horizon, does it make sense not to give up a current investment.
Tokenized real estate is an excellent class of assets with great economic potential; nevertheless, it requires a thoughtful approach. This is why investors should take one step at a time, conduct due diligence, and treat such investment responsibly in order to truly benefit from a low risk real estate tokens possess.
Apart from providing a helpful solution for raising funds, real estate assets tokenization possess better liquidity and can be used to build a new object or renovate the existing property.