How Blockchain Technology Could Transform Commercial Real Estate: Acquisitions
Hinckley Allen Real Estate
March 12, 2019
Have you ever wondered if there was a faster way to accomplish due diligence? Has your deal fallen apart because of disintegrating trust between buyer and seller? Blockchain technology could automate aspects of real estate acquisitions, thereby relieving some of the administrative burden in closing complex deals.
What Is Blockchain?
Blockchain is a distributed ledger system. It can keep track of more than just money. Blockchain can be used for recordkeeping or to manage agreements between parties. Each party to a transaction would be assigned a digital identity on the distributed ledger through which it could view and verify each step, fact, dollar amount, chain of title, zoning permit, and more. This creates transparency and provides an efficient means to flag errors before they would become more difficult to correct. Digital participants must verify information before it is recorded as a “block” on the blockchain, which is a time-stamped, permanent record.
You may also be interested in “How Blockchain Technology Could Transform Commercial Real Estate: Land Records.”
Creating Automated Contracts
Blockchain is powered by smart contracts, which are automated processes that update a transaction’s status upon certain conditions being met. Smart contracts are coded to automatically transition through each phase of the larger transaction. Smart contracts could automatically end due diligence, escrow funds, transfer title, send monies, and more, without intervention from title companies or attorneys. Smart contracts could be built and agreed upon by the attorneys, title company, lender, and buyer in the same way that the parties would enter into a purchase and sale agreement. The benefit would be greater transparency and systemized input and validation from environmental consultants, engineers, and other involved parties.
Streamlining Due Diligence
Blockchain could host all due diligence information so that it is transparent to the parties. It secures data with cryptography, so it is also tamper-resistant. Today, due diligence is done largely on paper, increasing the likelihood of human error and slowing down the process. Each property, as does each party, could have a digital identity to which parties attribute the information. Computers would consolidate data on vacancies, creditworthiness, environmental clearances, tenant leases and rents, chain of title, and other metrics. All parties would know all metrics in real time. Lenders could coordinate their due diligence of the buyer to assess loan terms with the buyer’s assessment of the property. Lenders could synchronize their smart contracts with the buyer, to the smart contracts between buyer and seller. This would make all due diligence more transparent and reduce overall time in the due diligence phase. Additionally, it would increase efficiency, lower costs, and reduce the chance of manual error.
Upon the conclusion of due diligence, each party could use its digital signature to confirm such completion. This would trigger a series of pre-negotiated smart contracts that initiate a series of events: the lender’s transferring funds equaling the sales price to the escrow account, funds moving to the seller, a lien generated in favor of the lender, and a transfer of the property title. Blockchain could even administer and automate the borrower’s loan repayments to the lender. Each of these events would create a new “block” on the blockchain.
Blockchains have the potential to increase efficiencies of Registries of Deeds and to help prevent fraudulent transfers. If a property were sold in a blockchain transaction, and its owner tried to sell the same property to someone else, the network of computers on the distributed ledger would identify the attempted sale as fraudulent because the property would be digitally connected to the identity of the true owner. This would eliminate the need for title professionals to take action to fix title issues, reducing risks and fees. The same network of computers would verify history of ownership, occupancy, income, and expenditures during the due diligence process. If blockchain technology were widely adopted to maintain land records, the transfer of title could be instantly recorded on local land records, eliminating the lag in recording along with the need for title bring downs and gap coverage in title insurance policies.
Blockchain technology has the potential to greatly increase efficiency and accuracy in acquisition transactions. Blockchain and smart contracts are essentially a computer-coded version of purchase and sale agreements and financing agreements. The blockchain ledger contains the transaction information that all parties are entitled to access, thereby increasing transparency and efficiency yet keeping the information secure. However, buyers and sellers will still need to negotiate a letter of intent—the terms of the deal on which the smart contracts are based.
Blockchain technology is claimed to prevent fraud by operating as a distributed ledger with readily transparent information accessible to all. But time will tell if it is as verifiable and trustworthy as industry experts hope. Computer scientists use the expression “garbage in, garbage out” (GIGO) to mean that flawed input will yield flawed output. Blockchain technology along with digital identities record all the information on properties, but the reality is that the initial property information is only as good as user input.
Blockchain maintains the data for transactions associated with a person or place, which can be telling about the latter’s integrity. Companies are working to develop solutions to GIGO problem, but for now, information is best verified only after enough historical data has accumulated on blockchain ledgers to show a pattern. Lawyers, title insurance companies, and lenders will be needed to ensure that the input isn’t garbage to begin with. Blockchain will not spare buyers and sellers the use of lawyers and other real estate professionals. Blockchain technology and smart contracts are relatively new technologies, but if used wisely, they have the potential to greatly increase the efficiencies of acquisition transactions, generally, and the due diligence process, specifically.
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