How the Blockchain Can Disrupt the Real Estate Rental Market

The housing market is a special kind of market. In contrast to others, such as the markets for food, books, smartphones, or toilet paper, the supply of land is inherently limited. There is a fixed amount of land available on Earth, and nobody is creating any more of it (except a couple of landfill projects in the Netherlands and the UAE, for example, but those can’t really house millions of citizens).

Of course, we have some options of increasing the housing space in spite of that: We can build higher (multi-storey apartments), and we can build on land which hasn’t been developed before. But the value of such new developments tend to be lower in general, fancy interior design notwithstanding: Only few people like to live on the 30th floor of an anonymous apartment block for more than a few years, and equally only a few people want to live in the middle of nowhere.

Instead, there are some regions that are constantly popular with buyers and renters, and these are the regions that are close to metropolitan areas, but have enough open space and greenery to avoid an “inner city” feel.

Competition for space in these regions is fierce in almost any country among both buyers and renters. However, buying and renting are two very different business models. The unique thing about buying is that you deal with an entity (the seller) with whom you will most likely never transact with again for the rest of your life. Renting is different: It’s a real marketplace in which trust between participants can and will make a significant difference in the outcomes. As we know, all trust-based marketplaces are candidates for disruption at the hands of blockchain technology. So, let’s take a look at the rental market first, and its potential disruption by the blockchain.

Is the Сurrent Real Estate Rental Market Fair to You?

The current rental market has another feature that makes it a likely candidate for blockchain-based disruption: It is not a perfectly transparent market between equal parties, but it is riddled with information asymmetry with lots of middlemen that increase prices without contributing any significant value. Let us first take a closer look at these participants:

Just Owners And Tenants?

In an ideal real estate rental market, real estate owners (supply) and renters (demand) would be equal partners, transacting with each other without any middlemen. In some cases, they still do.

Real estate owners

Real estate owners can be individuals renting out a single house or apartment complex, or they could be corporations that own hundreds or thousands of assets. And they can be anything in between. For example, individuals who own many rental properties (inherited or purchased), or smaller companies that play in a different market most of the time, but devote some resources to the renting out of surplus office buildings.

To simplify things, we can say that real estate owners can be divided into two groups: Those for whom the letting and maintenance of their buildings is their chief pursuit – and those for whom it is merely something on the side.

It is easy to see why part-time landlords choose to work with middlemen to bring their rental properties to market. They don’t have the time and/or knowledge to take care of everything themselves. But even large rental corporations often choose to work with freelance middlemen to market their properties, vet potential tenants, and take care of maintenance.

Middlemen

The classic middleman in the real estate business is the real estate agent. A real estate agent’s job depend on their individual agreement with the owner, and range from the creation of rental ads to meetings with prospects, as well as contract negotiations to overseeing maintenance and repairs.

Between these traditional middlemen and tenants, there is nowadays another layer of middlemen: Digital agencies and services that enable middlemen to find customers online through advertising.

Finally, yet another group of middlemen is emerging; digital platforms on which owners, middlemen, and tenants can find and contact each other over their respective offers. These often have advanced filtering options and the option to review transactions and participants. Therefore, in contrast to the other groups of middlemen, these services actually increase transparency, while other middlemen profit from intransparency because it allows them to leverage their own knowledge and impose additional fees.

Tenants

In the real estate market, the tenant is often the least well-informed player, as practically no one sees their own chief pursuit in renting apartments. Instead, this is a transaction that is done every few years and doesn’t get a lot of thought in the meantime. The tenant also tends to be the player with the least wealth. In combination, this leads to a power imbalance to his or her disadvantage.

So, returning to this section’s headline: If you’re a tenant, the answer is no, most likely the real estate rental market is not fair to you. The other players are better informed and wield more economic power. This disadvantage for the tenant is toned down a bit by strict laws designed to protect tenant’s rights in some countries. However, these are not a universal thing, and even in countries that do have such laws, property owners and middlemen often find a way around them.

The Real Estate Rental Market Economic Model

Now that we know the relevant players, how do they interact in the real estate rental market?

The most fundamental transaction is of course the rental contract. Property owners and tenants agree that the tenant will be allowed to live in and use a certain allocation of space within the building (a single apartment, an apartment with garden and/or garage, or even the whole house and plot of land). For this, the tenant pays the property owner (landlord or landlady) a certain amount of money in an agreed-upon period of time. In most countries, rent is paid fortnightly or monthly, but shorter and longer payment intervals are possible too. Rent can be paid via bank transfer, credit card, cash, or in any other form that owner and tenant agree upon. The rental contract can be terminated either by owner or tenant. Many countries impose certain restrictions on the owner’s ability to terminate the contract. However, repeated failure to pay the rent fully and on time is almost always grounds for termination.

How much rent will owner and tenant agree upon? This depends on a number of factors:

  • Size and quality of the property
  • Location of the property (more expensive: close to metropolitan areas, close to natural beauty such as forests or the sea, close to educational institutions, shops, freeways, public transport, etc.)
  • Local salaries and the cost of living
  • Length of the contract (if either of the two parties wants the contract to end after a certain period of time, it gives the other party leverage with the price)

How each of these factors influence the value and price of a property is a science in itself.

Middlemen are paid either with a flat fee or a percentage of the rent in question. For example, if a real estate agent closes on a rental contract with a tenant, they receive a one-time fee that is a certain percentage of the yearly rent. How much exactly depends on local customs; typically, between one and three months’ worth of rent. Who pays the commission – owner or prospective tenant – can also vary with local customs and legal regulations.

Thus, traditional middlemen have the following interests they want to protect:

  • They don’t want owners and prospective tenants to get in touch with each other directly.
  • They want to negotiate high rents. This typically works in the tenant’s disfavour if the tenant has to pay the commission. Then, he or she will not only be plagued by a high monthly rent, but will have to pay more commission as well.
  • They prefer short-term rentals because once the contract is signed, there is no opportunity for them to earn commission until the next tenant moves in.

In summary, traditional middlemen are incentivized to seek low market transparency and high prices, and they don’t have any incentive to ensure long-term happiness for the owner or the tenant. On the contrary, they earn more commission if unsatisfied owners or tenants lead to a high turnover in rental contracts.

Real estate agents earn more commission if unsatisfied owners or tenants lead to a high turnover in rental contracts. Click To Tweet

What is More Advantageous: Renting or Renting Out?

Of course, buying prices and rental prices are correlated. In regions in which houses can be bought cheaply, renting is usually cheap as well, and vice versa. A very rough estimate that is valid for many regions is that the buying price for a certain property is usually about 20 times as high as its yearly rent.

Thus, it is unlikely to find a cheap deal for buying property in a high-rent area, and vice versa.

But the question still remains: Should you buy or rent a property?

The answer depends on several individual factors:

  • Do you have the initial investment money available? Taking out a bank loan to buy a property adds another middleman – the bank – and it increases the price substantially. Even low interest rates in the traditional economy (such as right now) do not alleviate this problem because they are reflected almost instantly in increasing property prices –  once loans become cheaper, more people can afford to buy and demand for houses that exceeds the supply.

If you have to take out a loan to buy property, you will currently pay around 1% to 2% in interest. For a loan of 400,000 USD, that would be 4,000 USD to 8,000 USD per annum, or about 330 to 660 USD per month. Thus, in the first few years, private homeowners often pay more each month only to cover the interest than to actually pay back the loan.

But even in these times of low interest rates, beware: You can be certain of this tax rate only for the next 10 to 15 years, depending on your contract with the bank. After that, it may be significantly higher!

  • Do you have the skill, talent, time, and inclination for property maintenance? The general rule (with some exceptions) is that if something breaks on your property, you have to fix it. If it breaks on a property that you have rented, it’s the owner’s problem. Repairs can become extremely expensive, requiring tens or hundreds of thousands of dollars, depending on the property size. Take for example the high costs for a new roof, or for repairing heating or electrical systems. You can alleviate this problem somewhat by buying various insurances, but guess what? They also cost you money. However, if you are a skilled tradesperson or fixing things is how you relax after a long day at work, you can strike a good deal here because your improvements on the property, which only cost you your own time, can increase the value substantially, and it can even prevent the property from losing value in the case of damage.

When building a new house, a non-professional worker can expect to bring in about 10 to 15% of the house’s value in his or her own working hours to the table. In existing houses, the proportion of course depends on the amount of work needing to be done. In houses that are heavily in need of renovation, you may even come close to the amount for building a new house. Of course, if you are a skilled handyman or work in a skilled trade, you can create even more value with your own hands.

  • Are you ready to deal with paperwork and legal regulations? Buying a property comes with a lot more paperwork than simply signing a rental contract, and a legal middlemen (a notary) is always involved (not for free, as you have probably suspected by now). And even after that, property owners face a multitude of regulations regarding how to treat your tenants (contract terminations, etc.), duties towards the local council (road maintenance, sewage management, etc.), how to get along with neighbors (vegetation at the plot boundaries, distances of additional buildings, etc.). You can even be subject to legal regulations that didn’t even exist when you bought the property, for example new taxes or new environmental regulations that require you to spend a lot of money for building improvements such as insulation.

Notary fees vary significantly between countries, and they depend upon the property value. They include fees to be paid not to the notary themselves, but to the land registry as well. Typically, they will be between several hundred and several thousand USD for a property value of 300,000 to 400,000 USD. Other fees and taxes vary greatly not only between countries, but even between towns and cities.

However, an obvious fact in favour of buying remains: Instead of losing your money to a landlord each month, you own something of substantial value which you can use to earn revenue (by renting out the property) and even leave to your children and grandchildren. As we have discussed above, land and property will always be in demand even three generations from now, while your expensive laptop or a now fashionable piece of jewelry will probably not be a very desirable inheritance for your grandchildren.

In addition to the tangible financial benefits of buying, there are intangible benefits too:

  • If you don’t own the house, in a rental relationship between tenant and owner is a contract that can be terminated by both sides (within legal boundaries). That means that of course you can decide to cancel your apartment and move away, but the landlord can also decide that they don’t want you living on their property any more. Especially if you have lived there for a long time and made friends in the neighbourhood, this is the equivalent to losing your home against your will.
  • On other people’s property, you have to confirm to their rules: Whether or not you can keep pets, if you can redesign your bathroom when you’ve grown tired of it, if you can alter how the outward appearance of the house is supposed to be, which sources of energy and heating you may use, sometimes even who can spend the night or two weeks on your couch. In your own home, you are free to do as you please. Many properties even include a garden or a bit land. Again, if you own it, you are free to decide if you want to have a lawn, an apple orchard, a swimming pool, a halfpipe, or a helicopter pad out there.

And you are still free to go anytime you like: You can either sell the property or rent it out.

How Online Rental Marketplaces are Disrupting the Traditional Market

But even though the advantages of buying a home are significant, in the US market currently, more people are renting instead of buying than ever in the last 50 years, namely about 36% of all households are being rented out. This has been attributed to the financial crisis of 2008 and to rising student debt. In western European countries, the proportion of renters vs. buyers is similar or even higher – about 35% in France, 37% in the UK, 50% in Germany, and 58% in Switzerland.

The trend towards renting is most pronounced in households by younger adults, in non-white households (in the US), and in households with low incomes. This shows that the most important barrier towards home ownership is the massive investment that is required up front – even if you don’t intend to pay for your house in cash, you still need sufficient capital to even be considered for a bank loan. We will discuss this problem in greater detail further below in the article.

And wherever there is a trend, there is also someone on the web to cater to that trend:

As we have mentioned briefly in the section about middlemen, rental marketplaces are a new kind of middlemen that actually contribute to the transparency of the market instead of preventing it. They have done the same for the transparency and convenience of the rental market that Ebay and Amazon have done for the retail sector, Upwork and Fiverr for the freelance market, and Uber for individual transportation (and some may say Tinder and OKCupid for the dating pool).

Rental marketplaces are a new kind of middlemen that actually contribute to the transparency of the market instead of preventing it. Click To Tweet

The basic premise of all these marketplaces is to provide both the supply and demand sides of the market with an easy-to-use platform so they can directly get in touch with each other, cutting out the wasteful involvement of middlemen.

Of course, online marketplaces don’t do this for altruistic reasons. In this regard, they are still true middlemen: They also want their share of the cake, i.e. a fee or commission. But there are two chief differences between these arrangements and traditional middlemen such as real estate agents:

  • Online marketplaces can afford to have lower fees because most of their services are automated, requiring less manpower a real estate agent who needs gets in touch with his prospects in person or by phone.
  • They are less interested in maintaining intransparency because transparency – or at least the appearance of transparency – is one of their main selling points towards their users. In other words, users of online platforms expect that they can compare lots of rental properties, while the client of a real estate agent expects her to find just “the right one,” whatever that will be.

Another advantage of online platforms comes with the increased transparency. While the reputation of a certain property owner or real estate agent used to depend on word-of-mouth, on online platforms every participant of a transaction can leave reviews, thus giving a more accurate impression of the actual quality of services of the middlemen and owners.

Online marketplaces in other industries, like Ebay and Upwork, have commission-based fee structures. That means the platform earns a certain amount of money from every transaction. The same fee structure applies for traditional real estate agents, at least when they negotiate rental contracts. This business model suffers from the problem that transaction partners are incentivized to make off-platform deals to save on the commission. There are several measures to prevent them from doing this – most of them are based upon limiting the opportunities for transaction partners to get to know each other outside the platform and exchange contact details.

Rental platforms, however, usually have a flat fee model; the owner or real estate agent pays per listing. The reason for this is probably that off-platform deals would be hard to avoid in the real estate market – the platform must supply enough information to identify the property in question, and from there it would be easy to identify the owner or manager.

An example for a US-focused rental marketplace is rent.com. They offer different packages for property owners or managers, starting from 49.99 USD for a 30-day listing with a limited number of photos, to 179.99 USD for a 90-day listing with unlimited photos and improved search presence. Similar sites in other countries, such as Germany’s immobilienscout.de, share the same business model. While property owners or real estate agents always have to pay to list a property, sometimes there is also a fee for prospective tenants to create a more detailed profile with the idea to improve their chances of convincing a landlord to enter into a contract with them.

New Platforms, New Problems?

However, online rental marketplaces in their present form are certainly not the perfect solution to the rental market problem (yet).

For one, there is still a kind of information asymmetry between owners and middlemen on one hand and prospective tenants on the other. The former have much more experience in how to display their properties in a way that is most favourable, while the latter usually have little experience. They may have rented an apartment a few years previously, or never at all, and thus don’t know which pitfalls to look out for in a rental property listing.

But there are problems for property owners too. Prospective tenants are usually not required to register under their real names, and even if they do, they only need one person’s account to arrange accommodations for a family or a group of tenants. Thus, while property owners and middlemen need to be concerned about potential bad reviews, they are not a threat to misbehaving tenants. They can easily sign up again under a different name or their roommate’s name, and future owners will never learn about their misdemeanors in the past.

And finally, online platforms can only help the transacting parties to get in touch with each other. They don’t do anything to make the contract transaction easier, faster, or safer. After having found each other through the platform, the owner and prospective tenant are left to their own means to negotiate and close the contract.

Blockchain-Powered Rental: As Good As Ownership?

As we have seen with many other examples in the past few years, a platform with a community whose members are looking to perform transactions with each other but who don’t necessarily trust each other, is the prime use case for a blockchain.

Why is that?

  • Smart contracts can automate conditional transactions in a very efficient manner (unless there are scalability problems – see below), and they create results that cannot be disputed by either party.
  • Because blockchain entries and smart contracts can potentially become legally binding (if the government of the respective country decides so), even those parts of the rental process that used to be completely offline can now be automated, such as the signing of the contract in person or the handover of the property. With the help of Internet-of-Things components (for example, smart keys that activate upon the execution of a smart contract), the handover can be as automatic as the rest of the process, removing the need for the owner or her representative to be there in person.
  • Transactions will be stored indefinitely on the blockchain and can be audited in retrospect. This builds a real online reputation and history that will incentivize both renters and owners to behave in an honourable way, preserving their good reputations for future transactions. When reliable reputations like this are connected to provable offline identities, digital identities are created that become even more trustworthy than identities in the offline world.

More efficient processes, just like in any other industry, will lead to cheaper rent prices without cutting away any of the owner’s profits (it will, however, cut heavily into the middlemen’s profits, who may have to start looking for another occupation).

Blockchain, Asset Tokenization, and Co-Ownership

But in the rental market, the blockchain principles can be taken even further than just the rental contract itself. Even property ownership is a candidate for disruption on the blockchain by so-called asset tokenization. The auditability and clear ownership of blockchain-based tokens make it possible to anchor real estate property (or any other kind of property) to blockchain transactions. This feature is available in the offline world as well – think co-ownership or joint ownership – but in the blockchain world, it becomes much more flexible and unburdened by bureaucratic overhead. And because of this, a more granular concept of ownership becomes possible. If you always have to pay a hefty notary fee of several hundred USD, it is not efficient to buy 0.05% of an apartment with your savings of 500 USD. But if there is just a minimal transaction fee on the blockchain of a few cents or a few dollars, the picture looks significantly different and makes investments of even small amounts attractive.

The auditability and clear ownership of blockchain-based tokens make it possible to anchor real estate property to blockchain transactions. Click To Tweet

And this may even have disruptive social consequences as well. Traditionally, real estate investment has been a prerogative of the wealthy, i.e. those with sufficient capital to buy whole objects and cover the substantial overheads that come with this form of investment. Even for those not looking to pay cash for a real estate asset, a sufficient down payment is still a significant sum of money that young adults, adults with student debt, or from low-income families just don’t have on hand.

Thus, a potentially profitable investment sector has been unavailable to young people and those from less wealthy backgrounds, increasing the inequality of economic opportunity. With the blockchain-based streamlining of this process, real estate investment can become available even to those with just a few hundred USD to spare.

Solutions like this have already been available in the traditional economy in the form of equity-based housing cooperatives. However, they suffer from large bureaucratic overhead and inefficiencies.

Is The Blockchain Ready For Real-Estate Co-Ownership?

The blockchain is a very promising technology if you want to make asset tokenization real. So, now we will try to answer the question: Are there any blockchain startups that give you the opportunity to co-own rather than rent?

Rentberry 

Rentberrys mission is to make the rental market more efficient. They’re offering a much more sophisticated solution: In addition to digital contract signing, they have already implemented digital payments (although not on the blockchain) and other features:

  • Inviting potential roommates to an offer or requesting maintenance services online.
  • Crowdsourcing of rental security deposits, which are a significant burden for new renters without sufficient capital, and after signing the contract they sit unused in bank accounts for years or decades.
  • Auctioning technology which allows rental auctions between an owner and several prospective renters. In the current market where more people want to rent than ever before, rental prices are already going up much to the disadvantage of tenants. In a climate like this, rental auctions may contribute to higher prices, and therefore benefit the owners alone.
  • Raises privacy concerns by planning to implement a proprietary quality score for owners and renters, for which they want to access professional records.

In summary, Rentberry promises some improvements in the efficiency of the renting process, but they will most likely not do anything to improve tenants’ position in the rental market.

Doma 

Doma’s mission statement covers exactly what we have defined as the current market gap above: “Owning a home has become a luxury that fewer and fewer people can afford. All around the world, an increasing number of urban dwellers are resigning themselves to a lifetime of rent. It is time to change this unsustainable mode of living.”

Doma’s legal status is a non-profit housing cooperative known from the traditional economy (see above). It intends to purchase houses in urban areas and offer them for a monthly price that decreases over time. Thus, with constant payments, users can acquire equity over time. This acquisition of equity even continues when users move between the different properties of the cooperative. Its pilot round is planned to take place in the city of Kiev, Ukraine. From there, Doma wants to expand to cities in Europe and beyond.

However, no white paper with detailed information is available yet, just a pitch deck and a reference to the Russian summer school program in which the concept was developed. The team consists of designers and architects, so it will be necessary for them to assemble a strong technical team. Potential investors need to check back occasionally to follow the progress of Doma, or follow them on Twitter.

Crowdvilla 

Crowdvilla is a blockchain project that is not focused on the long-term rental market per se.

Instead, after the crowdsale of their CRV tokens, announced for March 2018, they are proposing to acquire a portfolio of holiday properties in the “casual luxury segment.” This portfolio will then be co-owned by all holders of the CRV token, who will elect asset managers to decide on property acquisitions, and who can redeem CRV-associated utility tokens to book their stay in the holiday property of their choice. So, basically:

Crowdvilla proposes a blockchain-based timeshare model.

However, the founding company Reidao (www.reidao.io) considers Crowdvilla only one of its projects. One can easily imagine that the same concept can be generalized towards long-term rental relationships, although no such project has been announced by Reidao so far.

Conclusion

What is the future of renting? Will anyone be willing to pay for the right to live in someone else’s apartment without getting any equity in return?

At the moment, it seems like renting is not going to die out anytime soon – quite the opposite in fact; demand for rental apartments and rental prices are going up. However, this upwards trend also increases the number of people who are dissatisfied with the current system, and dissatisfaction is a good foundation for disruption.

The technical basics are already available – assets can be tokenized on the blockchain and be owned by members of the crowd. However, there are a couple of issues that need to be sorted out prior to or during pilot projects:

  • Will homeowners be willing to sell their properties to blockchain cooperatives?
  • What is going to be the legal status of blockchain-based home ownership? In case of transactions gone wrong, will traditional courts intervene, or do participants carry all the risk, like in Bitcoin and other cryptocurrencies?
  • Will participants be able to reach a consensus over questions such as which properties to buy and how to maintain them? This may require that the market supports different cooperatives for people with different expectations and lifestyles.

If legal issues can be solved successfully, blockchain-based property ownership will have a promising future, and they will be backed by the trend towards asset-backed tokens that is present in the overall blockchain scene.

But depending on where you live, it may take up to ten years until you can be a blockchain-based home owner. You can’t terminate your rental contract just yet, but you can spread the knowledge with a share or a tweet to push the innovation even further:

SAY WHAT YOU THINK

Related