According to a report by the Indian Brand Equity Foundation (IBEF), the market size of the real estate sector is expected to reach US$ 1 trillion by 2030. By 2025, it will contribute 13% to the country’s GDP. Investments in the industry at the end of Q2 2022 were US$ 704 million, and the price rise was 5.2%. However, despite being a popular investment tool, there is a significant capital requirement, high transaction cost and lengthy transaction process in purchasing and selling a property.
Tokenization of real estate assets, a new application of Blockchain, is expected to tap into this ever-growing market by simplifying and securing the administrative processes of real estate transactions and making commercial and residential properties accessible to a broader investor base (Figure 1).
The tokenization of real estate is the process of fractionalizing a physical property into digital tokens created on Blockchain platforms.
However, a formal regulatory framework must be established before introducing the technology in the Indian market. Some of the key areas where regulatory compliance is required are:
1. Unregulated cryptocurrency market
The transactions of digital real estate tokens will be carried out on Blockchain platforms like Bitcoin and Ethereum. However, in India, cryptocurrency markets are largely unregulated and volatile. Therefore, a stable, regulated digital currency is needed to encourage serious investors. This makes a case for CBDC, which can become a viable option for trading in real estate tokens.
2. Registration and Stamp Duty
When a property is bought, and the ownership is changed, it is registered at the registrar’s office, and stamp duty is paid. If the payment of the stamp duty and registration process is integrated into the smart contract, is the registrar’s role rendered useless? Another issue in this scenario is that the Government will have limited access to the data related to the registered properties. The companies owning & managing the properties will hold the data.
3. Digital Infrastructure
National Payments Corporation of India (NPCI) launched the NPCI Tokenization system (NTS) in December 2021. Currently, this platform is for the tokenization of cards only. For real estate, either the same platform can be used, or another exclusive platform has to be built since the technology is now domestically available. In either case, there is a need for a licensed platform for tokenization.
Also, large-scale tokenizing real estate in India requires massive IT and power infrastructure. To ensure operational efficiency, high bandwidth internet, data storage capacity, and uninterrupted power supply are essential for the system’s effective functioning.
4. Property Taxation
The Indian Government has brought virtual digital assets (VDA) under the Income Tax Act 1961. If real estate is tokenized, then as per the definition of VDA, property tokens should be considered as VDA. According to the tax laws, a 1% withholding tax is levied at the time of buying the VDA, and a flat rate of 30% is charged on the income from the transfer of the VDA. However, if one buys a non-tokenized property, it is taxed based on the size of the property and profit from selling the property is also taxable. The key difference between VDA taxation and property taxation is that the interest paid on the housing loan is a deductible expense from the taxable income. However, in the case of VDA, no deductions are permissible apart from the acquisition cost. Hence, should this deduction be permissible if a token holder is considered a property owner?
5. Security of Digital Tokens
Blockchain is a safe platform for storing crucial information. However, with respect to the custody of tokens, there have been concerns regarding the security of vaults and other custody solutions. Some of the hacking heists worth millions of dollars have made international news. Regulators must ensure that history is not repeated by providing secure custody solutions for the real estate tokens.
If regulatory and legal compliances are in place, real estate tokenization can potentially transform investments in the sector. Since it is a popular investment instrument, if the benefits of tokenization are realized, it can also pave the way for the tokenization of other assets, particularly the illiquid asset class.
