Real Estate and the blockchain – a view into the future

1. Introduction

What is the blockchain anyway? Most people are probably now familiar with it in connection with the virtual currency Bitcoin, Ether and Co. However, the application areas of the blockchain go far beyond those of the crypto currencies. Hence, the blockchain is usable in far more areas than the virtual currency.

Unlike the financial services industry, which has long embraced technology as a means to generate better bottom line profits (think algorithmic trading), real estate is an industry that has remained largely unchanged for the last decades.

At the same time, digitalisation is not stopping at the real estate sector – albeit less quickly than in the financial industry. Instead, the potential has recently been recognised here as well. The International blockchain Real Estate Association (IBREA) is already an association dedicated to the implementation of blockchain technologies in the real estate industry. It is conceivable, for example, to set up a blockchain-based land register, to design contracts as so-called smart contracts and also to digitize financing.

In this context, it is argued that blockchain technology will play a major role in the processing of real estate financing and will thus drive digitisation forward. Of the technology companies, Google has already recognized this opportunity, which offers the real estate financing. As early as 2015, Google Capital had already acquired a stake in India’s largest real estate platform, called CommonFloor.

Back to the blockchain: This is also called a distributed database. It is a distributed register (English ‚ledger‘), hence the term Distributed Ledger Technology (DLT). The database system can be designed publicly as a „Public Blockchain“ or for a defined group „Private Blockchain“. Technically, data is stored linearly in individual ‚blocks‘. Between the blocks a connection (hence the term chain in blockchain) is created by a cryptographic checksum, which can no longer be changed, so the data of the blocks are safely stored in the chain.

The blockchain technology therefore has three particularly interesting characteristics:

  1. Distributed
  2. Unchangeable
  3. No middleman necessary

Distributed refers to the distributed data architecture, the ’single point of failure‘, which avoids the total loss of data and makes the system extremely resistant. Unchangeable is a property that has not existed in the digital world so far. No matter how secure a database is, there is still a ’super admin‘ who can change or even delete an entry. It is not like that with the blockchain. Everything that was once stored there is stored there forever unchangeably. This means that information can be traced back seamlessly using a blockchain and its accuracy ensured. Another strength of the blockchain: the network participants come to an agreement without a middleman as to whether a planned transaction will be carried out or not. Each participant in the blockchain network maintains its own logbook of all transactions for this purpose. This logbook is commonly referred to as a Distributed Ledger (DLT).

2. Fields of application in the real estate sector

1. The land register on the blockchain

There has been much discussion as to whether blockchain technology can replace and thus simplify the land registry system (Grundbuchwesen) in Germany. The convincing voices speak against this: the fact that high auditing and security standards are applied here by public notaries and land registries means that the security aspect has already been fulfilled and the blockchain technology does not promise any added value here. It would – on the contrary – would result in lower security. Ergo: the blockchain will probably not be able to replace the work of a notary.

The only thing that could support the blockchain at this point would be its speed. A transaction would take only a few days or hours in addition to registration; real estate transactions from the first contact of the parties to the registration of the transfer of ownership in the land register usually take longer than half a year, which is mainly due to the duration of the registration in the land register.

2. Processing of payments

The blockchain might make a comprehensive contribution to simplifying payment transactions in the real estate sector. For example, payment prerequisites and disbursements are regularly mapped as “if/then conditions”. First of all, partial payments in accordance with § 632a para. 1 of the German Civil Code (BGB) or with § 16 para. 1 of the German Award and contract regulations for construction services (Vergabe- und Vertragsordnung für Bauleistungen – Teil B, VOB/B) must be mentioned here. A contractor can then demand advance payments in the amount of the value of the respective service (“then” event) for the proven contractual services (“if” condition). Advance payments are an important refinancing instrument for construction companies, which can only demand payment for services once they have been rendered. In practice, the process of performance determination, invoicing, checking and approval or payment usually takes up considerable time and resources. Due to the existing if/then structure of the relevant regulations, automation seems possible and feasible when using the blockchain.

3. Contract committee and payment

Blockchain technology and a crypto currency as a means of payment open up further potential that can be made fruitful for construction contracts.

The contract itself can be concluded via a blockchain. The contracting parties do not sign a paper contract, but sign with their digital signature an electronically stored version of the contract, which has been stored in the blockchain in unchangeable form. The various practices of depositing large construction contracts together with their attachments with the notary then become just as superfluous as the time-consuming initialling of all contractual attachments. Additional advantages may arise in relation to the performance and warranty securities in use today. Such guarantees could be replaced by payment promises in crypto currency, which are automatically and guaranteed to be made on the basis of the Smart Contract (see below) when certain conditions occur.

4. Use of Smart Contracts

Within the framework of the rental process, considerable application potential is also seen for the use of blockchain technology, in particular as the basis for so-called smart contracts. Even though there are hardly any concrete applications here so far, announcements by industry participants already show that small-scale, repetitive processes, which are found in large numbers in the management of real estate, may be handled more efficiently than before with the help of blockchain technology.

This applies initially to the entire accounting system for energy and other utilities. This could eliminate the need for considerable effort in real estate management through automation, especially in the area of service charge accounting. However, automation could go much further with the help of smart contracts based on blockchain technology. Serious consideration is being given to enabling automated rental of rented premises by simply entering such rented premises. In such a case, the automated rental agreement could automatically check and execute the conditions of a rental, in particular also the payment. The entire transaction is validated and logged by a blockchain. Against the background of German civil law, there will still be many challenges to be mastered in order to actually make such blockchain-based Smart Contracts legally secure. Finally, a blockchain-based application is also being planned with an application for managing tenant reputation, which is intended to help overcome knowledge asymmetries between landlords and tenants.

The problem that arises is that the blockchain is necessarily an electronic construct that runs in a network distributed over several servers (usually on the Internet). This raises the question of whether Smart Contracts are also available for legal transactions involving specific forms. This may still be the case with a prescribed text form according to § 126b BGB. However, written form, public certification or other formal requirements cannot be actually represented in the blockchain and thus also not in Smart Contracts.

However, the conclusion that Smart Contracts could not be used in formal transactions is incorrect. Real estate transactions or surety agreements are a suitable subject of a Smart Contract if the parties agree to make the formal declarations of intent outside the Blockchain and then informally transfer them to the Blockchain for the purpose of triggering the Smart Contract mechanisms.

3. Outlook for the future

Such developments are not to be expected in Germany in the real estate sector in the medium term. Due to the high auditing standards by notaries and land registries, the security aspect offered by the blockchain technology is also of little relevance, as such security gaps do not exist in the current system either and there is no need for them.

However, the acceleration of transactions to a few days or hours made possible by blockchain technology would also be welcome for the German real estate market. Real estate transactions currently take a long time, usually never less than six months, from the first contact between the parties to the entry of the transfer of ownership in the land register. The only change in the German land register system in the foreseeable future is the introduction of a uniform federal database land register, which will replace the current graphic storage of entire land register pages, but is not based on blockchain technology. Although this may lead to an acceleration of the land register procedure in isolated cases, it will essentially not change anything about the current land register processes.