Strata Tecno 001: Future Technology Based Property Subdivisions

Let’s start with some forward thinking about technology in the property sector …

To get this series of articles about new and better strata tech started, I’m exploring some more esoteric ideas about the next technologies and how they might [or will] get used in the future in the strata title sector.

[10.5 minutes estimated reading time, 2118 words]

Introduction

Earlier this year I wrote in ‘Explorations into New & Better Strata Tech’ that I would be publishing regular articles showcasing existing and new technologies for the strata title sector called Strata Techno;

But, it’s taken a while to get started as I’ve struggled to find the right way to kick off the article series. 

I wanted to write about something completely new, novel and exciting by showcasing a non-mainstream initiative.  Plus, I wanted the first article to be about the future [not the present or the past] as those articles can come later.  So, I had to wait until I found the right subject and source.

I’ve now discovered that topic buried in a submission to the Federal Government’s Senate Select Committee about Australia as a Technology and Financial Centre that was written by three law professors at Griffith University and Bond University. 

It’s a bit esoteric, but I’ll try to show its relevance to our strata tech future.

So, here begins my/our journey into the future with Strata Tecno.

Emerging technologies meet traditional property law

There’s a great deal of interest by technology, business, and government stakeholders in new technologies around finance and money issues which is generally described as Fintech. And, unless you’ve lost all your electronic devices, you’ve undoubtedly heard of Bitcoin, cryptocurrencies and the Blockchain.  But, whilst technology, business, and government stakeholders have been focused on these new technologies for banking, equities, lending, transactions, etc, there’s been very limited focus on real property. 

I think that’s about to change as this article explains.

Let’s start with some basics as follows.

Blockchain is a technology system [software] that creates a growing list of records, called blocks, that are linked together using cryptography. Each block contains a replica of the previous block, a timestamp, and transaction data. The timestamp proves that the transaction data existed when the block was published in order to get into its transaction data. Blocks contain the hash of the previous block, forming a chain, with additional blocks reinforcing the ones before them. Therefore, Blockchains are resistant to modification of their data because once recorded, the data in any given block cannot be altered retroactively without altering all subsequent blocks.

It's a non-centralised way to store and process data.

You can read more about Blockchain as an introduction here.

FinTech describes technology innovations that compete with traditional financial methods in the delivery of financial services. It is an emerging industry that focuses on using new technology for banking, investing, borrowing services, cryptocurrency, to make financial services more accessible and cheaper to the general public. Financial technology companies consist of both start-ups and established financial institutions and technology companies trying to replace or enhance the usage of financial services provided by existing financial companies.

You can read more about FinTech as an introduction here.

Real property is an established way of identifying, dividing, and allocating ownership interests in land and airspace on earth.  It encompasses a range of real property types and systems [land as well as stratum/cubic space title] as well as different kinds of legal ownership interests in that real property [like ownership, mortgages, leases, easements, etc].  It’s traditionally been distinct from personal property [things] and contractual rights.

You can also read more about real property as an introduction here.

The Senate Select Committee about Australia as a Technology and Financial Centre was established in 2019 to inquire and report on the following matters:

• the size and scope of the opportunity for Australian consumers and business arising from financial technology [FinTech] and regulatory technology [RegTech],

• barriers to the uptake of new technologies in the financial sector,

• the progress of FinTech facilitation reform and the benchmarking of comparable global regimes,

• current RegTech practices and the opportunities for the RegTech industry to strengthen compliance but also reduce costs,

• the effectiveness of current initiatives in promoting a positive environment for FinTech and RegTech start-ups, and

• any related matters.

Although the Committee was due to report by October 2020, that date has been pushed out twice and it is now 30 October 2021.

For completeness, the Committee's issues papers are here [Issue Paper 2019] and [Issue Paper 2020].

But, it’s not the Committee’s direct work that interests me at the moment.  Rather it’s Submission 32 that was made to the Committee under the ‘any related matter’ category by three Queensland property law professors.

The property law professors' submission

Dr. Kate Galloway [Associate Professor, Griffith Law School], Dr. Louise Parsons [Assistant Professor, Bond University Faculty of Law], and, Dr. Francina Cantatore [Associate Professor, Bond University Faculty of Law] wrote a 5-page submission about how the new Blockchain technology would create opportunities in real property that will challenge many related stakeholders in regulatory, financial and other business areas.

The submission is here and I recommend you read it even though I’m summarising and analysing it below.

The summary of the submission prepared by the professors themselves reads as follows.

1.1  Blockchain systems are currently under consideration to register and trade in physical assets, that will likely integrate with FinTech or have implications for it.

1.2. Fractionalisation of land that is traded via blockchain will require widespread interoperability of land registries and land administration infrastructure, financiers, insurance companies, bodies corporate and local authorities.

1.3. The creation and use of ‘coins’ on a blockchain representing a proportion of a registered lot of real property create two parallel registries: blockchain and land titles.

1.4. The existence of a coin and the land it is attached to, is likely to constitute two different types of property at the same time: real and personal property. The personal property component may be best characterised as a financial product.

1.5. Inevitably, rendering land ‘liquid’ through blockchain (or other) technologies, has implications for FinTech: necessarily integrated financial technologies.

1.6. Potentially global capital movement in support of the trade in fractionalised interests in land raises multiple issues for regulators.

1.7. Although Australia has not implemented a system of fractionalised interests,3 regulators should be contemplating their place in the overarching ecosystem of FinTech.

What’s particularly interesting to me about their submission though are the following further points they make.

A.  They believe that Blockchain and FinTech will create a new hybrid form of property that crosses the boundary between real and personal property.

B.  There are two ways to break up a traditional property asset [thereby fractionalising it]:

i.  by tokenisation which involves creating a non-registered interest in the property asset where investors/fractional owners are entitled to some part of the property [like a managed investment scheme, a timeshare, company title, etc,], or

ii.  by registered fractionalised co-ownership or other traditional co-interested mechanisms [like tenants in common, leasehold strata, or even strata title at its most pure].

C.    Existing systems for tokenisation and fractionalisation of property assets can be done by Blockchain technologies.

D.    Fractional ownership of property assets by Blockchain involves what they call ‘RegTech’ or regulatory technology solutions for government regulators and interoperability of the land tilting systems, the ability to have non-physical documentation of property transactions and the use of smart contracts [automated and immutable transactions that are built into the Blockchain]. 

E.    Tokenisation of property assets by Blockchain is a lot more complex and difficult as it messes [my word] with the traditional elements of real property ownership in challenging ways over things like leases, easements, covenants, conditional grants.  They are also concerned about how these tokenised interests will work in parallel with contractual rights embodied in the tokenisation process.

I completely understand their concerns and they are right to conservatively warn the government about the challenges that these new kinds of real property interests future technologies will create.

Taking things a bit further down the future tech road

Luckily, I don’t have to worry about academic reputations or the government’s challenges.  Plus, I am much more interested in the tokenisation model for real property assets than simply fractional ownership [since it’s basically digitisation of the existing model].  After all, I grew up studying strata title’s hybrid property model from its early days and exploring its myriad nooks and crannies.

So, I’m adding the following thoughts to the debate about the future of Blockchain, FinTech, RegTech, and strata title property.

1.    We’ve already seen tokenisation in real estate

I believe that we’ve seen tokenisation before in real estate so it’s not that new or unusual. 

Company title is exactly that: an underlying real property asset where use and ownership are split via the mechanism of shareholding [equities] and contracts [company articles/constitution] which are regulated by statute.

Similarly, timeshares are the creation of contractual rights to use a real property asset temporarily on a flexible time-based cycle.

And, all those managed investments schemes for tourist strata buildings that were popular few decades ago were even more like the modern version of real property asset tokenisation we’re likely to see in the future.

2.      Strata title has [and is] teaching us how to handle hybrid real property

Since strata title is a hybrid form of real property: combining land titles, overarching contractual mechanisms, and statue based regulation; it’s been a 50 plus year case study in how to handle this kind of legal model

In my article ‘The Dilemma of One v. Many in Strata Buildings: Part 1’ I focus on the challenges inherent in strata title of balancing property interests with collective ownership and shared use and comment that ‘A strata title is, in my view, a new and different kind of property structure’.

So, future kinds of fractionalised or tokenised property interests can learn and benefit from the laws, Court decisions and experiences in strata title.

3.      It’s about uses and benefits, not ownership

Fractional ownership by tokenisation is not about the ownership or the underlying property asset as that asset can never be used entirely by the token owners or realised by them in specie [sorry that’s legal-speak for in its entirety as a piece of real property]. 

Rather, it's about the token owners’ use of the property asset, their earning income from the property asset, the capital growth they derive from property asset, and/or the other benefits they could enjoy from their interests.

So, traditional notions about the importance of the core bundle of legal interests in real property won’t matter as much to them.

After all, do the strata owners in leasehold strata buildings in Sydney’s Rocks care that there’s only 83 years left on the leases for the whole of their buildings?

4.      Management becomes the key to successful tokenised real property

When a token owners’ interest in a property asset shifts from the property to their use of it or other benefits they derive from it, the management of the property asset becomes critical.

Poor management affects amenity, value, revenues, capital growth and operating costs.  Conversely, good management preserves or enhances those things.   We see this in strata buildings when serviced apartment complexes are poorly run or maintained and occupancy rates and returns fall.

So, better, more consistent, and transparent management will be necessary.

But, coincidentally, the Blockchain with its ability to embed smart contacts into the operation of the property asset could actually provide easy paths to improved management.

5.      There is potential for a Droste Effect strata scheme

Tokenisation would potentially allow us to create the first Droste Effect strata scheme where there’s an almost endless splitting of the property asset into smaller and smaller parts as follows:

• An apartment building is subdivided into strata lots.

• The strata lots are tokenised so that there can be an unlimited number of token owners for each strata lot.

• There can be different kinds of tokens for different interests in each strata lot; tokens for use of the lots; tokens for shares in the capital gains from the lots; tokens for income generated from the lots; and; tokens for things we haven’t yet imagined the lots could be used for.

• And, then those tokens can be further fractionalised into substratum tokens or cryptocurrencies allowing for even more token owners and/or speculation. [Sorry, but this idea is so new there isn’t even a Wikipedia page for it and you’ll have to read tech nerd articles about it like this one by King Passive].

This opportunity adds a whole new dimension [or two] to strata titling.

Conclusions

Like it or not, the Blockchain is coming to all real property assets including strata title.

Blockchain use might be limited to FinTech or even RegTech applications.  Or, it might also extend to how registered fractionalised interests in strata property assets are created, recorded, and managed.

But, it is also possible [or even likely] that Blockchain will be used for the tokenisation of new and existing strata title interests and the creation of new and even more fractionalised and tokenised substratum interests.

Now, that’s the kind of Strata Tecno I’m looking forward to seeing!

May 05, 2021

Francesco