Are DeFi and Smart Contracts the Keys to Your Next Home?
DeFi Meets Real Estate
The Ethereum network is a decentralized platform overtaking the traditional financial sector with improvements in speed, inclusivity, security, and cost. The real estate market is a prime example of an industry ripe for disruption by Ethereum. Decentralized finance (DeFi) will disrupt and improve the real estate market to make it more inclusive, secure, and cost-effective. DeFi is where the $326.5 trillion USD global real estate market meets its future.
Traditional Finance: Property Purchasing
Purchasing property traditionally comes with many transactional costs. Transactional costs arise from the current system of paying realtors, lenders, title, appraisers and inspectors and are estimated to be 8–10% of the property purchase price in the U.S., and even more in other countries. That is a large sum of money, especially for a first-time home buyer or the average American. What if there was a system that could provide all of the services currently offered by third parties, but at a better price or lower fee? What if there was a system that was not only more cost-effective but more transparent, timely, and secure as well?
If the consumer cannot pay for the entirety of the property in cash they will need to obtain a mortgage from a qualified lender. This typically costs 2%-5% of the purchase price. Moreover, the lenders will on average take 30-days to determine if that individual qualifies for that property or not. Plus, the loan is an amortized loan which means the lender front runs the interest. Throughout the lending process, privacy issues are raised as the lender requests information on income, source of funds, employment status, credit history, etc.
What if there was a system just as secure as the current lending system which could complete the process within 10 minutes from anywhere in the world, 24/7, and was more cost-effective while allowing for more privacy?
It’s currently not much better for the seller of a property as they also have to pay realtors, title, and maybe marketing or appraisal fees; this is estimated to be 8%-10% of the final sale price in transactional costs. In essence, there are many middlemen grabbing a piece of the real estate pie. One will eventually ask themselves: “Is there a better way?”, and the answer is yes, DeFi offers this path. There is a way, through blockchain technology, that we could either lower or eliminate some of the transactional costs when buying or selling real estate. It really can be done faster and allow for complete inclusivity and privacy. Let’s learn how DeFi can bring an inclusive, secure, and cost-effective real estate market to reality.
DeFi + Real Estate = Future of Real Estate
Blockchain technology will enable real estate to be bought and sold in the same way as any Non Fungible Token (NFT). This can be done instantaneously and at any time, from anywhere in the world. Using blockchain technology means that every transaction is written on-chain on a public and verifiable record. This transparency allows anyone to corroborate the legitimacy of the transaction, in addition to other information deemed to be important. For example, if an owner decides to sell their property using on-chain, the transaction is permanently verifiable, thus proving the property ownership now rests with a different individual. Not only would it state the particulars of the property that was sold and its price, it could also include any additional information that is deemed to be important, for greater transparency of details and complete property title rights. This transaction, depending on the blockchain used, can take 3 seconds to 10 minutes for completion, benefitting market liquidity.
What do Realtors Get Paid For?
A realtor’s service is to help the client either buy or sell property. For this service they charge 2.5%-6% of the purchase price. They exclusively can view or list real estate on the Multiple Listing Service (MLS) for marketing or discovering what properties are currently for sale. Beyond this, the realtor helps the client through the entirety of the transaction. What if there was a decentralized MLS application that anyone could view and list properties on?
Think eBay or OpenSea but for real estate.
Anyone could list their property for sale and anyone could bid on that property to buy. Not only is this more transparent, it’s also working around-the-clock and opens up clientele and real estate to everyone in the world. The fee paid to realtors no longer seems justified if there are systems in place to bring these services to all.
Title and Escrow On-Chain
Title and escrow pre-date the internet. For title, individuals disputing property rights could go to a trusted third party and have them resolve it. Typically, these services cost around .05%-1% of the purchase price. Escrow was a needed service as well. Every real estate transaction needed a trusted third party to settle funds for the transaction. However, with blockchain these services can be completed more transparently and more cost-effectively on-chain, using smart contracts. This would reduce title and escrow costs because the blockchain removes the need for a trusted third party. If there was ever a dispute between two parties they could both review the on-chain metrics to prove who owns the rights. This new technology would reduce the transactional cost of .05%-1% of the purchase price down to the mere cost of the gas needed to complete the transaction on-chain.
Loans are a component of a typical real estate transaction, adding 2%-5% of the purchase price. DeFi hubs like AAVE or Maker offer loans on pretty much any asset. DeFi loans are completely anonymous and therefore inclusive in that race, gender, name, ethnicity, etc. are never a factor when considering approval. All that is needed is proof of ownership of the asset being used as collateral. Some of these loans even repay themselves. DeFi loans are quick to complete and typically have no transactional or origination fees. Instead, the individual only pays the gas fees to complete the transaction on-chain. In essence, obtaining a loan through DeFi is not only more secure and transparent, but also quicker and cheaper through a much less intrusive process.
A consumer pays for an appraisal because (1) the lender requires it and (2) the consumer would like peace of mind knowing that the purchase price is fair. The process involves the appraiser inspecting the house and checking previously sold comparable properties to determine the price, which usually ends up being the purchase price. The process is subjective. Through a blockchain the appraisal process gains transparency. Individuals can go on-chain and view for themselves the transactions of all properties in a prescribed timeline. With that information, they can make an informed decision on market conditions including property value. Time and cost are reduced while transparency is increased.
Home Insurance On-Chain
Lastly, let’s talk about the home insurance policy. Yes, in theory and reality having insurance on an asset is a great service. This allows the consumer to sleep at night, as the saying goes. However, what happens if you need to make a claim through the current system? Maybe the insurance agent who pretended to be looking out for your interests is now with their team of highly educated lawyers doing everything imaginable to avoid paying out on that claim. In such situations the property owner is stuck with little to no resources to fight against the big insurance company. Not only that, but this process can take time. There is no way of knowing for sure whether the insurance company will pay out the claim.
Image by Courtney (Unsplash)
If the claim is paid out, the insurance company increases your premiums to recover the costs of the claim. Plus, everyone knows the complete premium payment doesn’t go towards actual insurance costs. Instead, it goes towards the insurance agent’s golf game. What if there was a way to make sure that all the costs went toward the premium and if there is a rightful claim that the agency pays out the amount they agreed upon? DeFi is doing this. A protocol called Nexus Mutual believes it will be able to offer insurance on traditional assets at 20% less than traditional cost. Through on-chain analytics, a consumer would have full transparency of what they can claim, how much they will receive for a claim, and when that claim will be paid out.
The Future of Real Estate
The traditional way of purchasing real estate in America by utilizing realtors, lenders, title, appraisers, etc. was needed due to the lack of technology and a better system. Once DeFi meets the real estate market, this will change. Consumers will close deals in 10 minutes without the use of intermediaries, enjoying the anonymity and security of the blockchain which also leads to significant savings.
Estimated numbers on TradFi Real Estate vs. DeFi Real Estate
The vision of completing a real estate transaction on a permissionless exchange like eBay or OpenSea is being tapped into by companies like Helio Lending or Propy, the latter estimating they can get the transactional costs down from 8%-10% to a mere 2%.
However, both Propy and Helio Lending are centralized actors. There is a crypto company called RealT accomplishing “fractional and frictionless real estate investing”, and a DAO called CitaDAO, which is experimenting with buying a property in the UK, which are steps in the right direction.
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