141: Tokenizing Real Estate with Matthew Sullivan

Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast is Matthew Sullivan. He’s the founder of QuantumRE, a cryptocurrency startup that supports homeowners by helping them sell a fraction of the equity in their home without taking on more debt, now who doesn’t want that, right? Now Matthew is also the co-founder of the 50 million dollar secured real estate income strategies fund and is the founder and president of crowdventure.com which is a real estate crowdfunding company. You’re a busy guy, Matthew, welcome to Wealth Formula Podcast.

Matthew: Thank you Buck. Thanks for having me over.

Buck: So I want to start out a little bit. Obviously you are your bit of a serial entrepreneur. I’m sort of like probably the poor man’s version of you and that rather illustrious entrepreneurial career it seems. Give me some background on how you got into real estate and ultimately the evolution of the interest in blockchain application to this.

Matthew: Thank you. Well the the movement of real estate was relatively late. I’d spent most of my professional life, if you can call an entrepreneur a profession, I mean being in serially unemployable more like, but I focus much more on Finance and technology and telecommunications and real estate funnily enough seems almost the antithesis of that because it was solid and very slow-moving, but as the years went by and as I became older and wiser I realized the absolute importance and sheer foundation that the real estate brings to the economy. When I moved over here to the US of just over was just under five years ago, one of the first things I did was to set up a Crowd venture which is a crowdfunding company that allows people to buy small pieces of real estate investments which was really hot on the heels of the crowdfunding legislation which was the JOBS Act which was sort of freshly minted at that time. So really it you know I’m not a a career real estate guy, I’m much more you know technology and finance but so looking at real estate for me was through a different lens than a traditional investment side.

Buck: Sure. So how about blockchain? When did you discover it? What was your aha moment and why did you decide to marry these two?

Matthew: Well I think it’s a case of faint signals from the future. So back in the late 90s early 2000 I founded one of Europe’s first internet billing companies and that was a company that enabled it was a technology company we were selling services to large telcos and what we were able to do was bill Internet traffic by the packet so rather than telecoms companies just charging a flat rate per month, we were able to help them charge depending on the content that was delivered. So I was involved in the internet really right at the very beginning before it became the sort of behemoth that it is today and really seeing blockchain technologies, you get these sort of little pointers that this feels that it could be the same type of change, the same type of developments happening as we saw with the Internet. And also I am part of a networking group that meets up in Beverly Hills every Saturday and one of the fairly regular speakers there was Brock Pierce who at that point three years ago was the chairman of, Bitcoin foundation. And so he would regularly update us with things that are happening in the Bitcoin and the blockchain world. So I was sort of exposed to it from a technology perspective before the cryptocurrencies took on that massive rise that we saw last year.

Buck: Was that metal?

Matthew: Yes it’s metal.

Buck: I want to talk to you about that more too at some point, but so interesting let’s start broadly again taking this idea of the impact of tokenization . First of all define tokenization.

Matthew: Well it’s not, I mean you know the important thing to try and take into, look forward and see that blockchain is a technology that really and tokenization and all these words, these are technologies that really should not be uttered in normal everyday speak in the same way that when we talk about the internet, we don’t talk about HTTP and you know all the various different transfer you know ipv6, you know we just talk about applications. And so I think really what’s happened is because crypto currencies became center stage, because of all of these speculative activity and people thought that they could make instant money and then the sort of technology center stage when actually it should be the applications. So when we talk about tokenization and the use of blockchain, it’s really to solve a problem and that problem is liquidity in real estate. So we use the efficiencies that blockchain and those technologies bring to create digital assets that can be traded in a much more cost-effective and instant way than traditional securities. So blockchain and tokenization for us really is a mechanism to create liquidity in what is the world’s largest asset class which historically has been incredibly illiquid.

Buck: So I know what you’re talking about right now, but let’s try to break this down with some concrete sort of examples of how you utilize the technology to do things more efficiently in real estate, give me some examples.

Matthew: Well I think if you look at what we’re doing specifically with our fund which is we’re creating an asset-backed token. Because one of the biggest problems with Bitcoin and all of the cryptocurrencies is lack of intrinsic value and what that means is people don’t really know what’s behind these cryptocurrencies and that’s why you see set such volatility because it’s the sort of the herd instinct because if people think that everyone’s buying then they all pile in then the price goes up. If people think they’re selling the price goes down. And so the price of cryptocurrencies is entirely driven by sentiment and it’s also very easy to manipulate those if you’re a big buyer behind the scenes. So what we’ve done is we’ve created a fund that operates as a REIT which is something that we all understand in the traditional world it invests in a specific asset class which is the equity in single-family homes and I can expand on that in a moment, but rather than delivering shares or interests in that fund through traditional means, which is a certificate or a membership interest, we’re creating a digital asset, which uses the blockchain that enables it to move from person to person in a way that is kept in a ledger that cannot be changed. So what we’re doing effectively is we’re not tokenizing real estate, we’re not taking something that’s solid and making it into something that’s vapor for example, we’re just creating a structure and issuing ownership in that better structure by way of a share, an electronic share that uses a blockchain to enable it to be traded far more efficiently than…

Buck: In other words we’re just talking about it’s a security token.

Matthew: That’s exactly what it is. But the the really interesting thing that’s going to happen with securities starting this year is the emergence of a number of parallel trading floors and trading exchanges that are all registered with the Securities and Exchange Commission, they’re all regulated, but they enable the transfer trading and movement of ownership of securities in a way that’s much more open than the traditional you know stock market. So right now if you want to create a publicly traded company, you can either raise money through a private placement, and a lot of real estate developers familiar with you know GP LP structures or you know membership in a private placement through LLC’s, but if you buy a membership interest in a small fund, it’s really difficult if you want to get out. You have their gonna find someone else to buy your interest then they’ll want to negotiate you down and you have to sell it at a discount, you might only be able to sell, you might have to sell all of it rather than a piece of it. So there are all sorts of restrictions around you know trading shares unless you go public. Now if you want to go public then be prepared to get your checkbook out right you know sums with lots of zeroes at the end at the end because it’s a very expensive process. What the blockchain and security tokens will allow us you know this year is a halfway house. So it’s the ability to create liquidity in traditionally sort of private instruments, which will enable people to buy and sell those membership interests in a much more efficient way. So that that creates much more capital flow. And if people are able to buy into something with the knowledge that they probably got a fair chance of being able to get out, that solves one of the biggest questions that investors ask which is you know how do I get out of this stuff.

Buck: So this audience in particular includes a large number of people in my Reg D group and they’re familiar with the GP-LP structure etc and everything. One of the questions that comes to my mind is how do you do something like that? How do you create this liquidity within the regulatory framework that we know that’s out there, for example in our offerings, real estate offerings, typically we’re doing reg D 506Bs. And you know we’ve got accredited investors only. How do you maintain within the framework of the law, when when you’re creating that liquidity.

Matthew: Well with the regulations. I mean if you look at the Regulation D and a number of other regulations, there is a restricted securities element. So not to get too much into the weeds, but under any Regulation D you can’t sell your interests normally until you’ve held them for at least 12 months. Now after that they don’t become freely tradable but you are able to transfer them without those restrictions applying and that depends really on what’s written in the operating agreement, if it’s a partnership structure. But what tokenization does is it really wraps the interest in your fund so your membership interest is held within some computer code that can be transferred from one person’s wallet to another. So traditionally if you want to transfer ownership of a membership interest, it’s a ledger entry or you know somebody has to change an entry in a Excel spreadsheet somewhere and we have to bring back the old certificates and shred them and issue new certificates put them in the mail or you know so it’s a very time-consuming process, it’s prone to error. But if you can write into the code that’s attached to the ownership certificate, rules that relate to who can buy this and when they can buy it and that isn’t you know we’ve heard the term smart contract, what the token can do is actually can deal with all of the rules relating to the regulation D offering. So for example if you say that I don’t want anyone outside of this geography to be able to buy my tokens, then you can write that into the code and there are mechanisms that you can work with within the exchanges that will prevent someone from outside of your rule set from being able to buy your token so they’re really powerful thing about tokenization and digitization of assets is the intelligence that you can actually wrap around the certificate. So it’s not just a dumb instrument, it actually has a set of rules that make your job as a fund manager a lot easier and from a security perspective I know exactly who owns my assets at any one time and that means I can fractionalize them. That means I can have multiple owners rather having one or you know a small number because that’s difficult to manage and I can fractionalize the tokens and have many, many thousands of people potentially owning them because it’s much easier to keep track of you know that change of ownership process.

Buck: Right. So in effect you would be issuing cryptocurrency based on the number of shares that you owned, is that…

Matthew: Well you what you’re doing is, and this is where the confusion arises, because you’re not changing a fish into a fowl, you’re really just using a different mechanism to represent the…

Buck: They’re just electronic shares but in this case they’re crypto…

Matthew: Yes exactly but you’re using it and you’re using a cryptocurrency technology which sits on top of the blockchain. Now the blockchain is your audit layer, that’s your ledger, so you know the blockchain is not the crypto currency but the blockchain keeps track of all of these different changes of ownership. And the great thing about the blockchain is you can’t delete that, you can’t change it so it’s a a real layer of trust that you can use to make sure that you keep track of every change of ownership. And that makes it much easier for you to meet your regulatory obligations because if you know in any one time with a huge degree of certainty who your owners are and what the pathway has been between one owner to another then that makes it much easier to meet your regulations. But, what we’re not doing is we’re not turning membership interests into your fund into Bitcoin and that’s one thing that I come across a lot where people think that you’re by creating a fund we are turning our fund into Bitcoin or into Ethereum or something else.

Buck: You’re just digitizing the Securities that’s effectively what you’re doing.

Matthew: And that brings the same layer levels of improvements in efficiency as we see with things that have gone on to the internet. So if you think about how easy it is to buy airline tickets or insurance or banking online, that’s because of the digitization of those processes. And it’s the same sort of thing we’re gonna see again.

Buck: So me so I’m looking at and I you know I’m as as a guy who’s been on both sides because I you know I raise capital and I also invest as an LP, I’m looking at it from the GP side and I’m saying to myself why would I want to do this? This sounds awfully complicated, for what I’m doing is working already, what do you what do you say to a GP?

Matthew: I think it’s horses for courses. So in other words if you want to run a small fund as a private placement with a small number, I mean if you take non-accredited investors you know you’re limited to 35 anyway, so in a five or six B. Say this isn’t really relevant for small funds where you know the people and there’s really no realistic expectation of your members that they want to be able to trade their shares. Where it is relevant is if you’re using another type of exemption which is regulation A+ which is the sort of halfway house between a reg D and a private and a full listing. And if you want to go out to a much wider audience, so let’s say that you want to take your fund and make it more mainstream, let’s say did you have a stellar track record and you want to create a fund that goes out to a much wider audience, then the ability for people to be able to have the prospect of a secondary market becomes very enticing. So again for many people it’s a technology or it’s an application that really is never going to be relevant because they’re very successful at what they do.

Buck: Again going back to the GP side of that, if I again if I have a regulation crowdfunding you know reg A and I have got a 50 million dollar fund and you know I have a handful of friends who are in that position. If I’m doing that what does this add to the complexity on what I’m doing and the cost and what benefit, because obviously I understand what you’re saying from somebody who is buying this that there’s a secondary market and maybe you can you know you want to get out of something and there’s liquidity there but I would imagine there is some level of cost there’s some level of you know additional complexity on the GP side, am I wrong about that yes there is but it’s not prohibitive, in other words and these systems are being developed as we speak they’re being improved. This is a new technology and it’s based on the fundamental change is that the ownership records are based on an immutable or otherwise an unchangeable ledger. And so if you were ever going to build a security settlement system you would build it on blockchain because that is your layer of truth and that gives you one of the efficiencies that reduces your cost. So from a GP’s perspective and take it up to the mother of all GPS which is the sec. From their perspective the sec are looking at all of the regulation A+ offerings that are coming in and the questions they’re asking are how can you satisfy us that the processes that you use under when you’re creating digital assets meet these securities requirements for normal certificate so in other words, you’re issuing this as a digital certificate, how do you track it, how do you make sure that it doesn’t get into the wrong hands, how do you pay dividends, if someone loses their digital certificates how do you replace it, you know how do you maintain ownership of the cap table those are the questions the SEC are asking. But you know once those applications have gone through and we understand collectively what is needed to get an A+ offering through using digital assets. Then you’ll have a number of third-party service providers who will come to you and say if you want us to take your reg A plus fund and tokenize it, sign here and it will cost you X number of you know dollars as a setup fee and X number of dollars per month so it will become a standard process. At the moment because we’re at the very much the cutting edge it seems unwieldy. Well it is, it’s an unwieldy inefficient process unless you are very technically minded but that will change in the next few months. And there are already a number of companies that will work with aspiring GPS or with existing funds you know to provide that technology.

Buck: Let’s change a little bit a little pivot here and talk specifically about QuantumRE. What exactly do you do?

Matthew: Well we focus really on the major problems that homeowners have if they have equity in their homes and want to try and release some of it without taking on more debt so currently the only way that you can really unlock that equity is to go back to the bank or another financial institution and borrow more money whether it’s borrowing money through an additional secured mortgage or through a home equity line of credit or you know if you qualify it’s a reverse mortgage. All of those are debt products so you’re taking really an asset that you own that you’ve paid for and the only way you can realize that because your home is an illiquid instrument, is to go back and borrow more money against that. Now you know that’s not for us that that’s a big problem and there’s 15 trillion dollars worth of equity in the US residential market about 40% of which is in California. So there’s an enormous you know trillions literally trillions of dollars worth of equity that is owned by homeowners that really would be very useful to those homeowners from a you know a cash flow perspective if only they can unlock it without having to take on more debt. So that’s the problem that we solve and the way we do that is by buying the rights to the appreciation of that equity today so that you can release that equity without taking on more debt. So to give you an example if you have a million dollar house and you want to release two hundred thousand dollars worth of equity that’s 20 percent of the current value of your home so our agreement will say that anytime between now and the next thirty years so you’re on under no immediate time time pressure, but the moment you sell your house we get our two hundred thousand dollars back and we share in the appreciation of the house, so if your house has gone up in value then we take a share of that as well and that’s the return on our investment. So the way it works is it’s a formula so if we have released let’s say 10% so let’s say we wrote you a check for $100,000 that’s 10% of the value of your home when you sell your home we multiply that by 2.5 so we take 25% of the increase in value. So if your house has gone up say $100,000 from a million to one point one we get our $100,000 back and we get $25,000 from the increase so you keep $75,000 of the increase we get our $100,000 back because we bought a piece of your equity and our return on investment is that $25,000. So from a homeowners perspective you’ve had the use of that hundred thousand dollars for however long you want it without any monthly payments and without any interest accruing.

Buck: I’m trying to wrap my head around it a little bit and to the extent that is this collateralized debt? Is it I mean are guaranteeing it somehow or?

Matthew: No it’s not. I mean from an investor’s perspective it’s not debt it’s actually the opposite of debt and you know in the truest sense it is a position it’s an equity position so from an investor’s perspective we are buying we are the only way that you can buy into an owner-occupied home so we think that’s a very good asset because an owner is normally a very good steward of the home so somebody who owns the place looks after it and we’re helping the homeowner because we are buying something that is theirs for sale so you know they’d like to take a few chips off the table and it’s not debt because we’re not asking for any interest payments it’s a a shared risk approach so we are very much in partnership with the homeowner. So if the home goes down in value we do run the risk of losing money. If it goes up in value which you know it should if we do our job correctly as an underwriter and originator if it goes up in value then we make money.

Buck: Interesting so do you go through a traditional you know home appraisal? How does the process work say let’s just run through it I guess in practical terms because there may be people who are listening thinking it sounds like a good idea I don’t have to do a HELOC and pay interest I can just pull equity out and you know and use it now and you know when I sell my house and I’ll deal with it later. So say I come to you would come to your company and I say alright I got a you know I get a million dollar house here, first of all how much if somebody’s already got a you know 70% or 80% LTV how much equity are you willing to actually go up to?

Matthew: Well the first there are limits obviously so the amount of equity that we will release is capped at 30% of the current value of the home. And the combined loan-to-value so if you add the equity that we’re releasing together with your outstanding mortgage debt, that must not exceed 95 percent of the value though.

Buck: Okay well it’s still pretty significant because most people have more than five percent equity in their homes.

Matthew: Yeah I mean our team historically has originated over 300 of these transactions so we have a very experienced team that’s part of our group who were pretty much the creators of the equity release product. So over the last you know nine, ten years we’ve got some really good experience and funny enough most the people that want to release equity do so because they want to pay down their debt, whether it’s credit card debt or you know mortgage debt. So it’s a way of just expunging their debt once and for all. But so that our target market tends to have a lot more equity than you know like a you know the early stage buyers who whose only have a few percentage points. The average equity release over those 300 transactions is around 20%. So people tend to release you know there’s a fairly decent chunks of their equity really because if you write someone a check for $200,000, it’s quite important it’s quite meaningful to them and you know particularly if there aren’t any monthly payments associated with it. But to answer your question the process normally takes three to four weeks we start with an online application, fill in some details and that goes then to a origination team the process involves an appraisal. So we will send an appraiser out to give us a third-party value of your home according to local comparatives and you know current market conditions so it’s a third party physical appraisal that’s backed up by automated valuation mechanisms from the likes of Zillow and another company. So we sort of triangulate the value. And we then have an agreement with you where you sell us the future or the rights to future appreciation of a certain amount of your home or the equity in your home and in exchange for that you receive US dollars. So there’s no crypto involved at that stage it’s from a homeowner’s perspective it’s a very straightforward transaction and then you’re free to do whatever you want with that capital. So there are no restrictions that you must use it for you know home improvements or you know to do something specific, it’s entirely your capital.

Buck: Yeah I mean in that regard what you’re talking about right now, I mean I’m not sure I even really understand, I mean it’s a great model but I’m curious why you even need the blockchain there?

Matthew: Well what the blockchain does is it allows that the money’s got to come from our fund to be able to

Buck: Security tokens there’s a securitization

Matthew: That’s the other side, you’re right. Now behind the scenes we use blockchain to keep track of all of the transactions and the ownership because the blockchain is a very good stable ledger system, is a very good way of keeping track of ownership so we use that behind the scenes, but you’re right we could use any sort of database technology ready for that. But where we use the blockchain is in that enables us to raise the capital to go into the fund so that we can then allocate that, and we do that by issuing tradable tokens that have this sort of or will have this liquidity and so that’s from an investment perspective that’s you know compelling because I can buy into this fund, specializes in this particularly interesting large asset base that really can’t be accessed through any other mechanism and at the same time I get something that if I want to take some chips off the table myself I can go online to one of these up-and-coming security token exchanges and maybe sell a few tokens just to lock in some profit.

Buck: So right now where are you in the process? Are you actually are you actually in the doing this anywhere or?

Matthew: Well we started we launched our platform in December so just a couple of know two or three weeks ago. So you can now as an investor we’re limited to accredited investors because we are starting the process with paid Regulation D offering, you know that thing we all know and love. We filed a regulation A+ offering with the SEC three two to three months ago. So that’s going through the processes there. So the platform is live. We’re in the process of raising money through individuals who are accredited and we’re also out talking to family offices and other institutions who really like the asset because it’s effectively it’s like a leveraged proxy on the case-shiller index. Effectively it’s a great way of getting you know direct investment in that single family owner occupied residential asset class. So we’re raising money both online and offline and over the next you know few weeks and months you’ll see more and more activity on the site and as soon as we have a regulation A+ exemption approved then those shares that’ll be issued as tokens will be immediately tradable so you know, watch this space as they say.

Buck: Yeah so if if I’m an investor, so there’s two sides of this obviously you can participate I’m presuming you know you can participate on either side. If I’m an investor, what do you see as sort of your typical investment, I know you can’t really project returns but do you see like as as the fund grows at various times when money’s paid back, it’s not back, you wait until the house is sold. So every time a house is sold there’s some level of dividends that come out of that?

Matthew: Yeah, exactly.

Buck: Okay and then so it’s not just adding to the…

Matthew: We do. Because it’s a rate we have to distribute ninety percent of the profits that the fund makes each year. So what we do is every time you write, every time at home is sold, if we make a profit then that profit goes into the funds account and that’s the funds profit and then every six months or 12 months we will distribute those dividends to the existing token holders it’s a very straightforward process. So it is a it’s a dividend pace not income-generating like a traditional REIDs, yeah because you know you’re not getting income from rent, but as profit is goes into the fund that profit is distributed to the token holders.

Buck: Got it and the so you said the Reg D offering is live?

Matthew: Yes. It’s available to accredited investors.

Buck: Now you go to your website?

Matthew: Yeah it’s QuantmRE.com and it’s all there you just it’s relatively intuitive. So you just click a few buttons and you can go through the process, you register, you set up an account, you send us your accreditation proof and to make sure you’re sort of CPA letter or you know and then fund your account, and then what happens is we’ve just launched the fund so we have a minimum escrow figure of a million dollars. So the moment that we’ve reached our minimum of a million dollars, then we will issue security tokens, and the most important thing is that you don’t need an electronic or you don’t need a crypto wallet to be able to hold our tokens because we have a relationship with prime trust and prime trust acts as the custodian for our investors. So they can actually hold the tokens for you in their account in the same way that Schwab or another one of these companies holds shares and public companies on your behalf. So we can hold those digital assets for you through our relationship with prime trust.

Buck: What’s the minimum investment?

Matthew: It’s a thousand dollars. So you know we’ve we’ve kept it low because we really want this over time to be a mass market offering.

Buck: Right but certainly a very very interesting idea and I appreciate you being on the show today Matt and again the site just for people who are interested is QuantmRE.com

Matthew: Right yes yeah that’s right. It’s a bit of a mouthful unfortunately but since yes.

Buck: We’ll put it in the show notes as well so people can get an idea of what that is and I’ll be certainly watching this because I think this is one of those things that I think is sort of going to define the way real estate is going to go in the future and you know what’s gonna happen but good luck to you and thank you for being on the show.

Matthew: Thank you, Buck. It’s been a pleasure. I really appreciate you having me on.

Buck: We’ll be right back