April 22, 2023

JF3152: 3 Benefits of Tokenizing Real Estate ft. Joshua Kagan



Joshua Kagan is the CEO of Bonfire, which enables investors to own partial interests in commercial real estate like hotels, apartments, and industrial buildings without a down payment. In this episode, Joshua discusses how tokenization is aiming to solve some of real estate’s biggest issues such as liquefying investments, facilitating democracy, and removing the barrier to entry for lower level investors.

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Joshua Kagan | Real Estate Background

  • CEO of Bonfire
  • Portfolio:
    • Single-family rentals 
    • Multifamily
    • Industrial
    • Land
  • Based in: Denver, CO
  • Say hi to him at: 
  • Best Ever Book: Strategies of Genius by Robert Dilts
  • Greatest Lesson: Always look in the pathway of development and try to invest on the periphery of that.


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Ash Patel: Hello, Best Ever listeners. Welcome to the best real estate investing advice ever show. I'm Ash Patel, and I'm with today's guest, Joshua Kagan. Josh is joining us from Denver, Colorado. He is the CEO of Bonfire. It's Robinhood meets real estate; they tokenize properties. Joshua's portfolio consists of a bunch of single family rentals and investments in multifamily, industrial, and land. Joshua, thank you for joining us, and how are you today?

Joshua Kagan: Awesome. Thank you, Ash, for having me. It's an honor to be here, so thank you so much.

Ash Patel: Joshua, the pleasure is ours. If you would, give the Best Ever listeners a little bit more about your background, and what you're focused on now.

Joshua Kagan: Awesome. So I've spent the last 14 years working in the [unintelligible 00:02:04.08] environment. I worked at a venture capital firm that invested in Internet of Things, and things kind of related to smart buildings, and storage... And then Richard Branson and Al Gore had dinner, and Branson got really freaked out about climate change and wanted to do something about it, and created a company called the Carbon War Room, and asked my boss, who was the managing partner of our fund, to be the COO of it. He asked me to come over and I ran the energy efficiency in buildings division for four years, which was focused on investing in multifamily, office and hotel efficiency projects. We did that, got acquired, and then I went to a startup called Clean Fund, which is a venture-backed specialty finance company that provides capital for energy efficiency projects using a structure called PACE, Property Assessed Clean Energy. And all the while, in 2011 I did my first real estate project as a principal; my family comes from real estate, but I've never done a project myself. And I bought a foreclosure in the Berkeley Hills, and I did the BRRR method, buy, rehab, rent and refinance. I did another one, then started doing fix and flips, then started doing more BRRR method.

Bonfire was born a couple years ago; I met my co-founder, he came from India 10 years ago, started and sold three companies, including one for $200 million... And one of his problems is he owns real estate in the Bay Area, where he lives, as well as India. But he wants to build a bigger portfolio, and he doesn't have the bandwidth to vet outside of markets that he lives in India. It takes care of itself. He has someone who manages his portfolio.

So that's kind of where he was coming from, is "How do I build out a bigger portfolio of passive income without buying a REIT, or something that's kind of a managed fund, and how do I get access to real estate in other markets?" Where I was coming from in all this is my friends are in their 30s and 40s, they want to own real estate, but they have student debt, and interest rates have doubled in the last year, and private equity is buying a lot of the supply, so they're frustrated that they're not on the property ownership ladder. And we looked at every single platform that exists out there and we asked ourselves, "Why can't someone with one or two clicks buy actual tangible real estate and own it?" And that was the genesis of Bonfire.

Ash Patel: If you would, explain to our Best Ever listeners what tokenizing real estate is, and the benefits of doing that.

Joshua Kagan: So historically, real estate has suffered from, I'd say -- a number of issues, but one of them is liquidity, and being able to transact quickly, because you have to go down to a county assessor's office, and notaries, and signatories, etc. What tokenization is is basically we're able to record ownership interest in real estate on the blockchain. Now, what is the blockchain? Blockchain, think of it as a ledger on steroids, where you have a block of data that's connected to other data through a chain. It's kind of a geeky answer, but it's basically an immutable record. So blockchain enables us to record interest in real estate, so people want to buy and sell. It's permissionless, it's trustworthy, and it can happen faster. So by tokenizing a real estate asset, we're able to chop it up into smaller pieces.

Let's say, Ash, you and I and a friend decided to buy a building for a million bucks; each of us would have to come up with $330,000. With tokenization, we could chop it up into a million units, and have million people come in for $1. It's kind of a silly example. But tokenization facilitates democratization; it enables people who historically wouldn't be able to own real estate to actually get on that property ownership ladder.

Ash Patel: Some of the benefits of that are, for example, foreign investment. If you have geopolitical turmoil in whatever country, and the oligarchs or the high net worth people in that country want to put money into US real estate, what are they going to do? Are they going to fly to New York and buy an apartment? Or can they just buy a tokenized real estate asset that has exposure to US real estate? So a lot of benefits.

Joshua Kagan: You know, I would riff on that for a second and say, look, our platform is subject to Know Your Customer and Anti Money Laundering rules, so we don't allow Russian nationals and people from Syria or North Korea to purchase on our platform. But my wife comes from Turkey, and when we got married 11 years ago, it was at 1.5. Lira to the dollar. Now it's 19. So the currency has been debased 95%. And when we launched our MVP at the end of last year, it was astonishing the number of people who posted on Twitter and our Discord "Hey, I'm a cab driver in Jaipur, India" or "I'm an economist in Argentina, and I now own real estate in the US of A." That's powerful, especially for people in countries - again, to your point, who's facing geopolitical issues, and want to have tangible assets in the US.

Ash Patel: What are the challenges in a regulatory environment?

Joshua Kagan: It's a great question. Our regulatory council comes from the SEC, and specifically the enforcement division of the SEC. And when we were gearing up to sell out our MVP last year, our first asset, she said, "Look, historically, if you and a couple buddies come together and buy a real estate asset, it's like owning a tenancy in common. It's a cooperative; it's not considered a security." And then FTX blew up, and she spoke to her former colleagues at the commission, and basically the SEC has decided to take a bazooka to anything related to blockchain. So that forced us to say "We don't know, because of the lack of leadership at the SEC in terms of guidance around what constitutes a security versus not in a digital token, we're going to take the most conservative approach possible, and just assume that what we're selling are securities, and have to go through the various exemptions provided by selling a security." So what that means is it's a more cumbersome process for our users in terms of the information they have to give us, and it's a clunkier UI, but it's relatively the same exact process.

Ash Patel: I think it's important to discern, because there are hundreds of companies trying to do what you're doing. You see all the competition out there. And what Elizabeth Warren, her friends are doing since FTX is they're trying to put a kibosh on all of this. So are you telling me the way around this is basically trade this as a security?

Joshua Kagan: Yeah, Ash, that is what I'm saying. Basically, we are in just such a regulatory uncertainty environment, whether it's the Senate, whether it's the SEC... There's a such a lack of leadership in Washington around digital assets that we're just saying "We're just gonna assume that these are securities", and therefore the restrictions on retrading them have to apply... So depending on whether someone - I don't want to go too far in the weeds, but depending on whether some are accredited, or unaccredited, or international will depend upon how quickly these tokens can be retraded on a secondary marketplace.

Ash Patel: And that secondary marketplace is important because I can tokenize the house that I live in, and sell it to 10 different people. But if there's no way for them to cash out or trade it on a secondary market, there's no liquidity. They're just title holders or deed holders to this one piece of real estate, right? So what is that secondary market that you are using? A number of things there. One is just kind of a cool side use case of tokenization. Let's say you had a house that you're living in, and - we're just making up numbers - it's worth a million dollars, and you want it free and clear. And you're like, "I'd love 100 grand to buy a boat", or something. And you're like, "I don't want to have to go out and get a home equity line of credit where interest rates are 7% right now." What if we could help you tokenize it and you could sell 1/10 of the asset to whoever. And basically, they're just a passive investor. So one day when you sell the house, they get 10% of the equity. That's a new capital source for you and for anyone. So we're not focused on that use case, but we think that's a really interesting one down the line, especially when people are locked in with really low interest rates too in their assets.

The secondary marketplace right now that we're building is based upon [unintelligible 00:09:54.08] white-labeling someone else's license, because there's certain rules [unintelligible 00:09:58.02] and some other licenses that's going to take a year to get... So we're building it using someone else's licenses, white label until we have those licenses to build our own native platform, if that makes sense.

Ash Patel: And what that secondary market does is if I sell a 10th of my house for that $100,000, the buyer can then sell that token on that market. And if the market as a whole thinks my house has appreciated, he'll get more than $100,000. And if it's depreciated, he or she will get less. So it basically adds liquidity to me, and also the investor.

Joshua Kagan: 100%. And through our technology, we're embedding each of these tokens with smart contracts that say things like "Oh, your house has this mortgage on it. You paid the April mortgage on it." And asset level information, what's the tenancy, the occupancy, the vacancy, all that, deferred maintenance, inspection reports... All that stuff is built into our smart contracts. But then also submarket data, like there's a lot of supply coming online; new buildings permits were pulled in the last quarter of this much. There's so much data that we can embed within the tokens that can just give investors more confidence that, "Oh, if I'm buying a token, I really know what these tokens represent."

Ash Patel: Where are you in the development process? How close are you to tokenizing real estate?

Joshua Kagan: We tokenize real estate, Ash. We did a very modest proof of concept at the end of last year. It was a single family rental outside of Charlotte. $310,000 asset. We turned into 10,000 tokens, we sold it for $31. We had 1,250 people create accounts, about 200 buy, from 15 countries; they bought with US dollars through their bank, they bought with crypto, and we did zero paid marketing whatsoever. This was 100% word of mouth. And the whole point of it was an MVP, a minimum viable product to test out the tech, the marketing... Just how it all comes together.

We're actually launching our next asset in a couple of weeks, and it's a $50 million hotel repositioning project in the Bay Area, where someone's buying a hotel that's a two-star Four Points hotel and transitioning into a Marriott four-star hotel. And it's a sponsor that I personally invested three deals with before, and he's an A+ sponsor. And historically, with one of his deals you need a minimum of $50,000 or $100,000 to invest; we were able to tokenize our allocation and bring that down to $1,000. So historically, a lot of retail people don't have direct access to these kinds of deals, and that's the power of our technology.

Break: [00:12:35.12]

Ash Patel: The Charlotte example, the proof of concept - that was non-accredited investors, and that was before you had to market this like a security?

Joshua Kagan: Correct. It was non-accredited and accredited investors participating in it.

Ash Patel: And in this hotel, what's changed since this regulation?

Joshua Kagan: We can do accredited, non-accredited, as well as international investors. The only thing that's changed is specifically for the non-accredited we have to use a third party platform and their license. They have something called a qualified investor portal, QIP, that facilitates reg CF, reg crowdfunding, and they're going to handle some of our backend that can't go on our platform. It has to be kind of housed on there. So it's annoying from our end; our customers won't really notice a difference.

Ash Patel: Joshua, what's the minimum investment in this hotel deal?

Joshua Kagan: We're still working it out. I'll know more in the next couple days. I'd say somewhere between $1,000 and $1,800.

Ash Patel: The difference between what you're doing in terms of compliance, legal - what's the difference between that and a syndication?

Joshua Kagan: A number of things. We essentially are a syndication that's tokenized, and the advantage with that is a) our minimums are lower, but 2) when we finalize our secondary marketplace... Historically, with the syndication you're at the whims of the GP of when they have an exit. With our model, as an LP when we have our secondary marketplace built, you're not gonna be stranded in the deal. You're gonna be able to sell your tokens in a liquid market. And that's the power of blockchain and tokenization.

Ash Patel: Okay, so just trying to paint a picture for the Best Ever listeners - it is essentially a syndication, but your investment has some liquidity because of the marketplace; it would be the equivalent of me being in an LP in somebody else's syndication, and they allowing me to take myself off of that, and put somebody else in. So if I have an audience of 1,000 people, I can say "I'm getting out of this multifamily syndication. Who wants to take over my spot?" Pretty similar, right?

Joshua Kagan: Yep.

Ash Patel: Now, when you have a $1,000, investor, they have to get a K-1 at the end of the year. Is that correct?

Joshua Kagan: They do. Yes.

Ash Patel: So what does that do to your accounting cost, your backend costs...?

Joshua Kagan: We just went through this with our first asset. Classic startup - you fake it till you make it; you figure it out. So we had to interview 10, 20, 30 different accountants and different services. Fortunately, we found a really good one, that they just have certain economies of scale that's going to enable us to do this pretty inexpensively.

One mistake we made - I'll just be totally honest about things we've done well and things we've done poorly - is we didn't ask people at the outset what their social security numbers were. Because we don't want to be handling people's private data, as little as possible. But that was a mistake, because now we're having to go after the fact to do the K-1, and get people to fill in W-9's, and all that stuff. But in general, it's going to cost about $1,000 an LLC per year, which I don't think is a prohibitively expensive cost. And that's where we're at now. Maybe we can bring that down further.

Ash Patel: Got it. In terms of competition - again, this is a hot arena. A lot of entities are getting into this. What are you seeing for competition? And there's people behind you, there's people ahead of you... How do you gauge your competition, and what differentiates you?

Joshua Kagan: That's a great question. Look, are REITs a competitor? Maybe, because that's money that people who want to invest in real estate, and not necessarily do the projects themselves - they're putting money somewhere, and they're putting it into REITs. But that's an older demographic, so we don't really think that we directly compete with them. There's the Fundrise, CrowdStreet, Realty Moguls of the world, which in some ways act like private REITs. If I want exposure to multifamily in Northeast - great; I'll go to one of those platforms. But again, they're not necessarily directly enabling direct investment into a specific real estate asset as much as a mutual fund of real estate.

So every day someone sends me a PowerPoint of a new company that's trying to raise money off this idea, who've never transacted, never built smart contracts before, who don't even come from real estate. So there's a lot of noise out there. But there's entities like Arrived Homes, groups like that, and I have respect for all of them. Look, anyone trying to do this - this is hard. Anyone trying to enable more affordability of housing and investments in real estate, I tip my hat to them. It's a big enough market where we can all do well. I would say our key differentiations are a few. One is we're not just doing single-family rentals. In fact, our next assets are trophy deals; this hotel repositioning asset. We're working on an institutional-grade apartment deal in Dallas, and we have a whole bunch of other stuff in the pipeline.

So I think, because our team comes from real estate, our network of advisers are more real estate-focused than crypto, or something, we have access to really good deal flow. So we're more focused on commercial assets, and really high-quality sponsors. We're just laser-focused on delivering value to our customers, and really focus on these commercial assets.

Ash Patel: Joshua on these deals, can there be bank debt on a tokenized asset? Or does it have to be owned free and clear?

Joshua Kagan: Absolutely. There can be bank debt. Yeah. 100%. We roll up as an LLC or an SPV on the cap table. So the lender's still underwriting the GP. We're not the GP.

Ash Patel: Okay, so you're an entity. You're essentially an LP.

Joshua Kagan: Essentially, yes.

Ash Patel: Got it. Who is the ideal client for tokenizing one of their properties? Is it something where it's hard to find traditional financing for? Is it somebody that wants higher leverage? Who's the low-hanging fruit to go after, that would jump on a tokenized platform?

Joshua Kagan: That's a great question, Ash. A couple of different sponsored types that come to mind. One is - I don't know what your experience is, but in the last four weeks, ever since Silicon Valley Bank collapsed, debt markets have changed. Lending in the credit markets - I'm just being told this by my friends who are sponsors, that lending have just gotten much more restrictive. So maybe before you could get 65%, 70% LTV; now it's 60%, 65%. Covenants have changed, etc. So I think we're a new source of capital stack, we can replace other equity that would have to be raised, and maybe fill in some of the debt that's not being provided. That's one use case. Another is a lot of my friends who are sponsors and developers invariably in a project there can be delays, construction, things happen, and my LPs get impatient; they get divorced, or something happens where they need to exit, and they come to me and they say, "I need to get out of this", and there's no liquidity for them. So by enabling us to tokenize part of their syndication, whether we fill it or not, gives their investors a way out in the future. And that's powerful. I think that just makes it a more compelling deal relative to a competitor who doesn't have this opportunity for their LPs to get out.

Ash Patel: And in a perfect world, when all of this hits and it becomes relatively easy to tokenize real estate, what do you think that's going to do to asset prices, US real estate asset prices?

Joshua Kagan: Man, that's so hard to know... Because on the one hand, I could see a lot more capital coming in. On the other hand, I could see the real estate markets becoming much more efficient. I read a white paper that said because real estate is illiquid, you get sort of a premium, that it gets traded at a premium relative to what it should because of the lack of liquidity.

So I don't know, but the idea of trillions of dollars from people who historically don't invest in real estate coming in - it would be very powerful. I can't imagine that would cause prices to go down long-term.

Ash Patel: Yeah, I love hearing what you just said, because historically, I've only heard that foreign capital is going to come to the US. But you're right, the market's become a lot more efficient, and assets are priced the way they should be. Yeah, good point. Thank you for sharing that.

Joshua, what is your best real estate investing advice ever?

Joshua Kagan: Always look in the pathway of development. I was mentored by a guy named Richie Abramson, who talks about always look at the value generator. And for me, I drive around Denver and look at the cranes. And I create maps, where are the cranes going? And what's the next neighborhoods that surround my single family portfolio? Always looking at what are those value generators, and looking at permits being pulled, seeing where the activity is, and trying to invest on the periphery of that, versus the middle of nowhere and hoping that you build the development and everyone will come.

Ash Patel: Joshua, are you ready for the Best Ever lightning round?

Joshua Kagan: I hope so, man. Al

Ash Patel: Alright, Joshua, what's the Best Ever book you recently read?

Joshua Kagan: It's a book called "Strategies of genius" by Robert Dilts. He's the OG co-founder of neurolinguistic programming. And what he did is he studied the mental processes of geniuses like Aristotle, and Walt Disney. And what he found when he looked at Disney specifically - and I've actually started using this in Bonfire - is Disney, when he created Fantasia, he had three rooms: the creative room, the how to make things happen, and why the idea will fail. So what he did is he took all of his really smart creative folks, put them in room number one. And then when an idea germinated out of that, he was like, "Okay, let's go to room number two." He brought in different people, and those people - "How do we turn this amazing idea into something that's real?" Once he got through room number two, he brought in the most skeptical members of his team: "Why the idea is going to fail". And then depending on what happened in room number three, it either went back to room number one or two.

And I say that because in brainstorms -- if you bring in people who are just nervous Nellies, or they're just naysayers, they will kill creativity. So you have to really identify which room you're in, in any sort of meeting. And that's what I took from that book.

Ash Patel: I love that. And I think it can be applied to real estate very well. We need people to be skeptical of some of the deals that people are doing. We've had such a great run, prosperity, and had we stress-tested deals, had we talked through the what-if scenarios, I think not as many people would be feeling pain right now. So yeah, thanks for sharing that.

Joshua, what's the Best Ever way you like to give back?

Joshua Kagan: I like mentoring social entrepreneurs. And I only have a couple that I work with at a time, but it's usually younger people in their 20s, who have a burning [unintelligible 00:23:52.27] to solve some sort of silo problem using business or market-based force to do it, but have no idea where to start. And if I can impress upon them the mistakes I've made, so they don't have to go through it again and accelerate the process, it's a total win/win. I just love working with younger people and helping them accomplish their dreams.

Ash Patel: Joshua, how can the Best Ever listeners reach out to you?

Joshua Kagan: Find me on LinkedIn, Joshua Kagan, or on Twitter, @JoshuaKagan1. Also, you can go to Bonfire.capital.

Ash Patel: Joshua, thank you again for your time today, sharing what's going on in the world of tokenization, some of the challenges, some of the benefits that can arise from it. So thank you again for your time today.

Joshua Kagan: Ash, you're the man. Thank you so much. I really enjoyed this.

Ash Patel: It was a pleasure. Best Ever listeners, thank you so much for joining us. If you enjoyed this episode, please leave us a five star review, share this podcast with somebody you think can benefit from it. Also, follow, subscribe and have a Best Ever day.

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