Smart Contracts in Real Estate: Still Room for Perfection

Smart contracts have been making waves since the inception of the technology on the blockchain platform Ethereum. They are now used in the number of industries but haven’t fully lived to the hype. In this article, we are figuring out what challenges prevent smart contracts from widespread adoption in real estate transactions, particularly those related to insurance.

Before we dive into the details, let’s understand why exactly conventional contracts are becoming obsolete. The problem with traditional contracts is that they are meant to describe mutual terms of agreements, which are often ambiguous and can be interpreted from multiple angles. This is why parties can spend huge amounts of money and time arguing about what exactly the contractual terms are trying to enforce or what the exact duration of the agreement is. While smart contracts don’t solve the problem entirely, they can decrease the overall vagueness of conventional contracts.

The process of transferring property ownership has become stressful and often risky for both sides of real estate transactions. In very simple terms, the seller is hesitant to transfer the ownership before receiving funds, and the buyer is afraid to send money before receiving the property. Up to this point, the most effective method was to use third parties such as notaries to ensure agreement fulfillment and increase security, which, in turn, raised the costs associated with transferring property ownership and caused delays.

Essentially, smart contracts solve the aforementioned problem by consolidating all the functions of notaries and brokers into one autonomous mechanism.

To understand how it is even possible, let’s dive a little deeper into the technicalities of the technology. A smart contract is an electronic protocol that executes transactions when specific conditions embedded in the code are met. In a nutshell, what is conventionally expressed in a contract by sentences is expressed by smart contracts in a computer code. When parties enter into a smart contract, they automatically agree to fulfill it when the terms expressed in the contract are met. Not only does this eliminate the need for an intermediary but also decreases the risk of interpreting contractual conditions to one’s benefit and makes things like fulfillment delays clearly evident. Moreover, in case of a breach, smart contracts can also be set to automatically oblige the party responsible for the breach to pay penalties.

Now let’s look a little closer into this issue. Commonly, the buyer transfers money to the seller as soon as any property encumbrances have been eliminated. For example, a notary would notify the buyer that the mortgage has been paid out by the previous owner and the property can finally be safely purchased. In other cases, contracts express that the seller can receive the money only when the new owner is officially registered as such. In any case, there are always delays between condition fulfillment and transaction execution.

With smart contracts, computer code is set to automatically send money to the seller when the respective land register is detected in the database. This way, the procedure is completely automated and only happens when both parties have fulfilled the terms of the agreement. Neither participant can influence the transaction execution, which happens without delays and without the involvement of a third party.

Limitations
Real estate industry professionals would argue that the aforementioned example is among the most primitive and simplest examples of transactions, and they would be completely right.

In many cases, contract conditions are way more complex and cannot be processed by the software. Many common preconditions are construction-related or require the physical presence of a person to validate their fulfillment. Think about the long and detailed descriptions of land and material use that we often see in construction contracts. While it’s certainly technologically possible to create custom code involving computer vision for such cases, it would not be economically viable. And even then, how can a program reliably evaluate the quality of construction works?

This is why the notion of smart contracts in real estate, including insurance, is only applicable to simpler transactions, where condition fulfillment can be verified online. Essentially, if one of the contract stipulations needs to be physically checked, smart contracts become no longer practical. Unfortunately, such contract obligations are common for almost all real estate transactions. For example, if the tenant is obliged to move out on a specific date, someone needs to physically be in that space to ensure it. On the other hand, there are plenty conditions that have to be verified online. For example, the deletion of a previous owner from the land register always happens via the internet.

Being a very conservative industry, many real estate professionals would be hesitant to trust technology instead of a lawyer or a notary. Smart contracts help eliminate the human factor in the transaction by putting in a computer code instead. However, while blockchains — which are the substrate for smart contracts to operate — can hardly be hacked, the code embedded in a smart contract might be inherently flawed. One way to mitigate it is through smart contract consulting, which is an auditing and engineering service designed to ensure smart contracts run safely and accurately.

Some experts argue that the inflexibility and process automation implied by smart contracts pose certain risks. Once the conditions are met, money transfer happens immediately and can’t be altered. Sometimes the legal basis for the contract enforcement may become obsolete, making agreement fulfillment reasonably undesirable for a party. This is why it’s especially risky to use smart contacts for long-term contractual relationships.

In a nutshell, the ambiguity in real estate transactions is inherited and, in many cases, has to be addressed rather than eliminated. At the end of the day, disputes involving smart contracts are inevitable, which offers significant challenges for lawyers and judges. Contrary to conventional contracts, smart contracts can be read and understood only by software developers.

Closing thoughts
At first sight, smart contracts offer previously unseen levels of transparency and efficiency for real estate transactions. However, when diving deeper into the essence of the technology, its limitations as of now become evident.

For smart contracts to become a viable alternative, the industry players should have a thorough understanding of the technology. Most likely, we will see a very gradual adoption of this technology for the simplest forms of real estate transactions in the near future. As long as the industry becomes comfortable using it at least in some cases, the technology adoption will be ongoing.