Recently, LinksDAO raised over $10 Million USD to ultimately buy a Golf Course. About 33 and 1/2 years ago, in early December of 2021, The Mountain DAO announced on twitter that it was forming a DAO and raising capital to purchase a mountain in Virginia. The Mountain DAO has summarized its mission as:
“We are buying a mountain in Virginia (to start)! An experiment in decentralization, Real Estate tokenization, and the power of memes. Starting with one mountain, with the goal of decentralization & preservation of mountains around the world. A new take on public land!”The Mountain DAO
They are following in the footsteps of the Constitution DAO by using JuiceBox as the primary means of fund raising (Juice Box – Mountain DAO). They are taking in ETH and sending back (based on a few conditions) $MTDR. The ETH will presumably be used to purchase the property from the seller and then somehow they will have to register as owners of this property with a municipal agency in Virginia. That is where this gets interesting to me.
The NFTtorney has previously written about excellent articles on DAO’s (Here & Here) primarily focused on whether or not a DAO by itself would be considered a security. While I mostly agree with his conclusions on when a DAO would and wouldn’t be a security, buying a piece of Real Estate requires a name to be put under “Buyer” at the Register of Deeds office. For now, there are no counties or cities in the US that I am aware of which will allow a DAO to buy anything unless there is an entity (Corporation, LLC, actual person, etc. ) listed under “Buyer”. A DAO trying to interact with IRL assets that require recording at a governmental level changes much of the analysis of structuring a DAO.
I have helped set up what I am now calling “Analog DAOs” for my IRL job. By that, I mean I have helped draft Operating Agreements for Member-Managed LLC’s in which the operation of the LLC was limited to specific functions and most of the decision making was done before the LLC was formed. This is accomplished through an extremely detailed set of “if-then” type clauses within the Operating Agreement and designated the exact voting mechanisms for any situations that arise which weren’t contemplated by the Operating Agreement. There is no algorithm or code involved here, just detailed legal language. This “Analog DAO” works great for managing passive businesses like real estate with triple net leases and very few variables.
This structure is however, terrible for an active business that must respond with agility to an evolving competitive landscape. I believe this same distinction will hold true for actual DAOs, at least until better IRL options emerge for the legal structures. The Mountain DAO and other DAOs like it can have a lot of success in providing unprecedented access to Real Estate opportunities. The day to day operations of these DAOs may be accomplished by a combination of predefined rules and token-holder voting but, they must be careful in choosing how the DAO will interact with the real world. Here are 4 specific areas I think we need to focus on for the intersection between real estate investing and web3:
- Limit an investors Personal Liability from an investment property to only the amount of money invested into that property
- Avoid SEC Securities Regulations (See The NFTtorney‘s previous discussions on the Howey Test)
- Replace Traditional Middlemen involved in property sale
- Use a DAO as a tool to own and manage real estate
Direct (Traditional) Real Estate Transaction
A traditional real estate transaction can involve any number of parties acting as purchaser, seller, or both; the core components of the transaction are represented by the simple graphic to the right.
- Limiting Personal Liability: This method of direct acquisition offers zero liability protection and can create an unlimited liability on behalf of those that are purchasing this property.
- Avoiding Securities Regulations: This direct purchase model does very little to avoid SEC Regulations (The Howey Test was created on a case involving the direct purchase of Real Estate) but it certainly does nothing to provoke SEC Regulation. The facts and circumstances surrounding the operation of the property and the parties themselves will determine whether or not there should be compliance with securities laws.
- Removing Traditional Real Estate Middlemen: The traditional real estate transaction is the very reason there are so many middle men. These transactions require money to be placed in escrow, closing attorneys, title agencies, registers of deeds at a municipal level, etc.
- Managed by a DAO: Using a DAO to govern this transaction would be nearly impossible. Every DAO token holder would have to be registered as an owner (sorry anons – legal names only) with the register of deeds and then each time a token was sold, the register of deeds would have to be updated. This would be almost impossible without some significant limitation on the transferability fo the DAO tokens.
This is by far the worst structure I could imagine for a DAO to purchase a property. It offers only drawbacks.
Property Holding Entities (LLC)
These approaches show what it looks like to add some corporate entities between the actual human being who wants to buy a property and the actual property the human wants to own. I am going to assume you, dear reader, understand the basics of what a corporate entity is and not bore you with a summary. There are many advantages to adding corporate entities as a buffer but there are also a few drawbacks.
- Limiting Personal Liability: Corporations and as the name implies, Limited Liability Companies (LLC’s) provide very good liability protection to its owners. This protection is often referred to as the “Corporate Veil”. This protects owners from losing any of their assets outside of those inside the company in case the company is sued. Unless an owner/entity engages in pretty egregious behavior, piercing the corporate veil and opening up liability to owners personally is very challenging in this country. If you are going to own more than one property for investment, I recommend a separate LLC for each property which are all held by the Parent Entity which manages all the subsidiaries. This set up ensures that if anyone of the properties has a big loss of any kind, creditors of that property typically, cannot get to the other properties. An overly simple way to look at it is through buckets of water. If you have five different buckets each holding one gallon of water, the most water you can lose from one hole is one gallon. If you have 1 bucket with 5 gallons of water, you can lose all five gallons with a single hole.
- Avoiding Securities Regulations: This is where things get trickier. In regards to form, a member-managed LLC is probably the best option to avoid securities regulation. The more important aspect is function. As The NFTtorney has correctly pointed out, it is important that all members have an active role within the operation of the LLC. This is obviously much easier to accomplish with a passive business (such as buying and holding real estate) versus an active business which requires many decisions to be made. Until there is more information published on the SEC’s regulation of DAOs and DAO owned LLC’s, I think it is best to stick with simple businesses (MountainDAO is a lot simpler than LinksDAO) and make sure that every DAO token holder has a say in the very few decisions that need to be made.
- One possible alternative within this structure is for the Main Entity (“Legal Entity” in first graphic & “Parent Entity” in the second) to be based internationally. If that entity was in a non US jurisdiction which had relaxed securities (and preferably tax laws) such as Panama or the Cayman Islands, it would likely avoid any SEC regulation. You would need to find a jurisdiction which the DAO members were comfortable with the legal system, allowed DAOs to control LLC-type entities, and are either allowed to own property in the US or own US LLCs which in turn own property. This is an avenue I will absolutely be researching more on in the coming weeks as I feel it is likely a fruitful path.
- Removing Traditional Real Estate Middlemen: These transactions will still require money to be placed in escrow, closing attorneys, title agencies, registers of deeds at a municipal level, etc.
- Managed by a DAO: This should not be a problem thanks to Wyoming and their allowing of anonymous ownership of LLCs. I am unaware of another state that offers anonymous ownership of an LLC because Wyoming has always satisfied my requirements. A DAO will need a point person who can contract with a registered agent in Wyoming (there are many registered agent services in Wyoming) to act as a registered agent and to file the Articles of Organization. Wyoming has also created a new DAO LLC, but that seems to be a poorly written subset of their traditional LLC. The key will be the Operating Agreement, this document is like a contract between the owners of the business and the entity itself. I believe an anonymously owned Wyoming LLC can have an Operating Agreement which points to a DAO for all decision making. The concept of an anonymously owned LLC has one amazing benefit for everyone and two huge benefits to the web3 community. Firstly the benefit to everyone is that if your ownership of an LLC is not on the state record, it is very difficult for creditors to find it. The benefits to the web3 community are anons get to stay anonymous and secondly, there is nothing to update with the state when tokens (ownership) are transferred. Were it not for the Wyoming anonymous LLC, you would be required to disclose the identity of all token holders as owners and then update the Secretary of State of new owners every time a token is transferred.
- One Possible avenue for accomplishing DAO management for an LLC in a state that does not permit anonymous ownership would be through a DAO Representation Agreement (See: Ross Campbell‘s thread and template document). This agreement designates a representative to manage the legal operational concerns of the DAO. If done without creating a separate entity like an LLC, I believe this would leave the representative as the buyer on record for the real estate purchased. This may help prevent Securities issues in theory, but courts have shown time and time again that function is more important than form in enforcing the Howey test. Thus, I think this would do little to prevent securities regulations if the facts of the situation lend themselves to a finding of the DAO token being a security. I am skeptical about this approach though because the investor is not receiving shares in the Main Entity (“Legal Entity” in first graphic & “Parent Entity” in the second) and instead receive only a contract. In this scenario, the investors only have a contractual right to the property rather than an equitable right. In Construction Law we do everything we can to protect the lien rights of contractors that we represent because equity rights are important and often more important than contract rights. This Representation Agreement approach goes completely against that school of thought. Therefore, until I can do more research on how courts enforce these types of agreements, I am not interested in trading ETH for Tokens of a DAO that utilizes a DAO Representation Agreement in lieu of equity. One definite possibility would be the courts deciding this DAO Representation Agreement used to purchase property is actually an Implied Trust. If that occurs, why not just create a trust and name the representative as the Trustee? More on that soon.
Depending on the situation and the needs of each DAO, I would be comfortable investing my own money in a DAO that sought to own property through ownership of a Wyoming LLC or a foreign country LLC (after fully researching the corporate laws of that country).
Utilizing a Trust
Full disclosure here, I have almost zero experience with Trusts other than what I learned at law school. In fact, I had to dig up old notes and a text book from Wills, Trusts, and Estates just to be able to wrap my head around how to structure one of these deals. Luckily, The NFTtorney had some helpful ideas and helped me see a world in which DAOs can utilize a trust to own property. Let’s start with some basics on trusts but keep in mind, these are all notes regarding a South Carolina Trust as that is where I went to law school.
A Trust must split the legal and equitable title to a property. In leymans terms, it separates the decision making surrounding property from the profit derived by that property. This is often done by parents trying to protect their children from themselves. That’s where the term “Trust Fund Baby” comes from. In the simplest form, a Trust must have the following:
- Someone owns some property and through a legally binding document, they place this property into a Trust.
- The property could be stocks, bonds, real estate, fine art or just straight cash (homie).
- The instructions laid out in the trust can vary wildly, they just cant be illegal or violate public policy.
- The person creating the Trust is referred to as the Settlor.
- The Trust must have a Trustee who controls the property (they must follow any rules or guidelines laid out in the trust document)
- Almost anyone or any group of people can be the the Trustee(s) so long as they are competent and in most situations a Beneficiary can also be a Trustee.
- The Trust must also have at least one Beneficiary who will receive the benefits derived from this property.
- Beneficiaries again can be almost anyone.
To put it in the Real Estate DAO context, this plan requires a DAO to sell its tokens to a bunch of investors. The DAO then turns that money over to a Trust that the DAO creates. This makes the DAO the Settlor and the DAO token holders the Beneficiaries. In this Trust creating document, the DAO must also designate at least one Trustee and outline the rules which the Trustee must follow. The Trust purchases the desired property, the Trustee operates and manages the property, and the beneficiaries receive the profit. The Trust in this example should likely be a Revokable Discretionary Trust. If a trust is Revokable, the Trustee can be guided by the Settlor on issues not resolved by the Trust rules. If a trust is discretionary it allows the Trustee to decide how much and to whom to distribute profit. Let’s examine all of this under our existing 4 part framework:
- Limiting Personal Liability: This structure will almost certainly prevent personal liability for Beneficiaries from anything that has occured inside the trust. For the Beneficiaries, this is about as secure as you can get in asset protection. It is extremely unlikely that any liability from something occurring with the operation of the Trust or from the property in the trust will go beyond the assets of the Trust. Trustees on the other hand may be personally liable for their actions. Trustees have a duty of reasonable care, skill and caution in administering the Trust. If I was investing in a DAO that wanted to use a Trust to own real estate, I would not want to be a Trustee. Practically speaking, the Trustee should probably be a third party not invested in the DAO such as a law firm or maybe even a large property management firm.
- Avoiding Securities Regulations: I tried to find any case law on the SEC claiming that a Trust is a security but I could not find one. I am not saying that there is no guidance on this, I am saying I could not find any. To be on the safe side, you should create a Discretionary Trust, as discussed above, in which the Trustee has discretion on how much to pay out to beneficiaries. This would likely remove the argument for “expectation of profit” for Howey purposes.
- Removing Traditional Real Estate Middlemen: These transactions will still require money to be placed in escrow, closing attorneys, title agencies, registers of deeds at a municipal level, etc.
- Managed by a DAO: This is where the specific type of trust, Revokable & Discretionary are very much necessary. As previously mentioned, a Revokable trust allows the Settlor to have a lot more input on the Trustee. In fact, the Trustee of a revocable Trust may even follow the directions of the Settlor, when those directions are different from the rules of the trust. This is key, because the DAO would want the Trustee to act according to the votes and decisions of the DAO over time rather than the rules set out in the Trust creating document. It is absolutely essential that the Trustee is made fully aware of how a DAO operates and how they should operate as the Trustee. Discretionary Trusts allow a DAO to avoid the typical requirement for Beneficiaries to be definite or definitely ascertainable. In a Discretionary Trust, the beneficiaries can be part of an “indefinite class” and the Trustee may validly be given the power to select beneficiaries from the class. I believe “token holders” of a DAO would be sufficiently specific as an indefinite class. This would leave the Trustee to select beneficiaries from the class of “token holders”. This removes the need to name token holders (anons rejoice) and removes the need to update trust documents each and every time a token changes hands.
Depending on the situation and the needs of each DAO, I would be comfortable investing my own money in a DAO that sought to own property through the use of a Trust.
Forward Thinking Municipality
I believe that a forward thinking municipality will soon offer a limited number of “on-chain” deeds as a beta type program. Reno, NV and Miami, FL seem the most likely to me at the moment. This would allow property owners to put their title/deed on the municipalities’ Real Estate block chain and then decide how many tokens they should create to represent ownership. Those tokens could then be sold just like any other NFT. Owners could spruce up their tokens by attaching floorpans and professional photos of their property to the meta data of their tokens to help drive up the price. Maybe we are further away from this than I believe but we can still analyze the implications so that we are ready for when this day comes.
- Limiting Personal Liability: Unless this theoretical municipality passed legislation that also limited liability, “on-chain” deeds would do nothing to limit personal liability of the Deed Token Holders.
- Avoiding Securities Regulations: I see no reason why moving the deeds “on-chain” would do anything to help avoid Securities Regulations. In fact it may cause more property deals to be questioned by the SEC as it more easily allows divided ownership of a single piece of property.
- Removing Traditional Real Estate Middlemen: This is the only way I can see to remove the moats created around the middle men in the real estate industry. If a deed is on chain, there is no need for title searches and attorneys. With an on-chain deed, smart contracts can take the place of escrow and closing attorneys.
- Managed by a DAO: From a practical standpoint, this would likely help usher in a wave of DAO managed properties just because they would be crypto native and familiar with on-chain technologies. From a legal standpoint, however, I do not believe tokenized deeds would really aide a DAO in owning property as the municipality would still require the actual name and information fo the “Buyer”.
There is no way to know for sure how far we are away from this potential future but I believe we are getting very close to some limited roll outs of these type of token based deed programs to attract the attention and dollars of all the nouveau riche web3 degens.
King of the Mountain: DAO Structures
As I begin to build out my mental model for the project I would most like to invest some of my money toward, it looks a lot like the model above. Let’s break it down.
Firstly, the investors (Degens above) would be token holders and pump their ETH into the DAO. The DAO would start a foreign corporation in a business friendly country that I am comfortable with, right now I am leaning toward Panama. The DAO would identify properties in a municipality where you can buy property on-chain. As noted above, my guess is it will be in Reno or Miami. The Panamanian parent company would then start an LLC for each property the DAO identified in the state that the property is located in. For arguments sake, lets say Miami starts allowing on-chain property transfers tomorrow. Then the Panamanian parent company would need to create one Florida Member-Managed LLC for each unique property that they intend to purchase. Then each LLC would buy one of the properties identified. All management decisions of the properties would flow from the DAO to the Panamanian Parent Company down to the individual Florida LLC’s.
Of course, this is what I would hypothetically like to do with my money. This is simply insight into how my mind works. This not financial or legal advice. If you want my legal or financial advice, hire me (I am not cheap).