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When Tokenized Real-World Assets Collide With The Real World

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Biying Cheng and I have a column in Law 360, When Tokenized Real-World Assets Collide With Real World. It reads,

The city of Detroit filed a public nuisance lawsuit in July of last year in the Michigan Circuit Court for the Third Judicial Circuit against Real Token, its co-founders and 165 affiliated entities, alleging building code and safety violations across over 400 Detroit residential properties.[1] RealT is a blockchain real estate platform that sells fractional interests in individual U.S. rental properties through the issuance of crypto security tokens.

On July 22, the judge issued a temporary restraining order — later converted into a preliminary injunction on Nov. 4 — barring RealT from collecting rent, pursuing evictions without a certificate of compliance and directing future rent into escrow until properties are brought up to code.

Detroit v. Jacobson is ongoing, with a trial scheduled to begin in May. The case highlights the brave new world we face when real estate assets are tokenized via blockchain technology.

The facts surrounding the case raise three pressing questions. First, are these real estate tokens securities? Second, assuming they are, do investors know what they are getting into when they purchase them? Third, and most importantly, are the very human tenants in these properties being provided with habitable housing by their decentralized finance landlords?

Are real estate tokens securities?

Until the Trump administration indicated that it might be taking a new approach to crypto more generally, it seemed clear that tokens like those issued by RealT were securities. Gary Gensler, chair of the U.S. Securities and Exchange Commission under the Biden administration, had stated that security tokens were generally securities under the long-standing Howey test, derived from the U.S. Supreme Court’s 1946 decision in SEC v. W.J. Howey Co.[2]

Trump administration officials have not, however, spoken in one voice on the issue. While SEC Commissioner Hester M. Peirce, the head of the SEC cryptocurrency task force, stated in July last year that “tokenized securities are still securities,” SEC Chairman Paul Atkins stated that “most crypto assets are not securities” a few weeks afterwards.[3]

Further muddying the waters, President Donald Trump’s Working Group on Digital Asset Markets released a report around the same time that distinguished between tokenized securities and tokenized nonsecurities, such as “commercial real estate.”[4]

On July 31, Atkins also announced the Project Crypto initiative to aid “President Trump in his historic efforts to make America the ‘crypto capital of the world.'” Under the aegis of Project Crypto, the SEC intends to develop “clear guidelines that market participants can use to determine whether a crypto asset is a security or subject to an investment contract” to slot crypto-assets into various categories.

The initiative also contemplates “an innovation exemption that would allow registrants and non-registrants to quickly go to market with new business models and services,” with no need to comply with burdensome regulatory requirements.[5]

It remains to be seen which types of real estate tokens will be deemed by the Trump administration to be securities and which will be deemed interests in real estate. It is important to acknowledge, however, that it would be a radical change to deem real estate tokens like RealT’s not to be securities, and it would upend decades of settled law relating to the Howey test.[6]

Indeed, the U.S. Court of Appeals for the Ninth Circuit on Aug. 11 reaffirmed a broad interpretation of the Howey test in SEC v. Barry.[7] To determine whether a security token is a security, the starting point is to decide whether it is an “investment contract” for the purposes of the Securities Act. Courts have found that the Howey test requires four elements to be met to determine whether something is an investment contract: (1) there must be an investment by the investor (2) in a common enterprise (3) with an expectation of profit (4) derived primarily from the efforts of others.

The Ninth Circuit in Barry found that sales of fractional interests in life settlements were investment contracts under the Howey test, and thus are securities. A life settlement is a transaction in which someone sells a policy insuring their own life to investors for an agreed-upon price, and the investors then take over the payment of the premiums and collect the death benefit after the insured dies. The defendants were sales agents for Pacific West Capital Group, a firm that buys life insurance policies from seniors and then sells fractional interests in those policies to investors.

Applying Howey, the court held that investors’ expected profits depended on PWCG’s managerial and ongoing efforts, including its policy selection, operation of the premium-reserve mechanism and the fractionalized structure that left investors reliant on PWCG’s management. The life settlements were thus found to be investment contracts.

Although this case does not address the tokenization issue, it demonstrates that the Howey test is generally applicable to transactions that fall under the broad category of “investment contracts.” So, while recent regulatory announcements impose some uncertainty regarding the applicability of the test, the Ninth Circuit’s decision in Barry shows that the Howey test is still alive and well, at least for now.

Are investors protected?

Promoters of real-world asset tokenization claim that they can lower barriers to real estate investing by allowing retail investors into the types of deals that once required high investment minimums and limited access to accredited investors. While the low cost and ease of entry into the real estate tokenization market are real, major challenges remain for retail investors to understand the risks posed by the tokens, as well as those posed by the underlying properties themselves.

Under the current regulatory framework, if a real estate token offering meets the Howey test, it is an investment contract and thus a security. The transaction then must be registered with the SEC or exempted.

Real estate token issuers typically rely on exemptions such as Regulation A, Regulation Crowdfunding, Regulation D and Regulation S. Each of those exemptions has various limitations on solicitation, investor accreditation and amounts raised, as well as other aspects of the offering.

States such as New York and California also have their own regulations that tokens must comply with. State securities regulators have identified schemes tied to digital assets as a top threat for retail investors.[8] It is far from clear whether real estate tokens generally comply with all of the federal and state investor protection regimes that apply to them.

In addition to being exposed to fraud and misrepresentation by token issuers, retail investors are also exposed to real-world problems relating to their investments that can rapidly interrupt cash flows and investor distributions.

Are tenants protected?

The Detroit RealT lawsuit clearly demonstrates how digital assets and their underlying real-world assets interact in a way that an investor pitch deck cannot. As alleged in the lawsuit, tenants in their properties have suffered for months from lack of heat, leaky roofs and other unsafe conditions. Investors are suffering — albeit only financially — for owning such poorly maintained properties.

Tenants are not without remedies. Many local governments, including Detroit, have significant statutory protections in place for residential tenants. Residential rentals in Detroit must obtain and maintain a certificate of compliance, and courts can effectively halt rent payments or consider noncompliance against landlords in  cases. When units are out of compliance, tenants may be directed to escrow rent until code issues are fixed, as the judge in the RealT case has ordered.

What’s next?

We are just beginning to live in a world of tokenized real estate. The RealT case in Detroit should provide some guidance as to how we should navigate this new world.

But the regulatory environment is not yet clear. Investors do not yet understand what they are investing in. And tenants may be suffering real-world consequences until a whole host of regulatory and business issues are worked out.

The sooner we figure it out, the better for all.

[1] City of Detroit, City of Detroit Announces Major Lawsuit Against Real Token And 165 Related Corporate Entities for Widespread Nuisance Abatement Violations (July 24, 2025), https://detroitmi.gov/news/city-detroit-announces-major-lawsuit-against-real-token-and-165-related-corporate-entities.

[2] Gary Gensler, Chair, U.S. Sec. & Exch. Comm’n, Remarks on the Importance of Oversight and Investor Protection in Our Crypto Markets (Apr. 4, 2022), Securities and Exchange Commission, https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422. , 328 U.S. 293 (1946).

[3] Hester Peirce, Comm’r, U.S. Sec. & Exch. Comm’n, Statement on Tokenized Securities, (July 9, 2025), https://www.sec.gov/newsroom/speeches-statements/peirce-statement-tokenized-securities-070925; Paul Atkins, American Leadership in the Digital Finance Revolution (July 31, 2025), https://www.sec.gov/newsroom/speeches-statements/atkins-digital-finance-revolution-073125.

[4] President’s Working Group on Digital Asset Markets, Strengthening American Leadership In Digital Financial Technology 37 (July 2025), https://www.whitehouse.gov/fact-sheets/2025/07/fact-sheet-the-presidents-working-group-on-digital-asset-markets-releases-recommendations-to-strengthen-american-leadership-in-digital-financial-technology/.

[5] Paul Atkins, Chair, U.S. Sec. & Exch. Comm’n, American Leadership in the Digital Finance Revolution (July 31, 2025), https://www.sec.gov/newsroom/speeches-statements/atkins-digital-finance-revolution-073125.

[6] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[7] SEC v. Barry, 146 F.4th 1242 (9th Cir. 2025).

[8] NASAA Highlights Top Investor Threats, North American Securities Administrators Association (Mar. 6, 2025), https://www.nasaa.org/75001/nasaa-highlights-top-investor-threats-for-2025/.

Why Does a Bank Sell Your Mortgage?

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I was quoted in Marketplace’s story, Why Does a Bank Sell Your Mortgage? You can listen to it here. The transcript opens,

Right after Marc Hill bought his first home, a townhouse north of Chicago, in the summer of 2019, he got a letter telling him his mortgage had been sold. He didn’t think much of it after Googling around.

“I read that was kind of normal. And then it happened again. And then again. And I was like, ‘Well, what’s going on here?’” he said with a laugh.

Recently, less than five years after his purchase, the mortgage on Hill’s townhouse changed hands for the fourth time.

“Welcome to the 21st century housing market,” said David Reiss, a professor of real estate finance and housing policy at Brooklyn Law School. Today, upward of 70% of mortgages are sold into the secondary market.

“A lot of people have a sense that mortgages work like they did maybe in ‘It’s a Wonderful Life,’” he said. “Where you walk into your bank and if they think you’re a good risk, they’re going to give you some mortgage, and that’s going to come from money that they have from deposits.”

Sometimes that is how it works. But for the most part, Reiss said, “instead of banks lending you money that they have in deposit, once the bank makes the mortgage they then sell it to investors.”

When the bank or lender that originated your mortgage sells it, they get back all the money they lent you right away, plus a chunk of the interest you’re expected to pay over the life of your mortgage. They also get some of your closing costs.

Law in The Time of COVID: The Ripple Effect in Real Estate

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Dean Michael Cahill

In many ways, COVID-19 has changed the way we live for both the immediate future and long-term. Brooklyn Law School Dean Michael Cahill has been sitting down with members of the Brooklyn Law School faculty to discuss the legal ramifications of our response to COVID-19 and what a post-pandemic world may look like.  Here is the link to our discussion of the effect of the pandemic on the real estate market and beyond: https://youtu.be/j9DFBOsU3qw.

Nonbanks and The Next Crisis

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Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:

The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.

In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?

We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.

In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.

Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)

As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.

Ghost of A Crisis Past

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photo by Chandres

The Royal Bank of Scotland settled an investigation brought by New York Attorney General Schneiderman arising from mortgage-backed securities it issued in the run up to the financial crisis. RBS will pay a half a billion dollars. That’s a lot of money even in the context of the settlements that the federal government had wrangled from financial institutions in the aftermath to the financial crisis. The Settlement Agreement includes a Statement of Facts which RBS has acknowledged. Many settlement agreements do not include such a statement, leaving the dollar amount of the settlement to do all of the talking. We are lucky to see what facts exactly RBS is “acknowledging.”

The Statement of Facts found that assertions in the offering documents for the MBS were inaccurate and the securities have lost billions of dollars in collateral. These losses led to “shortfalls in principal and interest payments, as well as declines in the market value of their certificates.” (Appendix A at 2)

The Statement of Facts outlines just how RBS deviated from the statements it made in the offering documents:

RBS’s Representations to Investors

11. The Offering Documents for the Securitizations included, in varying forms, statements that the mortgage loans were “originated generally in accordance with” the originator’s underwriting guidelines, and that exceptions would be made on a “case-by-case basis…where compensating factors exist.” The Offering Documents further stated that such exceptions would be made “from time to time and in the ordinary course of business,” and disclosed that “[l]oans originated with exceptions may result in a higher number of delinquencies and loss severities than loans originated in strict compliance with the designated underwriting guidelines.”

12. The Offering Documents often contained statements, in varying forms, with respect to stated-income loans, that “the stated income is reasonable for the borrower’s employment and that the stated assets are consistent with the borrower’s income.”

13. The Offering Documents further contained statements, in varying forms, that each mortgage loan was originated “in compliance with applicable federal, state and local laws and regulations.”

14. The Offering Documents also included statements regarding the valuation of the mortgaged properties and the resulting loan-to-value (“LTV”) ratios, such as the weighted-average LTV and maximum LTV at origination of the securitized loans.

15. In addition, the Offering Documents typically stated that loans acquired by RBS for securitization were “subject to due diligence,” often described as including a “thorough credit and compliance review with loan level testing,” and stated that “the depositor will not include any loan in a trust fund if anything has come to the depositor’s attention that would cause it to believe that the representations and warranties of the related seller regarding that loan will not be accurate and complete in all material respects….”

The Actual Quality of the Mortgage Loans in the Securitizations

16. At times, RBS’s credit and compliance diligence vendors identified a number of loans as diligence exceptions because, in their view, they did not comply with underwriting guidelines and lacked adequate compensating factors or did not comply with applicable laws and regulations. Loans were also identified as diligence exceptions because of missing documents or other curable issues, or because of additional criteria specified by RBS for the review. In some instances, RBS disagreed with the vendor’s view. Certain of these loans were included in the Securitizations.

17. Additionally, some valuation diligence reports reflected variances between the appraised value of the mortgaged properties and the values obtained through other measures, such as automated valuation models (“AVMs”), broker-price opinions (“BPOs”), and drive-by reviews. In some instances, the LTVs calculated using AVM or BPO valuations exceeded the maximum LTV stated in the Offering Documents, which was calculated using the lower of the appraised value or the purchase price. Certain of these loans were included in the Securitizations.

18. RBS often purchased and securitized loans that were not part of the diligence sample without additional loan-file review. The Offering Documents did not include a description of the diligence reports prepared by RBS’s vendors, and did not state the size of the diligence sample or the number of loans with diligence exceptions or valuation variances identified during their reviews.

19. At times, RBS agreed with originators to limit the number of loan files it could review during its due diligence. Although RBS typically reserved the right to request additional loan-level diligence or not complete the loan purchase, in practice it rarely did so. These agreements with originators were not disclosed in the Offering Documents.

20. Finally, RBS performed post-securitization reviews of certain loans that defaulted shortly after securitization. These reviews identified a number of loans that appeared to breach the representations and warranties contained in the Offering Documents. Based on these reviews, RBS in some instances requested that the loan seller or loan originator repurchase certain loans. (Appendix A at 4-5)

Some of these inaccuracies are just straight-out misrepresentations, so they would not have been caught at the time by regulators, even if regulators had been looking. And that’s why, ten years later, we are still seeing financial crisis lawsuits being resolved.

It is not clear that these types of problems can be kept from infiltrating the capital market once greed overcomes fear over the course of the business cycle. That’s why it is important for individual actors to suffer consequences when they allow greed to take the driver’s seat. We still have not figured out how to effectively address tho individual actions that result in systemic harm.

The Mortgage Servicing Collaborative

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The Urban institute’s Laurie Goodman et al. have announced The Mortgage Servicing Collaborative:

All mortgage market participants share the same goal: successful homeownership. Failure to achieve that goal hurts not only consumers and neighborhoods, but investors, insurers, guarantors, and servicers. Successful homeownership hinges on several factors. Consumers need access to a range of mortgage products when buying a home and need effective mortgage servicing. Servicing is the critical work that begins after the mortgage loan is closed and includes collecting and transferring mortgage payments from borrowers to investors, managing escrow, assisting borrowers who fall behind on their payments, and administering the foreclosure process. If closing the loan is the birth of the mortgage, servicing is its day-to-day care.

Despite its importance, mortgage servicing is frequently overlooked in major policy conversations, including the housing finance reform debate. That is a mistake. The servicing industry has changed dramatically since the 2008 mortgage default and foreclosure crisis and subsequent Great Recession. Overlooking servicing while implementing changes to the housing finance system has resulted in some unintended and unwanted consequences, including significant increases in the cost of servicing, a suboptimal servicing system, reduced access to credit for consumers, and an exodus from the industry by depository servicers.

To address this policy oversight, the Urban Institute’s Housing Finance Policy Center (HFPC) has convened the Mortgage Servicing Collaborative (MSC) to elevate the mortgage servicing discussion and facilitate evidence-based policymaking by bringing more data and evidence to the table. The MSC has convened key industry stakeholders—lenders, servicers, consumer groups, civil rights leaders, researchers, and government—and tasked them with developing a common understanding of the biggest issues in mortgage servicing, their implications, and possible solutions and policy options that can advance the debate. And with the mortgage industry no longer operating in crisis mode, we believe now is the right time for this effort.

In this brief, the first in a series prepared by HFPC researchers with the collaboration of the MSC, we review how we arrived at the present state of affairs in mortgage servicing and explain why it is important to institute mortgage servicing reforms now. (1-2, footnote omitted)

The report provides a short but useful history of servicing, which at the best of times is a dark corner of the mortgage market. It also provides an overview of the risks inherent in a poorly constructed system of servicing for consumers and other players in that market. The Collaborative will certainly be taking deeper dives into these risks in future releases.

As with much of the Housing Finance Policy Center’s work, this collaborative is very forward-looking. Hopefully, it will help us prepare for the next downturn in the housing market.

FHFA’s Strategic Plan for Fannie and Freddie

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The Federal Housing Finance Agency released its Strategic Plan for fiscal years 2018-2022 for public input. As discussed in yesterday’s post, Director Watt is very focused on maintaining the health of Fannie Mae and Freddie Mac. The Strategic Plan reiterates that focus:

As conservator of the Enterprises, FHFA will also promote stability by working to preserve and conserve the Enterprises’ assets and business operations. Additionally, FHFA will encourage the Enterprises and the housing industry to adopt standards and practices that promote market and stakeholder confidence. (8)

The Plan goes into depth to describe the FHFA’s role as conservator:

The Enterprises were placed into conservatorships in September 2008 in the midst of a severe financial crisis. Their ongoing participation in the housing finance market has been an important factor in maintaining market liquidity and stability. Conservatorship permitted the U.S. Government to take greater control over management of the Enterprises and gave investors in the Enterprises’ debt and MBS confidence that the Enterprises would have the capacity to honor their financial obligations. As conservator, FHFA establishes restrictions and expectations for the Enterprises’ boards and for their managements while authorizing them to conduct the Enterprises’ day-to-day operations.

As detailed earlier, FHFA’s authority as both regulator and conservator of the Enterprises is based upon statutory mandates. FHFA, acting as regulator and conservator, must follow the mandates assigned to it by statute and the missions assigned to the Enterprises by their charters. Congress may choose to revise the statutory mandates governing the Enterprises at any time.

*      *     *

The Enterprises are also parties to PSPAs with the Treasury Department. Under the PSPAs, the Enterprises are provided U.S. taxpayer backing with explicit dollar limits. The PSPA commitment still available to Fannie Mae is $117.6 billion and the commitment still available to Freddie Mac is $140.5 billion. Additional draws would reduce these commitments, and dividend payments do not replenish or increase the commitments under the terms of the PSPAs. Starting in 2013, the PSPAs provided each Enterprise with a capital buffer of $3 billion to protect each Enterprise against making additional draws of taxpayer support in the event of an operating loss in any quarter, and the PSPAs provide mandated declines of $600 million each year to these capital buffers. On January 1, 2017, each Enterprise’s capital buffer declined to $600 million and the capital buffer is scheduled to decline to zero on January 1, 2018.

FHFA continues to encourage Congress to complete the important work of housing finance reform. FHFA has reiterated the urgency of reform and that it is up to Congress to determine what future, if any, the Enterprises will have in the future housing finance system. (16-17)

Reading between the lines, I see the FHFA under Watt doing whatever it has to in order to maintain stability and liquidity in the mortgage markets. If Congress does not act, if the Treasury does not act, I think that Director Watt will go it alone and do what it takes to maintain Fannie and Freddie’s reputation with mortgage lenders and MBS investors.