In the six months since rebranding Facebook, Inc. To Meta Platforms, Inc. The idea of the “metaverse” has taken off from little-known science fiction to the forefront of popular culture. Despite this increase in interest, there is still limited consensus on what the term means and what its implications are for consumers, different industries, and the economy as a whole. At least one area of economics has already become a focal point of the metaverse: real estate.
The concept of the metaverse can be traced back to sci-fi author Neal Stephenson whose 1992 novel “Snow Crash” depicted an immersive virtual reality-based successor to the Internet. And while this may sound a little more than science fiction, the metaverse is much closer to reality than many realize. For nearly two decades, digital platforms such as SecondLife and Entropia Universe have allowed users to immerse themselves in digital worlds where they can socialize and build lasting communities. Recently, popular games such as Roblox, Fortnite, and World of Warcraft have further blurred the line between the virtual and physical worlds, showing that consumers are willing to spend large amounts of money on virtual goods and even attend events, such as live concerts, in a purely virtual environment. .
The metaverse today (or for the foreseeable future) represents the next step in this evolution. It is a permanent and immersive digital ecosystem that allows individuals to seamlessly transition between their physical and virtual worlds, potentially based on next-generation consumer electronics with augmented or mixed reality capabilities that can act as a “gateway” to these virtual environments. It will contain advanced glyphs. It will be built on blockchain technology, allowing for decentralized infrastructure and independent governance. Its full potential will likely require interoperability between virtual environments.
real estate boom
Much of the metaverse is still ambitious. However, many companies and investors are already betting on metaverse real estate, with real estate sales in the metaverse exceeding $500 million in 2021 and expected to reach $1 billion in 2022. Already in January 2022, real estate sales have exceeded $85 million.
One of the main reasons for this interest in the metaverse real estate is that blockchain technology, which serves as the basis for many virtual metaverses, allows for “real” ownership of virtual properties. For example, in a traditional video game, the video game developer (or its licensors) generally owns the content and the intellectual property rights associated with the game. Although a brand may enter into a sponsorship agreement with a video game developer to display its trademarks or in-game content, the brand will generally not be able to purchase or own any part of the game. Furthermore, the code for the video game is hosted on the developers’ servers, allowing them to modify, suspend or terminate access to the game at any time.
In contrast, metaverses are generally divided into a finite number of plots or parcels. The ownership of each plot of land is generally recorded in a non-fungible token (“NFT”) tokenized on the public blockchain. Basically, NFTs are equivalent to a real-world instrument. Once the land is purchased, the landowner can build homes, shopping malls, museums, art galleries, or any other building, only limited by restrictions in the height, width, and depth of the land. Buyers can purchase individual parcels or purchase adjacent parcels to create virtual properties. Thanks to the underlying blockchain technology, the ownership of each virtual plot is permanently fixed on the blockchain network. Thus, once a plot of land is acquired, it cannot be controlled or changed by a third party; Basically, the ownership of the land is absolute and the owners can develop their virtual real estate, rent it, sell it or use it in any other way as they like.
A number of major investors and companies are already placing their demands in the metaverse, and the retail industry is one of the most active. For example, an investment company recently bought 116 packages in the fashion district of Decentraland for $2.4 million. In March 2022, the fashion district of Decentraland hosted Metaverse Fashion Week and major brands, including Forever 21, Philipp Plein and Estée Lauder, seized the opportunity to launch their flagship stores in the metaverse. These big brands, and others, hope that these virtual stores will give customers a similar experience to in-person shopping without the customer having to leave their home.
the potential risks
Although the opportunities in the metaverse may seem unlimited, there are still a number of risks that buyers must consider, including…
loss: Real-world property value is driven by scarcity or a limited amount of available land. There are currently a set number of parcels on the major platforms, but as demand grows in the metaverse, platforms can choose to create more virtual lands, reducing the value of each parcel.
Verdict: In the physical world, government agencies create zoning laws that control land use and building codes. If there are no restrictions on the use of each parcel, investors should be aware that an adjacent parcel could create the exact same adjacent structure or use the adjacent property in a disruptive way. At the moment, there is no way to file a complaint against a neighboring property owner who is causing a virtual nuisance.
protection: Although land owners and investors in the metaverse will never actually set foot on their property, many of the same risks associated with land ownership apply. Real-world landowners have a responsibility to protect the guests who come to their property and to protect their property from encroachments, trespassers, and hostile owners. It remains to be seen whether – and how – landowners will need to address such risks.
insurance: Landowners in the physical world purchase insurance to protect their property, as well as insurance against visitors’ property claims. In the metaverse, insurance may be needed to protect not only virtual property but other rights such as intellectual property, as well as to protect against cybercrime such as phishing and ransomware attacks. In addition, real-world buyers can purchase title insurance to provide protection for the chain of ownership of a particular plot of land. Currently, there is no way to secure ownership of NFT or other virtual assets.
Tax consequences: The IRS has released a few guidelines on how to handle the sale of an NFT. The majority of tax experts believe that profits from the sale of NFTs should be classified as ordinary income (subject to a high tax rate of 37%). However, some argue that NFTs should be taxed more similarly to “art collectibles,” which come with a different long-term capital gains rate. In addition, determining the estimated value of an NFT depends on a combination of factors: the floor price (which means the lowest price a buyer will pay for a particular token), the overall demand for NFT and the scarcity or limited availability of such an NFT. In short, until the IRS provides clearer guidance, owners will struggle to understand the tax ramifications of buying and selling NFTs.
There is a lot of excitement surrounding metaverses, including from a real estate perspective. However, like all new technologies, there are financial and legal risks for early adopters. Although there is still a lot of work to be done to create the true framework for Metaverse, there is huge potential for companies and investors alike.
Robert Kunin Partner in ArentFox Schiff that focuses on a wide range of real estate and financial transactions across all property classes.
Dan Jasnow He is a regulatory attorney at ArentFox Schiff who helps clients protect and promote their brands.
Kenon McDonald He is a partner in the ArentFox Schiff office in Washington, DC.
