In the six months since Facebook, Inc. rebranded to Meta Platforms, Inc., the idea of the “metaverse” has catapulted from a little-known science fiction fantasy to the forefront of popular culture. Despite this surge of interest, there is still limited consensus on what the term means and what its implications will be for consumers, various industries, and the economy as a whole. At least one area of the economy has already become a focal point of the metaverse: real estate.
The concept of the metaverse can be traced back to science fiction author Neal Stephenson whose 1992 novel “Snow Crash” depicted an immersive, virtual reality-based successor to the Internet. And while this may still seem like little more than science fiction, the metaverse is much closer to reality than many realize. For almost two decades, digital platforms like SecondLife and Entropia Universe have allowed users to immerse themselves in digital worlds where they can socialize and build durable communities. More recently, popular games like Roblox, Fortnite, and World of Warcraft have further blurred the line between virtual and physical worlds, showing that consumers are ready to spend big on virtual goods and even attend events, like live concerts, in a purely virtual environment.
The metaverse of today (or the near future) represents the next step in this evolution. It is a persistent and immersive digital ecosystem that allows individuals to seamlessly transition between their physical and virtual worlds, and it will likely rely on next-generation consumer electronics with augmented or mixed reality capabilities that can serve as a “gateway” into these virtual environments. It will feature advanced avatars. It will be built on blockchain technology, allowing for decentralized infrastructure and autonomous governance. And its full potential will likely require interoperability between virtual environments.
The Real Estate Boom
Much of the metaverse remains aspirational. However, many companies and investors are already betting big on metaverse real estate, with sales of real estate in the metaverse topping $500 million in 2021 and are projected to top $1 billion in 2022. Already in January 2022, real estate sales exceeded $85 million.
One big reason for this interest in metaverse real estate is that blockchain technology, which serves as the foundation for many metaverse virtual worlds, allows for “true” ownership of virtual property. For example, in a traditional video game, the video game developer (or its licensors) generally owns the content and associated intellectual property rights in the game. While a brand might enter into a sponsorship agreement with the video game developer to display its trademarks or content within the game, the brand generally would not be able to buy or own any portion of the game. Moreover, the video game code is hosted on the developers’ servers, allowing it to modify, suspend, or terminate access to the game at any time.
In contrast, metaverse virtual worlds are generally subdivided into a limited number of plots or parcels. Ownership of each plot is generally recorded in a non-fungible token (“NFT”) that is coded onto a public blockchain. Essentially, these NFTs are equivalent to a deed in the real world. Once the land is purchased, the landowner can construct houses, shopping centers, museums, art galleries or any other structure, limited only by the individual parcel’s height, width, and depth restrictions. Buyers can purchase individual parcels or buy adjacent parcels to create virtual estates. By virtue of the underlying blockchain technology, ownership of each virtual plot is permanently affixed to a blockchain network. Thus, once a plot is acquired, it cannot be controlled or altered by a third party; essentially, plot ownership is absolute and owners can develop, lease, sell, or otherwise use their virtual real estate as they wish.
A number of large investors and companies are already staking their claim in the metaverse, and the retail industry is one of the most active industries. For example, an investment firm recently purchased 116 parcels in Decentraland’s Fashion District for $2.4 million. In March 2022, Decentraland’s Fashion District hosted a Metaverse Fashion Week and big brands, including Forever 21, Philipp Plein, and Estée Lauder, took this opportunity to debut their flagship stores in the metaverse. These big brands, and others, are hoping that these virtual stores will give customers an experience similar to in-person shopping without the customer having to leave their home.
Although opportunities in the metaverse may appear limitless, there are still a number of risks for buyers to consider, including …
Scarcity: Property value in the real world is driven by scarcity, or a finite quantity of available land. Currently, there are a set number of parcels on the major platforms, but as demand in the metaverse grows, platforms could elect to create more virtual land, devaluing each parcel.
Governance: In the physical world, government agencies set zoning ordinances that control land use and building codes. If there are no restrictions on the use of each parcel, then investors need to be aware that a neighboring parcel can either create the exact same structure next door or use the adjacent property in some disruptive way. Presently, there is no way to file a complaint against an adjacent property owner that is creating a virtual nuisance.
Security: Although landowners and investors in the metaverse will never physically set foot on their property, many of the same risks associated with landownership apply. Real world landowners are charged with protecting guests that come onto their property and protecting their property from encroachments, trespassers, and adverse possessors. 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 insure against claims by visitors to the property. In the metaverse, insurance could be needed to not only protect the virtual property but other rights like intellectual property, as well as to protect against cybercrime like phishing and ransomware attacks. Additionally, buyers in the real world can buy title insurance to provide protection on their chain of ownership of a particular parcel of land. Currently, there is no way to insure ownership of an NFT or other virtual asset.
Tax Consequences: The IRS has issued little guidance on how to treat the sale of an NFT. The majority of tax experts believe that profits derived from the sale of NFTs should be classified as ordinary income (subject to a tax rate as high as 37 percent). However, some argue that NFTs should be taxed more similarly to art “collectibles,” which come with a different long-term capital gains rate. Additionally, determining an NFT’s estimated worth depends on a combination of factors: floor price (which means the lowest price a buyer would pay for a particular token), overall demand for the NFT and the scarcity or limited availability of such NFT. In short, until the IRS provides clearer guidance, owners will struggle with understanding the tax ramifications of buying and selling NFTs.
There is a lot of excitement surrounding the metaverse, including from a real estate perspective. However, like all new technologies, there are both financial and legal risks for early investors. Although there is still a lot of work that needs to be done to create the true framework of the metaverse, there is tremendous potential for companies and investors, alike.
Robert Koonin is a Partner at ArentFox Schiff who focuses on a wide array of real estate and finance transactions across all property classes.
Dan Jasnow is a regulatory attorney at ArentFox Schiff who helps clients protect and promote their brands.
Kinnon McDonald is an Associate in ArentFox Schiff’s Washington, DC office.