Unlocking the metaverse’s potential as a real estate investment

In 2021 and early 2022, there was a lot of buzz about virtual “real estate.” Investing in the metaverse was to be the “next big thing.” Early speculators invested hundreds of millions, if not billions, of crypto dollars in the first virtual land “gold rush.” Then, in the third quarter of 2022, as part of the broad fall-off in the NFT and crypto markets and the global economic downturn, sales volume and average prices for virtual land on the major metaverse platforms came crashing down.

Perhaps this volatility was to be expected, as nascent as the metaverse is and as embryonic as the first-gen technology on most platforms still seems to be. However, as metaverse technology optimizes over the next couple of years, many expect another gold rush. Countless metaverse real estate investment firms are undoubtedly betting on it. 

The speculators in that first gold rush were primarily crypto and fintech investors rather than traditional real estate investors. The latter largely watched from the sidelines as the virtual-land market went boom and then bust. Yet despite the recent headwinds, many of the savviest business minds remain bullish on the potential of virtual real estate. They believe it can fundamentally transform how, when and where we will meet up and conduct business in the future.

To realize that potential, metaverse platform developers would be wise to take note of at least some of the fundamentals that have attracted traditional “real world” real estate investors — and make some changes as they build out the metaverse version 2.0. 

In this article we identify a few areas that metaverse web designers should be focusing on to help them tap into the billions of dollars that traditional real estate investors invest in actual real estate annually. Getting the traditional real estate investor community to come off the sidelines and embrace virtual land as a viable real estate asset class may ultimately prove to be the driving force that helps the metaverse realize its full potential. 

Real estate 101: Location

In the real world, location relative to landmarks or other desirable properties is what primarily drives land value. The fascination with proximity to Snoop Dogg’s compound in The Sandbox has shown that the value of virtual land in the metaverse will also be driven by location. Metaverse developers therefore need to make location more important on their platforms, including elements such as wayfinding and navigation as well as landmarks such as plazas and neighborhood squares.

Decentraland allows users to “teleport” to other properties using its chatbox feature. The Sandbox allows users to teleport from one place to another via the platform’s main map. While a convenient feature for users, teleportation ignores the importance of location and proximity in creating and enhancing value. At the same time, it relegates some properties to the virtual wilderness. In addition, the scarcity of landmarks on some platforms makes it difficult to distinguish one neighborhood from another.

To help build virtual communities that also enhance land values, platforms should instead embrace navigation methods that highlight the interconnectedness of properties. For example, instead of allowing users to teleport to and from anywhere they want, developers might limit teleportation to landmarks or other central common areas (similar to public transportation). Doing so would also allow for more lucrative marketing and advertising opportunities.

In addition to teleport hubs, platforms should “build” and maintain landmarks and other common areas such as monuments, parks and similar features. These can become the gathering places and communal centers of a virtual neighborhood. 

Zoning, land use and community standards

The Sandbox currently allows virtual land plots to be linked into “Estates” governed according to rules established by the users who join them. Decentraland has “Districts” that are supposed to be themed, and abide by a few community rules embedded in their terms of service. But currently there are no teeth in the enforcement mechanisms. The Decentraland web designers have allowed decentralized autonomous organizations (DAOs) of users to mete out what serves as justice on the platform.

The mostly decentralized nature of these environments is part of their appeal for some users in the crypto/fintech space. But to attract investment by real-world real estate investors, metaverse developers should not rely solely on users or DAOs to create and enforce the rules. Instead, developers should look to incorporate into the platform’s basic rules some of the zoning, land use and community standards that traditional real estate investors are much more familiar with. The platforms should also retain some oversight or police power to enforce these rules, at least as the arbiter of first impression. 

Traditional real estate investors and other non-crypto investors are not likely to be enthusiastic about leaving their investments at risk, subject to the potential whims of their fellow users or a DAO that can override or overrule the platform’s supposed fundamental precepts. Instead, if virtual land were governed, at least in part, by a regime of standard zoning regulations, use and conduct restrictions and design standards that are binding on all users and that were initially policed by the platforms and readily enforceable by participants, traditional real estate investors would find greater security and stability in their virtual real estate investments. Without such a system, there would be no assurance that, for example, retail areas intended for luxury brands would always remain primarily for high-end shopping; adult content be restricted to designated “red light” districts; and advertising, signage and design standards be maintained. 

Also, keep in mind that the metaverse knows no regional or national boundaries. Given the diverse mores and customs of users from disparate places and divergent cultures, the potential for “neighborhood” disputes in the metaverse is much higher than in the real world. For this reason alone, building a platform that entirely relies on DAOs or the self-policing of rules by users comes with consequences that may deter investments by traditional real estate investors.

Immutability of the virtual grid

In economic theory, scarcity, or lack thereof, directly impacts value. Several platforms market that there will be limits to how much land will ultimately be available on their platform. But their terms of service do not restrict them from unilaterally creating more land. Unlike in the real world, there is nothing stopping a web designer from creating more virtual land, or even moving a block, or an entire neighborhood for that matter, to the other side of “town” and away from a valuable landmark or teleport hub. 

To attract traditional real estate investors, platforms should develop rules in the metaverse that would prohibit or place guidelines around the “terraforming” of new land, the manipulation of the location, or other fundamental characteristics of virtual land that’s already in the market. To unlock its full economic potential and maintain its long-term value, platforms should make land in the metaverse immutable and free from such “supernatural” intervention. Otherwise, an investment in a virtual property could be undermined by web designers playing God, something that mortals cannot do in the real world.

Assurances as to the maintenance of servers and key common areas, fees and transfer royalty

Unlike in the real world, where land does not just evaporate, virtual real estate could disappear if, for one reason or another, the power to the servers running the platform is cut off or the technology is not maintained. While it might seem counterintuitive for web designers to do so, to help align the long-term interests of the metaverse platforms with those of virtual real estate investors, the platforms should consider offering assurances that they will not only maintain the servers but also “build” and maintain the virtual common areas that aid in the creation and enhancement of value (that is, plazas, streets, landmarks and other virtual infrastructure). They should also assure that they will continue to police the platform’s core rules in perpetuity (or at least until some sunset date). 

The platforms should consider charging a small annual fee in exchange for providing this assurance. This would help defray the cost of running the servers and of employing the web designers who build and maintain the common areas that enhance the value of neighborhoods, and who police the rules and community standards. Or, in lieu of an annual fee, the platforms could charge a small royalty on any subsequent sale or other transfer of virtual real estate, like a transfer tax.

Such a royalty would create alignment between investors and the platforms in value appreciation. Like a mall owner getting percentage of rent from its retail tenants, giving a taste of the upside appreciation back to the platforms in the form of a transfer royalty would ensure that the platforms live up to their end of the metaverse bargain. 

The better the platforms are maintained and policed, the better the odds of such platforms earning higher royalties when investors sell an asset that has appreciated in value. This concept has already been embraced by the crypto world, as royalty fees are already common with NFT collectibles: Creators get a small percentage of every resale, which gives them incentive to seek the appreciation of their own brand’s value. Decentraland already has a 2.5% transfer fee on transactions made through its marketplace, but it hasn’t given any oversight or maintenance assurances in exchange.

Governance and enforcement 

In addition to retaining some oversight or police power over the enforcement of fundamental rules, the platforms should consider upgrading their other terms of service. Currently, the terms of service are extremely limited and favor the platforms (that is, terms that limit to $100 a platform’s liability for failing to abide by any of its own rules). In lieu of a set of rules, several platforms use, or plan to almost exclusively use, DAOs for metaverse governance. But to attract large-dollar investors, platforms should consider moving away from — or providing alternatives to — DAOs. Instead they should craft commercially-oriented terms of service that are fair and balanced and incorporate the platform’s basic land use and other community standards. 

In addition, as noted above, the metaverse’s appeal is potentially global, and it’s a safe assumption that investors and participants will come from all corners of the world. To avoid the jurisdictional uncertainty highlighted by the recent Chef Pierre case (Janesh s/o Rajkumar v. Unknown Person) — where a Singapore court ruled on an NFT contract that did not have choice of law or choice of forum provisions — web designers will need to establish in their terms of service what body of law will govern all participants and where, in the real world, disputes between users, and between users and the platforms, will be heard and decided. Savvy investors will want to see a uniform body of law developing in this emerging space, one that protects both the platforms’ and individual investors’ interests. Web designers should therefore focus on choosing to link with real-world jurisdictions that have a commercially-oriented legal system and are familiar to a multitude of investors.

Now that the metaverse has captured the imaginations of a large variety of early users and speculators, web designers building out version 2.0 of their platforms would be well served to shift their focus to analyzing what has made investors invest trillions of dollars in actual real estate. By making virtual land platforms a little more like real estate in the real world, metaverse platform developers could not only make their product better, they could unlock the investment potential of the real estate investment community.

While the ideas outlined here are not exhaustive, we hope they will spur a healthy discussion within the real estate community and among metaverse developers and web designers. We hope they will lead to an evolution of the platforms that unlocks the flow of capital to fuel the growth of the metaverse and the establishment of virtual land as the next real estate investment asset class. 

Ted Hunter is a real estate partner, Linda Rangel is counsel, and Jimmy Yuen is an incoming 2023 associate at Manatt, Phelps & Phillips, LLP.