Fractional ownership platforms make commercial real estate accessible

Until they come under Sebi's MSM REIT framework, retail investors must rely on their own due diligence when investing through them

With the number of fractional ownership platforms (FOPs) growing, and large sums of money belonging to retail investors being invested through them, the Securities and Exchange Board of India (Sebi) has come out with a consultation paper that is a precursor to regulating them under the MSM (micro, small, medium) REIT (real estate investment trust) framework. The idea is that if these real estate platforms grow within a regulated environment, they will be more transparent, financially disciplined, and accountable. Investors will also feel safer investing through them.

“The successful listing of commercial office REITs (real estate investment trusts) and recently of a retail REIT has given Sebi the confidence that such platforms, if regulated, will result in increased fund flows into real estate assets and enable retail participation,” says Anuj Puri, chairman, ANAROCK Group.

How do FOPs work

These platforms pool money from a number of investors and use the corpus to buy commercial real estate (usually an office building), which is held within a special purpose vehicle. Investors hold a share in the asset in proportion to their investments. They receive payout both from rental returns and capital gains (as and when the building is sold).

A fee of 3-5 per cent is charged at the time of entry. In addition, these platforms charge an annual management fee of 1 per cent.

These real estate platforms make commercial real estate accessible to retail investors. “A number of investors can come together and own a piece of a large asset that would otherwise be out of their reach,” says Sudarshan Lodha, co-founder and chief executive officer (CEO), Strata. With an investment of Rs. 10-25 lakh, an investor could possibly acquire a share in a Rs. 1,500 crore building. To invest directly, the investor would need a minimum sum of Rs. 5-10 crore.

According to Shesh Paplikar, CEO & co-founder, BHIVE Alts, “The risk-reward in commercial real estate is much better than in residential real estate.”  

Promoters of these platforms say the rental return and the capital appreciation together could fetch investors an internal rate of return in the range of 12-15 per cent.

Lack of regulatory oversight

The primary risk in this mode of investment today is absence of regulation. “Currently, the regulatory oversight over this sector is extremely limited,” says Vedika Shah, senior associate, Pioneer Legal. 

Another potential risk could arise from inadequate disclosures. “The nature of disclosures related to valuation of real estate, property title diligence, terms of lease, status of lease renewals, etc. to investors are inappropriate and limited,” says Harish Kumar, partner, Luthra and Luthra Law Offices India.     

According to Puri, disputes among co-owners regarding how the property is to be managed, utilised, or sold could hamper its smooth functioning. “Maintenance costs have to be shared among buyers. Even if one does not contribute, the burden will fall on the rest,” says Puri.

Investors could also face liquidity issues if they want to exit. “Since the units are unlisted, finding a buyer may not be easy,” says Puri. The relationship manager at the platform will help the investor find another buyer.  

The operator of the platform could be another source of risk. “If the operator were to shut down or face financial difficulties, it could potentially impact the investment,” says Lodha.

The usual legal complexities and risks associated with real estate transactions, such as clear title, exist here also.

Investors will also face macro risks related to the overall economy and conditions prevailing in that micro-market.

Due diligence

Before investing, an investor should evaluate the reputation of the platform and the expertise (including qualifications and experience) of the individuals running it.

 “Your due diligence should include not just the founder, but the entire team, including those in asset management, leasing, legal, finance, etc.,” says Lodha.

Paplikar suggests going with a platform that hires the best lawyers, and has the most competent team that can go through all the documents, understands the risk involved in the acquisition of a real estate asset, and handle them.

“If possible, connect with a few investors who have previously transacted on the platform to gain an understanding of its operating mechanism,” says Puri.

Understand the due diligence process followed by the platform for selecting investment opportunities. “Thoroughly evaluate and understand the investment opportunities offered by the platform, including the investment thesis and potential risks involved,” says Paplikar.

Lodha suggests that investors should check to see if the platform has backing from institutional investors as this can be a good indication of its credibility and stability.

Investors should also check the record of the platform as most have been around for a few years now.

Investors should not enter this investment avenue with a short horizon. “They should ideally invest for at least 7-10 years to do justice to their investment and benefit from the compounding effect over time,” says Lodha.

Start with a small sum and increase your exposure over time.

How are returns taxed

Tax experts say that there are no clear directions currently on how payouts from FOPs should be taxed. “Taxation will depend on how the ownership is structured,” says Archit Gupta, founder and CEO, Clear.

“Where the ownership is structured in a way such that every investor is an owner and is mentioned in the property documents, rent income may be treated as interest and taxed at slab rates applicable to the individual,” says Gupta.

He further adds that when there is a capital gain on the sale of a property, the gains may be taxed as long-term capital gains and taxed at the rate of 20 per cent if the property has been held for two or more years. If it was held for less than two years, the gain will be taxed at slab rates.

What Sebi’s proposals mean for investors

Fractional ownership platforms (FOPs) will have to register with Sebi

These platforms will be labelled as medium, small and micro (MSM) REITs and brought under regulatory oversight by including them in the REIT regulations

They will have to meet the minimum eligibility criteria set by Sebi

Their transaction structures will have to comply with MSM REIT regulations

They will have to send half-yearly and annual reports to investors

The assets will be held within a trust structure, with a designated trustee, thereby ensuring greater safety for investors

The assets will be handled by designated investment managers, who will have to meet certain criteria by way of qualifications

Investors will have access to grievance redressal mechanism