Real Estate Investment Trusts (REITs) have a long history in financial markets across the world. In India, SEBI introduced regulations specific to REITs back in 2014. Today REITs are no longer alien to seasoned investors.
Investors invest in a REIT which in turn invests in income-generating real estate properties – typically commercial property such as office spaces and malls. Participating investors can even buy or sell units of a REIT on the stock exchanges.
So far, the regulator’s focus had been on large REITs with minimum real estate assets of at least Rs 500 crore. Yet, there has been a growing interest – particularly among HNIs – in small enterprises that invest predominantly in luxury properties and holiday homes. In the last five years, several online ventures called Fractional Ownership Platforms (FOPs) have come up, allowing HNIs and retail investors to participate in such real estate investments with minimum investments ranging between Rs. 10 lakhs and Rs. 25 lakhs.
FOPs operate by pooling money from investors online to invest in luxury residences and holiday homes. An entity called special purpose vehicle (SPV) purchases and retains title to the property and the investors are issued shares in the SPV. Rental income generated by the property from time to time is then distributed by the SPV to the investors. Another variant of this strategy does away with the SPV structure and allows investors to jointly and directly own small percentages in real estate.
Fractional ownership in real estate has been gaining popularity because it: (a) removes the traditional barriers associated with real estate investment – a requirement for high capital and risk appetite, (b) allows retail investors to participate in the investment, earn returns and avail the benefit of rising valuations of the real estate market, and (c) opens up a new asset class for investments, thus promoting greater diversification in investment portfolios.
Also Read: New REITs regulations by Sebi is a gamechanger
Given the traction, SEBI has notified amendments to the REIT Regulations to introduce a framework for small and medium Real Estate Investment Trusts (SM REITs) on March 8, 2024.
Below we explain how the notified amendments are expected to benefit HNIs and retail investors investing via FOPs:
1. FOPs operating SM REITs to now be regulated by SEBI
With the increase in investors accessing FOPs and in investments being made through such FOPs, SEBI began evaluating the need for a regulatory framework for FOPs. As per SEBI, FOPs had adopted varying structures which resulted in concerns that could affect investor interests. Further, while some FOPs were operated by real estate agents and brokers who were subject to Real Estate (Regulation and Development) Act (RERA), SEBI found that not all their activities (such as operating the FOP) fell under RERA’s purview. Therefore, to protect interests of investors and to grow the REIT market, SEBI has introduced a separate framework for SM REITs.
A SM REIT is a structure that pools at least Rs. 50 crore but less than Rs. 500 crore, for the purpose of issuing units to at least 200 investors, and to acquire real estate assets which would entitle such investors to receive income generated from such assets. Going forward, any FOP that proposes to operate a SM REIT shall apply for SM REIT registration with SEBI. However, as for existing FOPs which currently operate unregistered REIT structures, they can submit a migration plan to SEBI and also apply for registration irrespective of their size and number of investors.
2. New investment criteria that make fractional ownership less risky
A common problem in real estate investments is related to investments being made in new projects where construction has not begun or are under construction. For various reasons such as lack of building permits, construction might be held up and returns on investment delayed. The new regulations will solve for this problem by mandating that at least 95% of a scheme’s assets be invested in completed and rent-generating properties. The remaining 5% may be invested in liquid assets.
3. More robust eligibility and governance norms
The regulatory framework for SM REITs also includes eligibility and governance requirements. The investment managers of a REIT would need to fulfil SEBI criteria relating to experience, net worth, and ‘fit and proper’ criteria. Further, managers are required to hold a minimum percentage of the units in the REITs they manage. This will encourage skin in the game by ensuring an alignment between interests of investors and those of managers, and thereby add to investor confidence.
4. Greater liquidity for investors
Prior to amendment, investors need to rely on FOPs to find purchasers for their shares. This dependence on FOPs was noted by SEBI as being unfavourable to investors. As with traditional REITs, SEBI requires that the units issued by SM REITs be mandatorily listed. This will permit investors to exit investments and unlock liquidity. However, it remains to be seen if there would be enough interest in trading in units of SM REITs once they are listed.
5. Increased transparency about the investment product
FOPs have followed ad-hoc investor disclosure standards, thereby resulting in varying disclosure practices among them. To correct this, SM REITs looking to raise capital will need to issue offer documents which comply with minimum disclosure requirements stipulated by SEBI. They will also need to provide periodic disclosures on various matters including the valuation of the properties managed under a REIT, details of the rental income being generated by them, and the fees and expenses being charged to investors, etc.
6. Regulatory oversight over redressal of investor grievances
One of the concerns with FOPs, as noted by SEBI, is the lack of a uniform and robust grievance redressal system. An additional concern being the absence of independent review of existing redressal systems. To address these concerns, SEBI has indicated that investors of SM REITs will now be able to lodge complaints against managers of SM REITs through the SEBI SCORES platform, the online portal set up to address complaints against SEBI-regulated entities.
With SEBI’s new regulation of fractional ownerships, investors will now have the comfort of investing in a regulated asset class, including in luxury properties that were earlier not within the reach of certain income groups. However, investors should continue to exercise caution like they would with traditional financial products, understand the associated risks, and seek professional advice before investing.
(This article has been authored by Varun Sriram (Partner), and Varsha Srinivasan (Senior Associate) at JSA Advocates & Solicitors.)
