How SM REITs have opened doors to fractional ownership in Indian real estate

The Securities and Exchange Board of India’s (SEBI) recent authorisation for the formation of Small and Medium Real Estate Investment Trusts (SM REITs) has positioned the Indian real estate sector on the crossover of a revolutionary shift.

This authorisation catalyses to mainstreaming of the emerging concept of fractional ownership of rental properties and goes beyond a mere statutory amendment.

SEBI Chairperson Madhabi Puri Buch said the SM REITs will help expand the market significantly so more retail investors can have fractional ownership in REIT units. She added the regulator is open to looking at creating more such products.

This article will explore the ramifications of SEBI’s decision, including its potential effects on investor confidence and the real estate market in India.

The regulatory framework

SEBI’s adoption of the amendments to the REITs Regulations, 2014, has assisted in the establishment of a regulatory structure that supports the operation of SM REITs.

In contrast to conventional REITs, SM REITs would boast a reduced minimum asset value of Rs 50 crore and provide investors with more attractive entry opportunities. However, SEBI has established strict restrictions for SM REITs.

The regulatory body imposes many standards, including mandatory listings, minimum asset amounts, net worth restrictions, and experience qualifications for sponsors and investment managers, to establish a secure environment for investors. 

Now, to safeguard small investors, SEBI this year released a consultation paper proposing regulations for all web-based platforms that provide fractional ownership of real estate assets, where it was suggested that real estate assets with such fractional ownership be brought under Micro, Small, and Medium REITs (MSM REITs).

Typically, in fractional investment of real estate through fractional ownership platforms (FOP), the cost of acquisition is divided among several investors who purchase securities issued by a special purpose vehicle (SPV) that an FOP has established. These SPVs buy real estate-related assets. Through the securities issued by the SPVs, FOPs enable investors to own a specific percentage or fractional share in the real estate asset.

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Fostering investor confidence

It is expected that the institutionalisation of fractional ownership will inspire investor confidence, extending beyond the domain of cheap housing to include commercial real estate.

The rise of this novel property ownership form is anticipated to be propelled by SEBI’s regulatory framework. Additionally, a proposal to implement a framework for fractional ownership of real estate assets could further diversify investment channels.

Although the amendments to the delisting rules were postponed pending additional scrutiny, SEBI’s dedication to formulating policies based on data remained apparent.

Challenges and opportunities

Although the advent of SM REITs and fractional ownership offers promising prospects, it is imperative to remain cognisant of possible obstacles. Limited control, liquidity difficulties, and co-owner disagreements are a few of the potential hazards linked to fractional ownership.

Nevertheless, the advantages, including increased financial diversification, improved affordability, and expert property management, surpass these difficulties. However, these challenges also offer unique opportunities.

It opens a new spectrum where real estate investing may become more accessible to a wider range of investors, thanks to fractional ownership that could democratise the market. Furthermore, transparency is improved by the regulatory clarity that SEBI's framework offers, boosting investor confidence and opening the door for a more stable and reliable market.

India’s real estate industry is about to transform as the fractional ownership landscape continues to evolve and stakeholders learn to overcome obstacles and seize opportunities.

Regulators' proactive approach and the real estate sector's flexibility in response to these developments create a climate where obstacles serve as springboards for innovation, which promotes a more robust and inclusive real estate ecosystem.

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The future

With increased regulatory clarity and recognition, the notion is anticipated to transition into the mainstream. Those who invest will be granted access to high-value properties, the ability to diversify their portfolios, and the benefit of expert management services.  

Further, it is anticipated that the tax regulations pertaining to the tax transparency of business trusts will be extended to SM REITs. It signifies that dividends, rent, and interest will be taxed in the investor’s account rather than the trust’s. By having capital gains taxed in the hands of the fund rather than the investor, this investment vehicle offers tax efficiency.

Organisational framework

Under the Indian Trusts Act, 1882, SM REITs will be registered as trusts, with a trustee retaining assets for the benefit of unit holders. Assets will be managed by the investment manager, a registered corporation; properties may be owned via SPVs. More stringent criteria for investment managers, such as minimum investment portfolio size and professional expertise, would assist in guaranteeing a methodical and accountable approach.

SM REITs shall have full control and shall hold a 100% equity share capital in all SPVs. The SPVs shall be required to have full control and shall hold 100%  ownership of all the underlying properties. Apart from having a trustee, it shall also have a sponsor and investment manager, with each such person being a separate and distinct entity.

Conclusion

SEBI's decision for MSM REITs marks a pivotal moment in the Indian real estate landscape, ushering in a game-changing era of fractional ownership.

By extending the reach of real estate investment trusts to a broader spectrum of investors, including small and medium-sized players, SEBI's decision aligns with global trends in real estate ownership.

It not only caters to a wider range of potential investors but also corresponds with worldwide patterns in real estate ownership. In light of the evolving legislative environment and the corresponding adjustments by market participants, fractional ownership is positioned to significantly influence the trajectory of real estate investment in India in the next years.

Speculators, builders, and the real estate sector as a whole stand to gain from this paradigm-shifting step toward a more inclusive and dynamic environment.

Vatsal Gaur is a Partner at King Stubb and Kasiv.

Krishnan Sreekumar is an Associate at King Stubb and Kasiva.