In recent years, digital platforms offering fractional ownership of real estate assets have emerged as a popular investment channel. These platforms allow investors to own a fraction of real estate properties such as office spaces, warehouses, and shopping centres, which were once only accessible to the top 1%.
With the increasing popularity and value of investments in these Fractional Ownership Platforms (FOPs), the Securities and Exchange Board of India (SEBI) is preparing to regulate such platforms to ensure investor protection and market development. In this blog post, we will delve into how the regulation of fractional ownership platforms is empowering investors in the real estate market.
The rise of FOPs offering fractional ownership of real estate assets has been notable in the past few years. These platforms enable investors to invest in high-value properties with a minimum investment ranging from INR 10 lakhs to INR 25 lakhs. The real estate assets offered on FOPs are similar to those defined under the SEBI (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations).
Globally, fractional ownership platforms have been in existence since 2015, with several notable platforms having registered users and significant assets under management.
The Need for Regulation
Given the increasing value of investments and the growing number of investors in FOPs, it has become crucial to consider the registration and regulation of these platforms. By bringing FOPs under the regulatory ambit of SEBI, regulatory oversight, standardized disclosure practices, investor protection measures, liquidity provisions through listings, and redressal mechanisms can be established. These steps aim to safeguard the interests of investors and promote orderly development within the sector and the market as a whole.
Understanding REIT Regulations
SEBI introduced the REIT Regulations in 2014 to provide a regulatory framework for Real Estate Investment Trusts. REITs offer investors an avenue to invest in real estate assets that would typically require substantial capital. These trusts are structured with parties such as trustees, sponsors, and managers, ensuring operational responsibilities and oversight. REITs can invest in completed and revenue-generating properties as well as under development properties, subject to certain criteria defined by SEBI. The regulations also emphasize the distribution of net distributable cash flows to investors and set minimum lot sizes for investments.
Fractional Investment or Ownership of Real Estate Assets – How It Works
Investing in real estate has traditionally been capital-intensive, making it challenging for non-institutional investors to participate. Fractional investment or ownership through FOPs provides a solution by splitting the acquisition cost among multiple investors. In this model, investors purchase securities issued by a Special Purpose Vehicle (SPV) established by the FOP. The SPV then acquires the real estate asset, and investors share the costs, benefits, and returns of the asset.
FOPs enable a diverse set of investors to pool their resources, allowing for joint or fractional ownership of real estate. By investing in primarily pre-leased properties, investors can earn rental yields and potentially benefit from the appreciation of the real estate asset. The income generated is distributed among investors, accounting for management and maintenance fees. Fractional ownership not only reduces the financial burden on individual investors but also allows them to diversify their real estate portfolios and gain exposure to premium properties that would otherwise be financially unattainable.
Transaction Structure of FOPs
The transaction process in FOPs typically follows a structured approach:
- The FOP identifies a property for investment.
- The property is listed on the FOP’s website, inviting expressions of interest from the public with a token amount ranging from INR 10,000 to INR 1 lakh.
- Once 100% expression of interest is received, the placement memorandum is forwarded to the investors. This memorandum allows investors to subscribe to the securities issued by the private limited company, i.e., the SPV responsible for purchasing or owning the real estate asset.
- Investors transfer the investment amount to an escrow account.
- The investors are then allotted the securities corresponding to their investment.
The process flowchart followed by most FOPs
Benefits of Fractional Ownership
Fractional ownership of real estate assets through FOPs offers several advantages for investors:
Lower Entry Barrier: Fractional ownership allows individuals with limited capital to invest in high-value properties that would otherwise be out of reach. Investors can participate in premium real estate assets with a relatively small investment.
Diversification: FOPs enable investors to diversify their real estate portfolios by investing in multiple properties across different locations and cities through SPVs. This diversification helps mitigate risk and enhances investment opportunities.
Reduced Financial Burden: By sharing the acquisition and maintenance costs among multiple investors, fractional ownership lowers the financial burden on individual investors. This allows them to generate a steady stream of cash flows and potentially benefit from long-term returns.
Professional Management: FOPs typically have professional management teams responsible for property management, tenant acquisition, and ongoing operations. This relieves individual investors of the challenges of managing the property independently.
Proposed Regulations for FOPs
The consultation paper aims to extend the framework of SEBI (Real Estate Investment Trusts) Regulations, 2014 to bring FOPs under regulatory oversight.
The proposed regulations include:
Registration and Regulation: FOPs offering fractional ownership of real estate assets would be required to register with SEBI and adhere to regulatory requirements. This ensures transparency, accountability, and investor protection.
Standardized Disclosure Practices: FOPs will need to follow standardized disclosure practices, ensuring that investors have access to comprehensive and accurate information about the properties, associated risks, financials, and any potential conflicts of interest.
Liquidity Measures: The proposed regulations may require FOPs to provide liquidity measures such as listings on stock exchanges or establishing mechanisms for investors to exit their investments.
Investor Redressal Mechanism: To safeguard the interests of investors, the regulations may outline a framework for a robust investor redressal mechanism, ensuring prompt resolution of grievances and disputes.
Regulatory Oversight of FOPs – Ambiguous or Absent
The regulatory oversight of Fractional Ownership Platforms (FOPs) is unclear and ambiguous. While some FOPs are operated by real estate agents or brokers, it is uncertain if they comply with registration requirements under the Real Estate (Regulation and Development) Act, 2016 (RERA), which may not adequately address investor issues.
RERA’s responsibilities for real estate agents do not sufficiently protect investors in the unique operations of FOPs. FOPs often involve investor participation in Special Purpose Vehicles (SPVs) that own real estate, requiring independent oversight outside of RERA’s scope. FOPs establish SPVs as private limited companies governed by the Companies Act, 2013, with limited oversight and a restriction on the number of investors.
This raises concerns about compliance with collective investment scheme regulations. Varying structures of FOPs also raise concerns about investor protection, disclosure standards, transparency, fees, and liquidity. Extending the regulatory framework of Real Estate Investment Trusts (REITs) to FOPs could provide a regulated environment, investor options, mandatory distributions, and asset valuations. Migration to the REIT framework may offer tax benefits to investors.
The fractional ownership platforms (FOPs) that target non-institutional investors in real estate raise several concerns for investors, including:
- Ambiguity and opacity in transactions executed on FOPs, particularly as they involve non-institutional investors and real estate transactions with untested instruments or mechanisms.
- Lack of uniformity in disclosures regarding property valuation, investment solicitation, property title documentation, lease agreements, ongoing disclosures, and disclosure and management of conflicts of interest.
- Issuance of unlisted securities for fractional investments in real estate, which creates dependency on FOPs for information and potential challenges in exiting or liquidating investments.
- Direct joint ownership structures facilitated through power of attorney (POA), which limit owners’ independent decision-making and transferability, posing valuation, liquidity, and transparency issues.
- Non-compliance with KYC/AML norms and lack of standardization in customer identification, raising risks of money laundering and compromising the financial system.
- Lack of uniformity in investor grievance redressal processes, with each FOP having its own mechanism, potentially lacking evaluation and independent review.
- False sense of regulation as FOPs may have real estate agent registration under RERA, but it does not cover the entire FOP and its activities, exposing investors to potential consequences.
- Misleading sales practices, including high-value or high-profile tenants, waitlists, and sold-out statuses, without independent review or validation of valuations, leading to potential mis-selling.
These concerns highlight the need for a regulated and transparent environment that safeguards investor interests in FOPs.
Proposed scope of Regulation:
To address the concerns related to fractional ownership platforms (FOPs) and ensure investor protection, it is proposed to bring FOPs under regulatory ambit by introducing a chapter under the Real Estate Investment Trust (REIT) Regulations. These regulated FOPs will be labeled as MSM REITs.
The key points of the proposed regulatory framework are as follows:
Registration and regulation: FOPs facilitating fractional investment in real estate will be required to register with SEBI as MSM REITs and fulfill eligibility criteria. Existing FOPs must migrate their transaction structures to the MSM REIT framework.
Structure of MSM REIT : MSM REITs will be established as trusts under the Indian Trusts Act, with separate schemes for owning real estate assets through special purpose vehicles (SPVs) as companies under the Companies Act, 2013.
Mandatory SEBI registration : No person can operate as an MSM REIT without SEBI registration. The sponsor will apply for registration on behalf of the trust, and a debenture trustee will be appointed. The Investment Manager of the MSM REIT must have relevant experience and meet net worth requirements.
Valuation of assets : Quarterly valuations, including physical inspections, will be carried out by registered valuers, and full valuations will be required for property purchases or sales.
Disclosure and reporting requirements : MSM REITs will have specific disclosure and reporting requirements for initial offers, continuous compliance, and quarterly valuations.
Investor rights : Investors will have rights to remove the Investment Manager, seek winding up of schemes, and participate in annual meetings to discuss financials and decision-making.
Expense ratio and transparency : SEBI will specify the cap on total expense ratio for MSM REITs, and minimum disclosure requirements will be prescribed for offer documents, annual reports, and listing agreements.
The proposed regulatory framework aims to provide a transparent and regulated environment for FOPs, ensuring investor safeguards and enhancing transparency in the sector.
Benefits of the proposed Regulatory framework:
The proposed regulatory framework for Fractional Ownership Platforms (FOPs) under the SEBI REIT Regulations offers several benefits to the market and participants:
Standard KYC requirements: Registration of FOPs will ensure compliance with KYC norms, enhancing transparency and security for clients.
Sound financial health: Net worth and deposit requirements for sponsors and managers will promote stability and financial strength among these platforms.
Fair dealings: Mandated code of conduct for managers will ensure fairness in their interactions with clients.
Regulatory oversight: FOPs will be subject to regulatory inspections and oversight, instilling investor confidence and attracting more participants.
Distribution opportunities: Regulated entities in the financial services sector will be able to undertake distribution of MSM REIT, expanding business potential for FOPs.
Elimination of limitations: Artificial limitations on the number of investors and the creation of multiple SPVs to overcome them will be eliminated.
Listing of units and trading through stock exchanges will provide additional benefits:
Robust risk management and surveillance: Stock exchanges offer a well-established framework for risk management and surveillance, enhancing market integrity.
Fair and transparent pricing: Trading through stock exchanges ensures fair and transparent pricing mechanisms.
Guaranteed settlement: The stock exchange platform provides guaranteed settlement, reducing counterparty risk for investors.
Liquidity and exit opportunities: Listing of units on stock exchanges provides liquidity and exit opportunities for investors.
Market making: The presence of market makers enhances liquidity and facilitates efficient trading.
Investor grievance redressal: A well-defined framework is established for addressing investor grievances and providing efficient resolution.
As a leading new age alternative investment platform, we welcome the Securities and Exchange Board of India (SEBI) considering the regulation of Fractional Ownership Platforms (FOPs). The proposed developments will open doors to lower entry barriers, increased diversification opportunities, and reduced financial burden which will take this industry forward with increased investor confidence.
At Assetmonk, investors have the incredible opportunity to explore alternative investment opportunities backed by high quality real estate assets which were once inaccessible to retail investors with a new-age approach like fractional ownership. Our investment philosophy gives utmost importance to transparency, accountability, and investor protection, as evident from our motto of being “Investor-First”. Investors across 16+ geographies have applauded Assetmonk for its product curation, exceptional, industry-best returns, and our overall service to non-institutional investors.
Continuing on our mission to making high quality alternative realty investments accessible through an investor-friendly platform, we look forward to continue and evolve our processes to be in the best interest of all investors.