[By Shaswat Kashyap & Snigdha Dash]
The authors are students at Gujarat National Law University and National Law University, Odisha respectively.
Introduction
In recent years, India has seen a rise in web platforms, such as WiseX and others, offering investors the chance to invest in real estate (RE) assets through fractional ownership. Recognizing the growing value of investments and the increasing number of investors, the Indian watchdog deemed it crucial to formalise the sector. In a move to safeguard the interest of investors, the Securities and Exchange Board of India (SEBI) in its 203rd board meeting dated 25 November 2023, took a crucial step by granting approval for the implementation of a regulatory mechanism governing fractional ownership of RE assets. This strategic move followed the issuance of a Consultation Paper (CP) on May 12, 2023, which proposed the inclusion of Fractional Ownership Platforms (FOPs) within the purview of SEBI (Real Estate Investment Trust) Regulations 2014 (The Regulations) through necessary amendments.
In the CP, the regulatory watchdog proposed Real Estate Investment Trusts (REITs) type registration including listing, terming it as Micro, Small and Medium (MSM REITs). In common parlance, REITs are types of trusts or corporations that invest in real estate directly by purchasing properties or buying mortgages. The Board approved the amendments to the Regulations for SM REITs with an asset value of at least 50 crores as opposed to a threshold of 500 crores for existing REITs. SM REITs shall have the facility to formulate mechanisms for real estate asset ownership through Special Purpose Vehicles (SPVs) constituted as companies. This aims at providing investor protection measures that will thereby ensure the orderly development of the Real estate sector and the market. The move would be beneficial, especially for retail investors unfamiliar with such a structure.
Understanding Fractional Investment
A concept still at its nascent stage in India, Fractional Investment is an investment strategy wherein the acquisition cost is divided among various investors who invest in securities issued by SPV established by the FOP. Such investment serves investors with a limited appetite for real estate who desire focused investment in a specific location through multiple SPVs and helps one maintain a diversified portfolio when one has a low capital to invest. FOPs play a vital role by providing investment in pre-leased real estate by bringing a pool of investors on the same paradigm.
Fractional Investment in real estate or property provides an alternative to engaging in the real estate sector via REITs and reduces the financial burden on single investors while allowing them to generate a steady stream of cash flow and long-term returns.
Decoding the Rationale behind this Approval: Addressing the Challenges
The regulatory oversight of FOPs is either ambiguous or absent. SEBI, with recent approval, is making efforts to address various other challenges that include:
First, In most cases, the SPVs are constituted as private limited companies and are thus subjected to the regulations outlined in the Companies Act, 2013. However given how the FOPs obtain the interest of participation from members of the public, the SPV may have undertaken a Deemed Public Issue (DPI) without complying with issuing a prospectus and filing and registering with SEBI. It may further breach the maximum number of shareholders permitted for the private companies as per the Companies Act, i.e., 200.
Second, even though the FOP provides fractional ownership to purchase real estate, it doesn’t necessitate any uniformity of disclosures regarding the valuation of RE and other disclosures. Such Fractional Investment mainly targets Non Institutional Investors (NII) but the investor has to depend on the FOP for the necessary information to aid diligence by potential investors Insufficient transparency and disclosure of essential information to an investor could result in financial losses for the investor. This may occur due to misrepresentation, the sale of real estate assets/securities from SPVs without accurate valuation awareness, and similar factors.
Third, the mode and manner of completion of the purchase/ acquisition of RE is ambiguous and doesn’t have a mandatory independent review or assurance mechanism. The CP suggest that such an amendment will rescue the investors who fall prey to mis-selling and provide an end-to-end regulatory mechanism for grievance redressal.
Further, the migration of current SPVs or other structures established by FOPs to the REIT may result in the treatment of such investment by investors as investment in Business Trusts under the Income Tax Act which provides certain tax benefits which are otherwise not granted to the SPV in the existing scenario. Therefore, the proposed amendment will also ensure to reduction of the complexity attached to the issuance through SPVs.
Proposed Scope of Regulation: A Brief Overview
1. It facilitates a provision for registration and regulation of FOPs under REIT Regulations: Any person or legal entity including FOPs who facilitate fractional investment by any structure is required to register with SEBI to work as SM REIT in the manner specified by SEBI in its standard format.
2. It is optional to come under the ambit of REIT: The chairman of SEBI, Madhabi Puri Buch clarified that the existing fractional ownership has the option to either navigate to the ambit of REIT or stay under the company structure. The better explanation to register under REIT will reach a wider audience ensuring credibility and attracting overseas flows.
3. It ensures investor interest: There is an expectation that the FOPs will comply with the new framework and further upgrade their scale, the new framework is investor-friendly. While still trying to evolve from a nascent stage, the investors will get the right investment option and attract larger portfolios ensuring continued assets to meet the increasing demand. It will also make sure that investors are protected, common practices are disclosed and there is a robust redressal mechanism.
4. Another proposal suggests setting a minimum subscription of Rs. 10 lakh. Currently, most platforms maintain a minimum ticket size of Rs. 25 lakh. The regulator is considering further reductions as the market matures.
Critical Analysis
The NIIs apart from having limited ability to pay huge amounts, may have limited knowledge of real estate to invest high capital. Real Estate Regulation and Development Act 2016 (RERA) is the statutory authority that lays down the responsibilities of a real estate agent but such has failed to offer protection to investors. There is still an ambiguity as to whether all sets of activities are under the ambit of RERA. The governance under RERA might create a false sense of relief for the investors, but as opposed to the real scenario, it doesn’t mean that the FOP is fully regulated. The state-level RERA comes up with structural variations of the FOPs and doesn’t provide end-to-end regulation for its role. If the same is under the ambit of SEBI, mandatory disclosures, the flexible uniform mechanism will come into place. The proposed amendments will be beneficial for those unfamiliar with such rent-yielding properties of fractional ownership through its formalisation.
By such regulation, investors who have been trying to seek alternatives to the equity markets will get viable alternative investment avenues to retail investors. The reduced minimum asset value of Rs 50 crore for SM REITs presents attractive prospects for investors looking for more attainable entry options into real estate ownership. Decreasing the minimum threshold to 10 lakh rupees diminishes barriers to entry in REIT investments and renders them more attractive to institutions and retail investors who were previously unable to participate. The capacity for SM REITs to establish distinct schemes enhances flexibility and innovation in shaping real estate portfolios.
On the flip side, the transition from minimal to highly regulated status raises concerns about the impact of the introduced regulations on FOPs. As discussed in the CP, SEBI proposes strict compliances such as mandatory registration for existing FOPs as MSM REITs, subject to specific eligibility criteria. Non-compliance may result in winding up operations. Additionally, the minimum net worth requirement for sponsors and investment managers could pose entry barriers for major fintech players. While SEBI aims to protect investors with MSM REITs, the stringent norms may prompt industry players to exit the FOP business.
Conclusion and Suggestions
Despite the substantial potential in real estate investment, the limited number of REITs in India can be attributed to the stipulated minimum asset value of INR 500 crores and minimum offer size of INR 250 crores outlined in the REIT Regulations. As of March 31, 2023, only 5 REITs are registered with SEBI, with three having issued units listed on the stock exchange, amounting to a total unit capital of INR 54,411 crores. In response, SEBI has opted to introduce SM REITs into the REIT Regulations as a middle ground, catering to investors interested in RE assets but with a lower initial investment. With the increasing value of investments through FOPs and a growing number of investors, it is the right time to mandate the listing of these FOPs.
Everything keeping in mind, the correct implementation with rightful amendments as suggested in the CP will create a level playing field for the investors. SEBI’s proposed guidelines play a crucial role in formalizing the sector by addressing the ambiguities of SPV securities issuances. Especially remarkable for NII unfamiliar with such structures, these regulations are expected to foster confidence in such innovative forms of ownership of property that match with best practices of developed countries.
Lastly, the CP and the current approved regulatory framework in the board meeting are only in relation to real estate. Fractional ownership models are still prevalent and exist in various properties that provide income, such as furniture leases, gold, or a large number of solar assets. It is to be seen if SEBI comes up with the regulations for such FOPs.