Sebi wants to nurture Indian real estate’s ₹4,000 crore baby. But why? | Mint

Few individuals can invest in a commercial property—let’s say an office floor in a central business district—on their own. The commercial real estate asset class has been the playground of large institutional investors for years.

What if many retail investors pooled in their money?

Fractional ownership platforms, which have become popular in India ever since the pandemic, facilitate exactly that. In short, fractional ownership is a co-ownership model where individual investors can own commercial real estate through an alternate investment route. An office, retail space or a warehouse is listed for investment. The platform markets the property and raises investor money to buy the asset through a special purpose vehicle (SPV) or a private limited company. The assets are usually pre-leased. Investors, therefore, get a monthly rental.

In the last three years, Poddar invested in commercial real estate assets sold by two fractional real estate companies, hBits Proptech and Strata Property Management. From hBits, he picked an office space in Mumbai while he invested in a warehouse property near Chennai through Strata. The investment? ₹25 lakh each. Under the fractional ownership model today, ₹25 lakh is the industry standard for minimum investment required. This cutoff keeps small investors at bay.

The secondary market is not that mature and platforms are less receptive in helping with an exit —Suresh Poddar

Poddar says his experience, thus far, is good. The assets are of good quality and were already leased out by the time he invested. He receives timely rents. But he does have concerns. Exit through a secondary sale won’t be easy, he feels. Then, there are other questions. Many platforms promise high rental yields (yearly rental income as a percentage of a property’s value) of up to 9-9.5%. Is that even feasible? Office real estate investment trusts (Reits), in contrast, typically end up with 5-6% annual rental yield, industry watchers said. Residential real estate’s rental yields are in the range of 2-3%.

The fractional platforms aren’t regulated in India yet. So, will they deliver what they promise?

“The secondary market is not that mature and platforms are less receptive in helping with an exit," Poddar said.

His advice: read the fine print carefully.

How does it work

“Grade A commercial real estate is now within your reach. Have multinational corporations as your tenants," a promotional video from hBits tells us. “Join the league of private equity giants like Blackstone and Brookfield and own a fraction of real estate from ₹25 lakh onwards with the single push of a button," the video further exhorts.

Joining that big league is surely aspirational for many retail investors. Capitalizing on that aspiration, about a dozen fractional ownership companies are currently operating in India. Under this sort of ownership, investors get equity and compulsory convertible debentures (CCDs) to the proportion of their investment made in the SPV for a particular asset. If the rental income is 9%, the platform usually deducts 1% as platform or management fee and deposits the rest as rent in the investor’s account.

Investors can exit their investment in two ways—either through a secondary sale or when the platform finds a buyer for the property.

However, thus far, the industry has been outside the purview of India’s market regulator, the Securities and Exchange Board of India (Sebi). These platforms are typically registered under the Real Estate (Regulation and Development) Act or RERA.

If the rental income is 9%, the platform usually deducts 1% as platform or management fee and deposits the rest as rent in the investor’s account.

Change is coming soon. As per industry estimates, fractional ownership platforms have over ₹4,000 crore in assets under management (AUM) already—big enough to grab Sebi’s attention. The regulator wants all such platforms under its jurisdiction. It wants all SPVs to mandatorily list on the stock exchanges. More of this a bit later.

The beginnings

Co-ownership of real estate has existed in India for years, albeit in an unorganized fashion. For instance, some office spaces in Nariman Point, Mumbai’s premier business district, had been sold to multiple individual investors but there is probably no large platform behind this.

A decade ago, Kunal Moktan left Blackstone Real Estate Partners to start Property Share with his IIM-Ahmedabad batchmate Hashim Khan. This is when fractional ownership started in earnest.

From creating a business model and the SPV structure, to the ₹25 lakh minimum investment, Property Share built the foundation for many other platforms to follow today. Like we mentioned earlier, most companies in the space flourished only during and after the pandemic.

“Once we find a property, we make an investment note, list it on the platform, and present it in the exact same way we used to present it to the investment committee at Blackstone’s New York headquarters. It was initially difficult to sell a ₹25 lakh investment product," Moktan, also the chief executive officer (CEO) of the company, said.

In its last big transaction, Property Share, backed by Lightspeed Venture Partners, WestBridge Capital and BEENEXT, bought office space at Prestige Tech Platina in Bengaluru for ₹720 crore, in two tranches. It entered the UK market in 2022 where it has three warehousing assets.

“We always played a conservative game. Many platforms are aggressive and want to grow their AUM, because valuation is AUM-based," Moktan said. “Sebi woke up to this because its experience with real estate and retail money in the past has not been good. Regulations will tell how you can market the product, who you can market it to, and how investing will happen," he added.

Sebi’s worry

In early 2022, when the stock market was volatile during the Russia-Ukraine war, Mumbai resident Neeraj Shah decided to invest in an asset through a fractional ownership platform. He works as a relationship manager in a home finance company and a colleague introduced him to the concept saying it was a “safe investment" with “decent returns".

He invested but a year later, when the stock market bounced back, Shah wanted to exit. He realized that there was no standard mechanism in place. “The platform executives said they would help but they didn’t. Eventually, I got it done through my own network and sold my shares to another investor in the asset," Shah said.

Since he exited the asset in a year or so, there was not much capital appreciation on the property. Shah didn’t make a profit but he didn’t lose any money either.

Nonetheless, his trouble exiting underlines the need for regulation.

Reit regulations in India were in the making for over a decade before the Blackstone-backed Embassy Reit initial public offering launched in March 2019. With Reits, Sebi created a framework for investing in high-end office spaces that were out of reach for even wealthy retail investors earlier. The three office Reits (Embassy Reit, Mindspace Business Parks Reit and Brookfield India Real Estate Trust) and one retail Reit (Nexus Select Trust) have around ₹1.2 trillion in gross AUM, the Indian Reits Association said last September.

With Reit regulations in place, Sebi now has moved to create a similar framework for the nascent fractional ownership platforms. A small and medium real estate investment trust (SM Reit) will hold assets under the fractional ownership model.

Following a consultation paper released in May last year, Sebi on 25 November approved amendments to Reit Regulations 2014 to facilitate SM Reits. The regulator’s framework lays out the Reit structure, obligations of the investment manager, minimum unit holding requirement, investment norms and distribution norms among others. The final amendments are expected soon.

According to the framework, each asset or property has to have a minimum value of ₹50 crore. A platform can also club a few assets under an SPV, adding up to a minimum ₹50 crore in value. The SPV can then be listed on the exchanges as an SM Reit.

What worries Sebi? One, a lack of standard and uniform selling practices. A second concern is lack of independent valuation of assets. Third, disclosures made to investors when soliciting investments aren’t enough. Property title, know your customer documentation and property tax payments are the other issues.

Given that many platforms take money from retail investors, it is important to oversee the nature of projects —Vedika Shah

If you browse through some of the platforms, you are likely to see ‘wait list’ tags on listed properties. Sebi’s consultation paper stated that such ‘wait list’ and ‘sold out’ tags used to entice investors need to be reviewed.

Exits may also become easier with the new regulations. Once listed on the stock exchange, the shares of any scheme can be traded.

“It is necessary to bring in a regulatory framework in the industry. Given that many platforms take money from retail investors, it is important to oversee the nature of projects, ensure that thorough due diligence is undertaken vis a vis the projects, and the credentials of the property managers are vetted and scrutinized," said Vedika Shah, senior associate at law firm Pioneer Legal.

Pain and gain

Many in the industry are therefore worried. There is palpable nervousness about what shape and form the final regulation could take. Will it boost the sector or scuttle it?

Initially, at least, the sector is bracing for some pain. Smaller companies will be more impacted than the large—smaller companies with limited asset and investor base can get acquired, going ahead. They will find it tough to keep up with the regulations.

The mandatory listing proposal, while it is investor-friendly, may turn out to be a headache for the platforms. “Mandatory listing (of assets) could be a concern, as there is added cost of compliance and volatility in pricing," Gaurav Karnik, partner and real estate leader at EY India, a consulting firm, said. “The SM Reits have to invest in 100% rent yielding assets, with no investments in under-development assets," he added.

Bigger Reits today can own 20% in under-construction properties.

Mandatory listing of assets could be a concern, as there is added cost of compliance. —Gaurav Karnik

As per the proposal, the SM Reit sponsors need to invest and hold a minimum of 15% of the total units of the trust for at least three years from the date of listing. This means platforms need to invest money up front for each listing.

“In a regular Reit, because a developer’s margins are higher, they have the capacity to hold inventory. In SM Reits, we have to put 15% of our money in every transaction. I am an asset manager, not a developer. I charge an asset management fee. So, where do I bring 15% from? It’s a non-starter," Sudarshan Lodha, founder and CEO, Strata, said. The company has an AUM of about ₹1,300 crore.

Meanwhile, SM Reit schemes cannot raise debt funding—that would restrict the SPV’s access to capital.

“If a platform has to fund 15% of every deal, it is important to be well capitalized," said Moktan. “Sebi has also made it clear that after the regulations are published, there are six months to get a licence. That will remove the riff-raff. Scaling up will become more difficult."

After bearing out the short-term pain, the sector may eventually grow fast and get bigger. Regulations will usher in more institutional capital.

So, the sector is likely to slow down before it grows again. Some platforms are already treading carefully, in anticipation of the coming regulation.

Prudhvi Reddy, founder and CEO of Assetmonk, another fractional ownership platform, said that the company has multiple deals in the pipeline. “But, we have slowed down a bit. We want to understand what the regulations would mean and require," Reddy said.

After pausing new investments in November 2022, WiseX (formerly Myre Capital), said it has re-entered the fractional ownership market with Sebi approving the amendments.

“We are aligning ourselves to the new compliance norms. There will be short-term pain for many but it will ensure that there are only serious players. It will also create an entry barrier in some sense," Aryaman Vir, founder and CEO of WiseX, said.

After bearing out the short-term pain, the sector may eventually grow fast and get bigger. Market watchers believe and hope that the regulations will usher in more institutional capital, particularly from those who are familiar with the Reit ecosystem. Better quality assets may be available in the fractional market with more developers or landlords willing to sell to the platforms. Indeed, a few developers may explore the fractional ownership market themselves. While consolidation will eliminate competition in the near-term, it could be a different story a few years from now.