Fractional ownership, a gateway to commercial realty for retail investors

Fractional ownership transforming the real estate landscape, providing retails investors access to commercial properties previously out of reach

The initial investments required for real estate are typically substantial. When considering the yield, such as the rental income from residential properties in India, it usually ranges between 3-4 per cent of the property value. Commercial properties offer better returns, potentially doubling or tripling residential levels, but they come with significantly higher investment costs. A good commercial property could even yield rentals in the lower teen percentages but such a property the initial investment runs into a few crores. Also, the availability is scarce especially of those which are at good locations.

Fractional ownership in commercial real estate addresses this need. This is a more professional and refined approach to the age-old practice of the developer driven incentive or interest schemes. In a real estate project, the bulk of the asset appreciation happens during the initial green field to the construction stage. Traditionally, the developers used this space to lure the investors by offering lower prices or rates per square foot which could be used as a seed investment to bring up the project.

As the project advances and demand increases, the prices increase bringing in more investors. As the investment capital at these levels are larger, it was out of reach for the retail investors to participate in such activity. These schemes were mostly restricted to the High Networth Individuals (HNI) and as some of the developers resorted to fractionalization in this aspect, the RERA (Real Estate Regulation Authority) has played spoilsport.

For instance, a good commercial or an office space in any prime location of a city would begin at a few tens of crores of rupees. Assuming a 100 crore asset or property would generate 10 crore as rent, the rental yield stands at 10 per cent. This kind of investment is out of reach for any retail investor. As the name suggests, in a fractional ownership, multiple investors come together to hold an asset equal to their respective contributions. Each individual investor is offered a percentage or fraction of the asset depending on their contribution.

With the advent of technology, multiple platforms now offer such investment options for retail investors. By lowering the barriers of entry, i.e., the minimum investment cost, they began to provide convenient options to explore commercial real estate, even for retail investors. One could now invest across multiple projects at various locations simultaneously which was almost difficult in earlier years, earning a moniker ‘laptop landlords.’

The platform or the investment company facilitates this transaction by pooling these contributions and by either creating a separate entity or a Special Purpose Vehicle (SPV) registers the proportionate property on them. The generated rent is also distributed accordingly as the proportion to each of the investors either monthly or quarterly. There could be a facilitation fee or management charge that would be collected from across the investors as a percentage of the income or investment.

At times, the facilitation company or the platform explicitly collects the fee or implicitly discounts into the rental yield. Suppose a developer itself launches an investment option of fractional ownership, it may insist for a lease back to the developer upon registration, with a guaranteed rental income appreciating at a fixed percentage at a pre-decided interval. In this scenario, the investor is not dependent upon the tenant occupancy, maintenance costs, etc. but the investor mayn’t realize the actual rent generated from their property. That’s the cost of convenience.

As these avenues became more popular with investors and facilitators began to raise larger funds, SEBI began to consider regulating these entities. The regulator has proposed, though await confirmation, to transform these Fractional Ownership Platforms (FOP) into sponsor and operator of the trust. Then the trust buys the property and issues units to the investors. The Net Asset Value (NAV) is calculated quarterly. These are bundled up part of the larger REIT (Real Estate Investment Trust) regulation with a subcategory as mid, small and micro (MSM REITs).

As greater regulation comes into effect, the bankruptcies could become remote, could be rated, listed and traded better. This could also make the taxation more transparent, may be on the lines of the existing REIT regulations.

(The author is a co-founder of “Wealocity”, a wealth management firm, and could be reached at [email protected] )