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Thursday, June 1, 2023

All you need to know about fractional real estate ownership

“Fractional ownership is a way of investing in which several unrelated parties can join hands to share in, and reduce the risk of ownership of a high-value tangible asset.”

What are the key benefits of fractional ownership?

The key benefits are that an investor will have the following advantages:

• Provides regular income from the investment, typically, 7% – 15% based on market cycles and interest rate movements
• Helps investors buy expensive property at a cheaper cost and yield commensurate returns based on their holdings
• Helps in getting better compliance and risk management framework as it is managed by professionals
• Assists investor in mitigating risks and liability and diversifying his portfolio across geographies.
• Generates higher capital appreciation, smoother exits, and navigates the turbulence of the real estate market.
• Brings trust, transparency, and control with the choice of choosing his property.

How does fractional ownership work?

Fractional ownership is nothing but freehold ownership of property shared equally between multiple people and is held directly through company shares. Here properties get listed on online portals in Bharat which already has tenants. The minimum investment size in Bharat is 25 lakhs up to a maximum of 50 crores per investor.

For each commercial property, fractional ownership is implemented through a Specific Purpose Vehicle (SPV). Funds pooled from each investor are routed through a trusteeship company or a limited liability partnership (LLP) within which the SPV operates. Ownership is transferred to investors/fractional owners via SPV. The investment portal must obtain a license from RERA for its operation.

To get registered with ROC under MCA, investors need to sign the SPV agreements. Each investor thus owns an equal number of shares, ultimately giving them a fraction of the freehold ownership as well as the rights to use the property or derive income benefits from the rental inflow which acts as a dividend. The trustee manages the Escrow accounts, legally vetted properties, third-party valuations, and corporate governance with investor control to simplify the process.

How does fractional ownership differ from ‘timeshare’?

Timeshare simply put is a contract between the owner of a property and a person who agrees to pay to ensure he has the right to use the property for a certain pre-paid period which is re-saleable. That person thus becomes the timeshare holder and he/she shall hold no claim to the title of the property and neither any ownership of the physical property at all.

How is it different from REITs?

Fractional ownership allows you to diversify and invest in multiple properties across different regions. REITs on the other hand represent a portfolio with a fixed number of assets in it.

Fractional ownership allows higher liquidity, and investors are free to sell their shares whenever they want subject to lock-in periods. REITs cannot be transferred or sold as per the investor’s choice.

Fractional ownership can undertake properties that are under construction or not in use presently. However, based on SEBI guidelines, REITs ought to have a minimum of 80% of their investments in income-yielding properties.

Who manages the company?

The company appoints director or directors who are responsible for filing annual returns to the government on behalf of the shareholders. The director or directors is/are provided by the developer/developers who is/are also responsible for:

• Assuring the property manager fulfills the contractual obligations
• Ensuring the rental manager fulfills their contract
• Sharing annual financial reports and other disclosures to the shareholders
• Disseminating any rental income to shareholders earned
• Divesting the entire property asset should a bonafide offer be received after any lock-in period specified as per the regulations of the portal.

What is the management fee?

The developers usually decide mutually and they make it certain that each fractional property purchased shall have a very low expense ratio of up to 1% for the lock-in period until they can be divested.

What are the minimum investment and rental yields in Bharat’s market?

A minimum investment of 25 lakhs is to be made in Grade-A commercial properties which can be warehouses, office spaces, SEZs, etc. in large cities and industrial hubs. The rental income received is between 2 lakhs to 2.5 lakhs on an investment of 25 lakhs which corresponds to 8-10% with an IRR of 16-20% over a 5-year horizon.

Who can invest in such assets?

Any NRI having an NRO account or any resident of Bharat can invest with valid KYC documents at the time of investment.

What are the tax implications?

There have been no specific regulations categorized for this asset class. As per the current income tax regulations, rent received from the Commercial real estate property is taxed as income from other sources based on the applicable tax slab. A home loan taken to buy a house property falls under the tax exemptions laid under Section 24 and Section 80C of the Income Tax Act. NRI investors can get benefits under the Double Taxation Avoidance Agreement (DTAA) signed with the country of their current residence.

A TDS of 10 percent is levied by some investment portals on the rental income before the payout. The profit on the sale of commercial property falls under capital gain. The same is recognized as long-term if the property is held for more than 24 months and is taxed at 20 percent with indexation, irrespective of the size of gains. Subsequently, if the property is sold before 24 months, the profit becomes taxable as short-term capital gain and is taxed based on the income tax slab of the investor.

What are the key risks involved?

This asset class is subject to the following key risks:

• Interest rate risk- When RBI raises interest rates, the demand and consumption are hit causing the prices of such property to fall and thus generating lower ROI.
• Geopolitical risk- Macroeconomic tensions can cause supply chain disruptions and may lead to cost escalations impacting the overall demand side.
• Credit risk- Properties facing huge debt may receive poor credit ratings or non-investment grade ratings which may spiral down the prices.
• Political risk- With changing government regulations and with an onset of new ruling parties, there can be uncertainty in terms of the regulations and policy framework causing volatility in prices.
• Concentration risk- Properties are allocated within geography and thus any domestic issue imposes concentration risk.

Thus, this asset class is more suited for risk-taking investors and not risk-averse investors because of lower liquidity as investors hold unlisted shares in an SPV.

How are the exits structured?

Lock-in and exit policy varies from portal to portal and can have a lock-in of 6 months or 5 years or altogether no lock-in period at all.

Generally, there are 2 ways to exit:

• Private sale where investors can sell their fractional ownership to any other buyer/investor on their own subject to KYC and other regulatory protocols
• Complete asset sale when the entire property is sold.

Who are the key players in the market and the overall market size?

The industry is now valued at $5 billion in Bharat. Some of the renowned and established players with sizeable AUM are:

• Aurum PropTech (NSE & BSE Listed)
• MYRE Capital
• hBits
• BRIK itt
• Frxnl
• Assetmonk

Which entity conducts the valuation of such commercial properties?

Well-known and established players like JLL, Knight Frank, and CBRE are front runners for the valuation of the property during the complete sale and the overall due diligence.

What are the key challenges expected to arise?

However, there can be challenges ahead as it lacks awareness in Bharat and is still in a nascent stage. Also, there are no standardized processes for entry and exit levels and also may lead to rise in disputes regarding the division of usage of the property and the key expenses incurred coupled with a rise in individual defaults which may cause some problems going ahead.

What is the global perspective on this theme?

Fractional real estate ownership has gained a lot of traction in the USA, Singapore, and Hong Kong and has seen massive growth in Assets Under Management. Investors in these markets have higher confidence and have made sizeable returns over the past.

What are the future outlook projections?

The future holds great potential as and when there is a much better regulatory framework and with the adoption of Blockchain technology we see exponential growth in the coming 3-5 years for immutable transactions. Also, with the digitization of banks, the lending processes will get seamless and faster, and hence, a higher uptick is forecasted for such properties.

A significant rise in global ETFs is seen which invests in such sub-asset categories to bring down costs drastically and open the market to retail investors with decent risk appetite and low investment threshold.

There is immense potential seen with the emergence of ‘Metaverse’ which allows investors to buy fractional ownership of the virtual land and receive handsome gains.

– Zubin Mehta

(Featured Image Source: Random Dimes)

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