Fractional Ownership of Real Estate: 6 Ways SEBI is Making it Safe for Investors

Fractional ownership of real estate has emerged as a new and exciting avenue for investment in recent times. It allows individuals to invest in a portion rather than the whole property. This can be an exceptionally feasible option for those who may not have the capital to buy an entire property outright or want to diversify their investment portfolio across multiple properties.

Fractional Ownership – Introduction

SEBI’s initial 2014 regulations focused on large Real Estate Investment Trusts (REITs) with significant asset requirements, but a shift has occurred.

Smaller players targeting luxury properties and holiday homes have emerged, attracting the attention of High-Net-Worth Individuals (HNIs). This trend has been further fueled by the rise of Fractional Ownership Platforms (FOPs) in the past five years.

These online platforms have allowed HNI and retail investors to participate in the fractional ownership market.  With minimum investments typically ranging from Rs. 10 lakhs to Rs. 25 lakhs, FOPs make investing in high-end real estate more accessible.

The new SEBI regulations provide enhanced oversight and ensure the safety of these investments, making fractional ownership a safer option for a broader range of investors.

SEBI Steps into Safeguard Investors

SEBI has amended REIT Regulations to introduce a framework for Small and Medium Real Estate Investment Trusts (SM REITs) on March 8, 2024.  These new regulations aim to address the concerns such as:

1. SEBI’s Regulatory Oversight Extends to FOPs Managing SM REITs

SEBI now regulates FOPs operating SM REITs due to increased investor access and concerns over varying structures impacting investor interests. While some FOPs were subject to RERA, SEBI found inconsistencies in their activities. This led to the valuation of implementing a regulatory framework to ensure investor protection in the fractional real estate market. Now, FOPs intending to operate SM REITs must apply for SEBI registration, while existing unregistered FOPs can submit migration plans.

2. Revised investment guidelines to lower the risk linked to fractional ownership

Real estate investments often face delays due to construction issues. To address this, new regulations stipulate that 95% of scheme assets must be in completed, income-generating properties. The remaining 5% can be in liquid assets. This ensures investor protection by minimizing exposure to projects under construction, reducing the risk of delays and potential loss of returns.

3. Enhanced Eligibility and Governance Standards

SM REIT regulations encompass eligibility and governance criteria. Investment managers must meet SEBI standards for experience, net worth, and ‘fit and proper’ status. Additionally, they’re mandated to hold a minimum percentage of REIT units, fostering alignment between investor and manager interests. This enhances investor confidence through increased accountability and ensures that managers have a stake in the success of the REITs they oversee. 

4. Increased Investor Liquidity

Before the amendment, investors had to depend on FOPs to find buyers for their shares, a reliance SEBI deemed unfavorable. Like traditional REITs, SEBI now mandates listing units issued by SM REITs. This requirement enables investors to sell their investments and access liquidity. However, whether there will be sufficient interest in trading SM REIT units once they’re listed remains uncertain.

5. Enhanced Clarity on Investment Product

FOPs have inconsistent investor disclosure practices. To address this, SM REITs must issue offer documents meeting SEBI’s disclosure standards. They must also provide regular disclosures on property valuation, rental income, fees, and expenses. This ensures transparency and helps investors make informed decisions.

6. Regulatory Supervision of Investor Grievance Resolution

SEBI has identified issues in FOPs regarding inconsistent grievance redressal systems and lack of independent review. To tackle this, investors in SM REITs can now file complaints against managers through SEBI SCORES, an online platform for grievances against SEBI-regulated entities. This ensures a standardized and transparent process for addressing investor concerns within the real estate sector.

Past Concerns Regarding Fractional Ownership

In the past, there have been some concerns regarding the safety of fractional ownership of real estate. This is because there was a lack of regulations governing this sector. This lack of regulation could potentially expose investors to several risks, including:

• Risk of fraud: Fraudulent operators could enter the market and sell fractional ownership interests in properties that did not exist or were not adequately valued.
• Lack of transparency: Without regulations, investors were not guaranteed to receive the information they needed to make informed investment decisions.
• Illiquidity: It can be difficult for investors to sell their fractional ownership interests, especially if there is no secondary market for such investments.

Benefits of Fractional Ownership of Real Estate

Fractional ownership of real estate can offer several benefits to investors, including:

• Accessibility: Fractional ownership makes real estate investment more accessible to a broader range of investors, including those with limited capital.
• Diversification: Fractional ownership allows investors to diversify their investment portfolio across multiple properties. This can help to reduce overall investment risk.
• Potential for high returns: Real estate can be a good hedge against inflation and offer the potential for high returns on investment.
• Passive income: Investors in fractional ownership can earn passive income from the rental income generated by the property.

Potential Drawbacks to Consider

While fractional ownership of real estate offers several benefits, there are also some potential drawbacks to consider, including:

• Liquidity: Fractional ownership investments can be less liquid than traditional real estate investments. Selling your fractional ownership interest quickly may be difficult, especially if no secondary market is available.
• Management fees: Fractional ownership platforms typically charge management fees to investors, which can reduce returns.
• Dependence on property manager: As a fractional owner, you rely on the property manager to take care of the property and generate rental income. Choosing a reputable property manager with a good track record is important.

Conclusion

Fractional ownership of real estate is a new and evolving asset class. Introducing new regulations by SEBI is a positive step that will help make this asset class safer for retail investors. Fractional ownership can offer several benefits to investors, but it is important to be aware of the potential drawbacks. Before investing in fractional ownership, it is important to carefully consider your investment goals and risk tolerance.

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