On May 12, 2023, the Securities and Exchange Board of India (“SEBI”) issued a consultation paper proposing the inclusion of Fractional Ownership Platforms (“FOPs”) within the purview of the SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”).
Following the receipt of public feedback, SEBI approved the regulatory framework for Small and Medium Real Estate Investment Trusts (“SM REITs”) in its meeting held on November 25, 2023. Building on this decision, SEBI amended the REIT Regulations on March 8, 2024, to provide the detailed regulatory provisions governing the SM REITs.
In the light of our previous analysis of the consultation paper and examination of the principal challenges associated with implementing SEBI’s proposal, we will now delve into the key aspects of the newly introduced amendments.
HIGHLIGHTS OF THE SM REITs:
- SM REITs have been interestingly conceptualized as a sort of hybrid of REITs and AIF model. Unlike REITs but similar to AIFs, SM REITs possess the authority to introduce multiple schemes for property acquisition and issuance of units.
- SM REITs are authorized to invest in real estate properties, subject to the condition that the size of the asset proposed to be acquired in each scheme of the SM REIT is at least Rs. 50 crore and does not exceed Rs. 500 crores. This facilitates investment opportunities in smaller properties, specific floors, or proficient residential projects.
- SM REITs are prohibited from lending funds to any entity other than the Special Purpose Vehicle (“SPV”) formed for the intended investment in the real estate project and the SPV is also prohibited from lending to any entity.
- The minimum investment threshold is established at ₹10 lakh, rendering it accessible for individual investors, and the price of each unit shall be ₹10 lakh.
- SM REITs are obligated to invest at least 95% of the value of the scheme’s assets for each of its schemes in completed and revenue-generating properties and shall not invest in under-construction or non-revenue generating real estate assets. This mitigates risks for investors, as these properties demonstrate a proven history of income generation.
- SM REITs must disclose whether a scheme involves leverage in the scheme offer document. Only after such disclosure can they utilize leverage for that specific scheme through borrowings or debt securities issuance under the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) Regulations, 2021. Otherwise, they are not permitted to do so.
- REITs, unlike conventional REITs, are prohibited from entering into related party transactions except for payment of fees to the investment manager and the trustee for carrying out the activities of the SM REIT.
- Existing FOPs, in the nature of SM REITs, have been provided a span of six months for registration as an SM REIT under the amended REIT Regulations and a further span of six months from the date of grant of registration for completing the migration of such FOPS.
CONVENTIONAL RIETS VS SM RIETS:
| Basis | Conventional REITs | SM REITs |
|---|---|---|
| Concept | REIT Regulations expressly provide that no scheme shall be launched under a REIT | SM REITs have been allowed to introduce multiple schemes for owning of real estate assets or properties through special purpose vehicles |
| Special Purpose Vehicle (SPV) | SPV in case of REITs, means a company or LLP in which either the REIT or Holdco holds not less than fifty percent of its equity/ interest | SPV in case of SM REITs must be a wholly owned subsidiary company of the scheme of such SM REIT |
| Raising of Debt | Allowed to raise external debt | Allowed to use leverage only if disclosed under scheme offer document |
| Holding percentage in SPVS | Either REIT or Holdco shall hold not less than fifty percent of the equity share capital or interest | SPV shall be a wholly owned subsidiary of SM REITs |
| Asset Size | Minimum Asset Size- INR 500 crore | Minimum Asset Size under each scheme – INR 50 Crore and not more than INR 500 crores |
| Investment in properties | At least 80% of the value of the REIT assets shall be invested into complete and revenue generating properties and the balance 20% may be invested in underdeveloped properties and other specified securities | At least 95% of the value of the REIT assets shall be invested into completed and revenue-generating properties, Additionally, no more than 5% of the investible funds may be directed towards unencumbered liquid assets. |
| Distribution Requirements | Not less than 90% of net distributable cash flows of the REIT shall be distributed to the unit holders, not less than once every six months in every financial year | 100% of the net distributable cash flows of the scheme of SM REIT shall be distributed to the unit holders, at least once in every quarter of the financial year |
| Basis | Conventional REITs | SM REITs | |
|---|---|---|---|
| Experience | Sponsor
Minimum 5 years of experience in the real estate industry or real estate fund management of sponsor(s) or its associate(s) Where the sponsor is a developer- minimum of two projects have been completed |
Manager
Minimum 5 years of experience of –
in fund management or advisory services or property management in the real estate industry or in development of real estate |
Investment Manager
Minimum 2 years of experience in the real estate industry or real estate fund management of the investment manager If the investment manager fails to meet this requirement, it must engage at least two key managerial personnel, each possessing not less than five years’ experience in the real estate industry or real estate fund management. |
| Net worth | Sponsor
Net worth of not less than one hundred crore rupees, on collective basis. Net worth of not less than twenty crore rupees for each sponsor. |
Manager
Net worth of not less than ten crore rupees if the manager is a body corporate or a company or net tangible assets of value not less than ten crore rupees in case the manager is an LLP |
Net worth of not less than rupees twenty crores.
Provided that not less than rupees ten crores of net worth is in the form of positive liquid net worth |
Concerns among existing FOP participants
However, while aimed at fostering investor protection and transparency in an unregulated domain, SEBI’s actions have evoked apprehension among existing FOP participants, primarily for the following reasons:
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- Prerequisites with respect to net worth and experience of an investment manager have been implemented to augment the financial commitment of the founders in the Fractional FOP model. However, it also implies that only businesses with substantial financial resources can participate. Although some leniency is granted by allowing the employment of two key managerial personnel in case of non-compliance with the prescribed requirements, economic constraints persist for small-scale FOPs.
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- Each FOP encompassed within the SM REIT scheme is obligated to undergo the extensive process of initiating an initial public offering, acquiring the requisite funds, comprehending pre-listing compliances, ensuring compliance with specified issue and subscription sizes, and managing the intricacies of ongoing compliances. Such proposals incur significant costs and may appear daunting for both existing and potential FOPs.
- A narrow timeframe of six months for existing individuals/entities or structures owning real estate asset(s) or property(ies) in the nature of SM REIT, has been laid down for transition to the SM REIT scheme. Such a brief duration may pose challenges for small-scale FOPs in ensuring a seamless transition while also adhering to the statutory prerequisites prescribed for SM REITs.
CONCLUSION
SEBI’s recent initiatives regarding the inclusion of FOPs within the regulatory framework have sparked both optimism and concern within the real estate sector. On the one hand, these measures are poised to stimulate fresh investments, provide diversification opportunities, and enhance transparency, thereby benefiting both individual investors and the overall market. Additionally, the regulations signify SEBI’s commitment to regulating fractional ownership in the residential real estate sector, a move that has been long-awaited and is likely to drive further interest and activity in this space.
It will be intriguing to observe how existing and potential FOPs navigate these challenges and adapt to the new regulatory landscape. The successful implementation of these regulations will not only shape the future of the FOP market but also serve as a testament to SEBI’s effectiveness in promoting a robust and inclusive real estate investment environment.
