Real-Estate has always been an attractive asset class for investment but was always marred with controversy due to lack of investor protection as the sector was hardly regulated. The introduction of the Real Estate (Regulation and Development) Act, 2016 gave the much need impetus to this sector. Over the years, new and innovative ways of investing in real estate through Real Estate Investment Trust, fractional ownership, AIFs have emerged. While Real Estate Investment Trust is already prevalent in the global market, it gained popularity in the Indian stock market after the issuance of the  SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”).

Understanding- “Real Estate Investment Trusts”

Real Estate Investment Trusts, also known as REITs, are SEBI regulated investment vehicles, registered in the form of Trust (under the Indian Trusts Act, 1882) while the operational requirements are undertaken by a Body Corporate- ordinarily, in the form of a Company or LLP.

The first commercial REIT i.e., “Embassy Office Parks”, was listed in 2019.

Till date, there exist a total of 4 listed REITs on the Indian Stock Exchanges, the most recent being the listing of India’s first Retail REIT-
“Nexus Select Trust”- raising around INR 3,200 crore in its IPO.

How does a REIT function?

Similar to mutual funds and targeting the commercial real estate sector- ranging from IT Parks to shopping malls- REITs enable investors to park their money in such high value real-estate assets. A professional fund manager shall make all such investments on behalf of the investors and in return of the amount invested, the REIT shall issue units to the investors and undertake periodical distributions.

Major parties involved in REIT:

• Sponsor- Entity forming the REIT, generally the entity or developer desirous of raising funds through REIT.
• Trustee– Person appointed by the Sponsor and holding assets on behalf of the unitholders.
• Manager- The Trustee appoints a Manager, responsible for making investment decisions and undertaking the routine compliances.
• Unit holders- The beneficiaries of the Trust and indirect holders of the REIT assets. They have voting rights to key decisions related to REITs.

The Securities and Exchange Board of India (SEBI) recently issued a Consultation Paper on introduction of MSM REITS in order to bring the Fractional Ownership Platforms (“FOP”) within the ambit of the REIT Regulations.

Understanding- “Fractional Ownership”

In layman terms, “fractional ownership” indicates a situation wherein an investor owns a percentage of the asset, after paying a proportionate sum of money and earns benefits in the form of usage rights, income sharing, priority access, and capital gains.

How has this concept been popularized in real estate?

Investing in real-estate seemed intimidating to the non-institutional investors, thereby leading to this market being primarily dominated by investors capable of pooling in a hefty sum of money.

Popularized by indigenous web-based applications, multiple such FOPs have emerged up in the recent few years, thereby enabling small investors to pool their resources for owning a high value real estate asset.  Investors are provided with a plethora of investment options ranging from building and office spaces to shopping centres, conference halls, warehouses, etc.

Benefits of FOPs:

• Portfolio diversification due to investment in different real-estate assets across different geographical locations.
• Investing in pre-leased real estate, ensuring rental yield as well as earning by way of appreciation of asset.
• Keeping a check on property-specific investment and particular use of funds.

How does the FOP Model work?

The cost of acquiring such high-value real estate asset is split among several investors, who invest in securities via a SPV- Special Purpose Vehicle, established by the given FOP. Such SPV purchases the real-estate assets, however, shall not be responsible for the day-to-day operational requirements. The securities shall be issued through the SPVs as well.

Why SEBI felt the need to regularize FOP?

1. Lack of investor protection- Even though most of the FOPs are registered as real-estate agents under the state specific RERA, investor protection is compromised owing to the fact that it is an unregulated sector with lack of accountability.
2. Flexible Exit Options: Investors are dependent on the FOP without assurance of exit, due valuations, liquidity or transparency is unfavourable for the investors and is not in their long term interests.
3. Abuse of Power of Attorney (“POA”): The POAs executed for joint ownership by individuals, is subject to misuse and manhandling.  
4. Handling of Investor Grievances: Owing to lack of uniformity in handling of investors grievances, there is ambiguity among the purchasers on the practices to be followed.  
5. Lack of end-to-end regulation: Since there is no end-to-end regulation, after obtaining real-estate registration, such FOPs are not wary of the consequences upon breach.

Key proposals mooted by SEBI under the Consultation Paper

The proposals under the Consultation Paper are discussed below vis-à-vis existing set of regulations for REITs

1. Registration as a MSM REIT

   Entities engaged in FOP or fractional investment in real estate will have to get the same registered with SEBI under REITs Regulations as a MSM REIT. MSM REIT shall be set up as a Trust under the provisions of the Indian Trusts Act, 1882 with the ability to establish separate and distinct scheme/s for owning of real estate assets through wholly owned special purpose vehicles constituted as a company under the Companies Act, 2013

2. Sponsor Criteria

Existing Sponsor under the SEBI (REIT) Regulations	Sponsor under the MSM REIT scheme
Minimum 5 years of experience in the real estate sector. For developers- 2 projects (minimum) to have been completed.	Minimum 5 years of experience in the real estate sector.
Shall have a net worth of at least INR ten crores	Shall have a net worth of at least INR ten crores. The net worth shall be in the form of positive liquid net worth.

3. Manager Criteria

Existing Sponsor under the SEBI (REIT) Regulations	Sponsor under the MSM REIT scheme
Minimum 5 years of experience in the real estate sector. For developers- 2 projects (minimum) to have been completed.	Minimum 5 years of experience in the real estate sector.
Minimum Net-worth: INR 100 crores. Individual Net worth (Sponsor)- INR 20 crore. No mention of holding of liquid net worth in this case.	Minimum Net worth (Sponsor)- INR 20 crores. Out of the specified limit, an amount of INR 10 crores shall be in the form of positive liquid net worth.

4. Debt raising

Existing REITs	MSM REIT Scheme
Can raise external debt	No external debt allowed to be raised

5. Asset Ownership

Existing REITs	MSM REIT Scheme
The ultimate holding interest of the REIT in the underlying SPV(s) is not less than twenty six percent	MSM REITs shall hold 100% ownership of its SPVs.

6. Differences in- Initial Offer of Units.

Existing REITs	MSM REIT Scheme
Have to launch an initial public offer of its units within three years of registration	Have to launch an initial public offer but timelines not outlined
Minimum Asset Size- INR 500 crore.	Minimum Asset Size- At least INR 25 crores and not more than INR 499 crores.

7. Asset holding criteria

Existing REITs	MSM REIT Scheme
At least 80% of the value of the REIT assets shall be invested into complete and revenue generating properties. (The balance 20% may be invested in underdeveloped properties and other specified securities).	It is to be noted that the proposed regulations specifically state that the schemes of MSM REIT shall NOT be allowed to invest in under construction or non-rent generating property- since 95% is invested in complete and revenue generating property; the remaining 5% in liquid assets.

8. Scheme

Existing REITs	MSM REIT Scheme
RIETs can float scheme	MSM RIET can float multiple schemes

Exit to unitholders

Existing REITs	MSM REIT Scheme
No binding obligation to provide exit	Exit Opportunity to the existing investors, who are not desirous of continuing under the MSM REIT scheme, shares to be acquired at fair value by Sponsor

9. Criteria for distribution to unitholders- MSM REITs.

Unlike the existing REITs who are required to distribute 95% of their net distributable cash flows to the investors, MSM REITs shall ensure:

(a) Minimum 95% of the net distributable cash flow shall be distributed, and,  

(b) 100% of the cash flow of the MSM REIT shall be distributed to the scheme wise unit holders.

The regulation of fractional investment in real estate is definitely a welcome step as it will lead to development of the sector and increase in investor confidence but SEBI while trying to regulate these activities should be mindful of over-regulation.