Indians are known for their penchant for real estate with each individual aspiring to own one or more real estate assets in their lifetime. There are many who claim to have made fortunes by investing in real estate and have strong conviction about the ability of the asset class to generate returns and stand the test of time.
During the last residential real estate cycle, several investors made phenomenal returns by investing in residential real estate. However, now that the tide has turned and the residential segment across most cities in India is on a downward spiral, the investor flock has abandoned residential and are now scouting for opportunities in commercial real estate. When it comes to investing in commercial real estate, the High Net Worth Individuals (HNIs) who have deep pockets and can purchase the asset on sole ownership basis, are generally more active compared to retail investors.
For a retail investor, investing in commercial is a more complex affair compared to investing in residential. As the rental yields on commercial real estate are higher – being in the range of 7.5% to 9.5% compared to 2.5% to 3.5% for residential -the aspect of leasing and ensuring occupancy of the commercial asset becomes as paramount as selecting the right location. This is because the Internal Rate of Return (IRR) achieved from a commercial asset is dependent on both the rental income as well as capital appreciation. Further, the ticket size for investing in commercial real estate is generally higher acting as a huge barrier. As a result, a large segment of retail investors are not able to invest in commercial real estate. This entry barrier is now being addressed to some extent by the Real Estate Investment Trust (REIT) and fractional ownership structures.
The country recently witnessed the debut of its first REIT which has given phenomenal returns to its investors since listing. REITs are new in India but have been traded across the globe for several decades now and investors are now well aware of the operating structure of REITs.
The concept of fractional ownership in India has been in practice for several years but awareness amongst retail investors and their participation is low. The traditional fractional ownership model is similar to joint ownership or co-ownership of an asset, where a group of investors form a company or a Limited Liability Partnership (LLP) to invest in commercial real estate. The asset is purchased in the name of the company or LLP and shares are distributed in the ratio of their investment. An alternative method is dividing the asset in terms of area into distinct units and registering each unit in the name of a particular investor.
While these were the traditional methods of fractional ownership, the new age start-ups which have come up in this space are trying to take it to the masses using blockchain technology and marketplace model. This newer model involving blockchain technology is where the asset is purchased in the name of a trust and the entire area of the asset is divided into smaller blockchain units in terms of area, be it square meter, square feet or even as small as a square inch. The trust allots these fungible blockchain units to investors in the proportion of their investments. These blockchain units of a particular asset are listed on an online marketplace for trading. This model is similar to the REIT, however, there are certain differences w.r.t structuring of the transaction and the taxation aspects. Further, REITs are regulated by Securities Exchange Board of India (SEBI), whereas fractional ownership businesses are not. The clear advantage that fractional ownership offers over REIT is giving the choice of selecting the asset (property) to the investor. In REITs, the investment manager selects the properties on behalf of the investor, while in fractional ownership, the investors choose it themselves based on the various assets available on the marketplace. If the investor is confident about the prospect of a property in a particular locality which the investor is acquainted with, they can purchase it through the fractional ownership marketplace. The table below highlights the nuances amongst the various avenues of investing.
Table: Comparison of different ownership structures presently available to retail investors for investing in commercial real estate
|Investment type||Fractional ownership||REITs||Direct purchase|
|Minimum investment size||Low to moderate||Low||INR 50,000||High|
|Asset selected by||Investor||Investor||Investment manager||Investor|
|Control over the asset||Moderate||Moderate||Low||High|
|Units allotted in the form of||Shares or
area of property
|Divisibility of investment||Easy||Very easy||Moderate
|Selling part investment||Moderate||Very easy||Moderate
|Taxation at the time of sale (best case)||Same as sale of shares of unlisted company||Capital gains + stamp duty + registration||15% if sold in less than 36 months and 10% if sold after that||Capital gains + stamp duty + registration|
|Minimum number of assets||1||1||As per SEBI norms||1|
|Regulated by SEBI||No||No||Yes||No|
|Time required to list the asset||Low to moderate||Low to moderate||High||Not applicable|
Source: Knight Frank Research
While the fractional ownership concept is yet to reach its inflection point and the space is unregulated, it has started gaining traction amongst retail investors. If these companies offering fractional ownership are able to deliver the desired returns to investors, fractional ownership can emerge as a credible avenue for investing in commercial real estate.
– Mr. Nibodh Shetty, Consultant – Research, Knight Frank India