The Securities and Exchange Board of India (SEBI) is considering the regulation of platforms offering fractional ownership of real estate assets to retail investors. Through its Consultation Paper titled “Regulatory Framework for Micro, Small, and Medium REITs (MSM REITs),” SEBI seeks to bring fractional ownership platforms (FOPs) under the existing framework of SEBI (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations). The move comes in response to the sudden rise of FOPs over the past few years, which have allowed retail investors to invest in commercial real estate previously limited to institutional investors.
SEBI, through its consultation paper titled “Regulatory Framework for Micro, Small and Medium REITs (MSM REITs)” dated 12 May, 2023, proposes to regulate platforms that offer fractional ownership of real estate assets. The paper sought public feedback on regulating these platforms.
Over the years, numerous real estate fractional ownership platforms have come up into existence. Most of these platforms are aggregating investors under the umbrella of a holding company / entity, and investing in commercial real estate with rental income.
Fractional ownership platforms enable retail investors to invest in high-value commercial real estate such as buildings and office spaces, warehouses, malls, etc. Given the big investment sizes, such properties were earlier primarily restricted to institutional investors and big investors / HNIs (high net-worth individuals).
Recently, a fractional ownership platform got SEBI go-ahead for its Alternative Investment Fund (AIF) for investing in the commercial real estate sector across India’s key markets.
The Need for Regulation
The consultation paper highlights the rapid growth of FOPs, leading to an increase in investments and the number of investors. SEBI aims to examine whether the registration and regulation of FOPs are necessary to ensure regulatory oversight, standard disclosure practices, liquidity measures, and investor protection. The proposal aims to safeguard the interests of investors participating in fractional ownership of real estate assets.
SEBI has observed that the underlying real estate assets offered on FOPs are similar to the real estate or property defined under the REIT Regulations.
The existing REIT Regulations, enacted in 2014, provide a regulatory framework for Real Estate Investment Trusts (REITs), allowing investors to invest in real estate assets. Some key features of the REIT Regulations include setting up REITs as trusts registered under SEBI, requiring a registered Debenture Trustee as the REIT trustee, and investing primarily in completed and revenue-generating properties.
Challenges with Real Estate Fractional Ownership
SEBI notes several concerns with FOPs, including potential evasion of regulations, limited governance oversight for SPVs, lack of uniformity in disclosure standards, transparency in valuations, investor redress mechanisms, and unregistered collective investment scheme risks. Additionally, the ambiguity of RERA’s oversight over FOPs raises questions about the applicability of certain regulations to these platforms.
SEBI proposes to introduce a new chapter under the REIT Regulations to regulate FOPs as MSM REITs. The key highlights of the proposed regulatory framework include:
- Registration Requirement: FOPs facilitating fractional ownership must register with SEBI as MSM REITs and meet specified eligibility criteria.
- Structure of MSM REIT: MSM REITs will be set up as trusts with separate schemes for owning real estate assets through wholly-owned special purpose vehicles.
- Additional Registration Conditions: Various conditions, such as net worth requirements and experience criteria, will apply to MSM REITs similar to those imposed on existing REITs.
- Valuation of Assets: A proper valuation of assets will be mandated, including physical inspections on a quarterly basis, to ensure accurate net asset values (NAV).
- Investor Rights: Investors will have rights to remove the Investment Manager, auditor, seek winding up of schemes, and approve changes in investment strategies.
SEBI Proposal for Fractional Ownership REITs
In a bid to strengthen the regulatory framework for Real Estate Investment Trusts (REITs), SEBI has put forward a set of proposed conditions for Micro, Small, and Medium REITs (MSM REITs). These conditions aim to ensure greater transparency, investor protection, and efficient management of assets in the commercial real estate market.
The application process for registration as an MSM REIT will be facilitated by the sponsor on behalf of the Trust, following the format specified by SEBI. Additionally, the instrument of Trust will be in the form of a deed duly registered in India under the provisions of the Registration Act, 1908.
To ensure expertise and experience in the real estate industry, the Sponsor will be required to have a minimum of 5 years’ experience as either a developer or a fund manager. Furthermore, they must hold at least 15% of the total units of the MSM REIT for each scheme for a period of at least three years from the date of listing of such units, with any holding exceeding the minimum required to be held for a minimum of one year from the listing date.
The Investment Manager of the MSM REIT should be a separate and distinct entity whose primary business is to manage assets and investments of the MSM REIT. They must also have a net worth of at least INR 10 crores, with the net worth being in the form of positive liquid assets.
To qualify as the Investment Manager, at least 5 years of experience in fund management in the real estate industry or advisory services in the real estate industry, property management in the real estate industry, or development of real estate is mandatory. Additionally, the Investment Manager must have at least 2 key personnel, each with a minimum of 5 years’ experience in the aforementioned areas.
To ensure impartiality, at least half of the directors of the Investment Manager of MSM REIT should be independent and not directors of the Investment Manager or Manager of another MSM REIT/REIT.
An essential requirement is that the trustee should be registered with the Board under SEBI (Debenture Trustees) Regulations, 1993, and should not be associated with the sponsor(s) or Investment Manager.
Another crucial aspect of the proposed conditions is that no unit holder of the MSM REIT scheme shall enjoy superior voting or any other rights over another unit holder in the same scheme, and there should be no multiple classes of units of REIT in each scheme.
In terms of financial eligibility, the MSM REIT and parties involved should meet the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.
SEBI will grant the MSM REIT certificate of registration after being satisfied with the eligibility conditions. Upon receiving the certificate, the Sponsor will establish a trust and appoint a SEBI registered Debenture Trustee as a Trustee, and also identify an Investment Manager. The Trustee will then appoint such Investment Manager for launching and administering the MSM REIT and its Schemes.
Furthermore, the MSM REIT will be allowed to launch schemes, each identified by a separate name. The listing of units of the MSM REIT Scheme/s will be mandatory and will be listed on the stock exchange. The units of the scheme will be held in dematerialized form.
The proposed conditions also outline the investment criteria for the MSM REIT Scheme, including the minimum size of the asset to be acquired, the percentage of assets to be invested in completed and rent-generating properties, and the distribution of net distributable cash flows of the SPV and the MSM REIT to investors.
Moreover, the MSM REIT Scheme should raise funds from at least twenty investors unrelated to the Sponsor, its related parties, and its associates. MSM REITs will have the flexibility to raise funds from both resident and foreign investors.
In terms of subscription, the minimum size for units of the MSM REIT Scheme will be INR 10 lakhs, and the unit size will be INR 10 lakhs. Additionally, the maximum subscription from any investor (excluding sponsor(s), its related parties, and its associates) should not exceed 25% of the total unit capital.
While MSM REITs will not be allowed to enter into transactions with related parties, they will be permitted to pay fees to the Investment Manager and trustee for carrying out their activities.
These proposed conditions are part of SEBI’s ongoing efforts to create a robust regulatory environment for MSM REITs, ensuring the growth and stability of the commercial real estate market while safeguarding the interests of investors.