Fractional ownership – A piece of the action

Fractional ownership is a new buzz phrase in India’s real estate market gaining popularity with retail investors looking for lucrative projects. Amit Aggarwal, a senior partner at SNG & Partners, and Devyani Dhawan, an of counsel with the firm, explain its relevance.

Presently, there is no specific regulation governing fractional ownership of real estate in India. However, in May, the Securities and Exchange Board of India (SEBI) issued a consultation paper titled Regulatory Framework for Micro, Small & Medium REITs, with a view to regulating the platforms offering fractional ownership of real estate assets to protect investors.

What is fractional ownership?

In simple terms, an investor owns a fraction of an asset along with other co-owners, thereby splitting the cost of investment among a pool of investors.

A co-owned asset can be anything from a holiday home to a private jet, a luxury yacht, collectables and, more recently, non-fungible tokens (NFTs). However, one of the most popular income-generating assets is commercial real estate. With huge investment requirements, ownership of high-end commercial real estate is usually out of reach of retail investors. However, if a group of investors pools funds and agrees to an ownership model, they can each become co-owners and enjoy the generated income.

Real estate fractional ownership platforms (FOPs) enable retail investors to invest in real estate under a fractional ownership model with the click of a button, from the comfort of their home.

Fractional ownership models

Some of the most popular models are discussed below.

Special purchase vehicles (SPVs). In India, real estate FOPs generally follow an investment model where:

• An FOP identifies an asset;
• A private company is set up to own the asset;
• The asset is listed on the FOP’s website with diligence details, valuation, minimum investment, return on investment and any lock-in terms;
• On reaching a targeted expression of interest, investors are invited to subscribe to securities in the private company. Most FOPs keep a minimum investment range from INR1 million (USD12,000) to INR2.5 million;
• Investors’ funds are collected for the securities;
• The private company purchases the asset with the pooled funds;
• Upkeep costs are shared among the investors;
• Rental and other income from the asset is distributed among the investors;
• The FOP charges investors management and maintenance fees; and
• After expiry of any lock-in, investors may exit by selling their securities in the private company.

This model is most popular. The interest in the real estate asset is represented through securities in the private company. The SPV remains the registered owner of the real estate and there is no transfer of actual ownership of the asset to the investors. Investors become indirect owners of a share in the asset by virtue of their shareholding in the private company.

Joint ownership. Some FOPs allow direct joint ownership of the real estate asset among a large number of individuals. In this case, investors are direct registered owners of an asset. The investors then grant the FOP powers of attorney for managing and dealing with the asset on their behalf. In such structures, even usage rights may be shared among the co-owners, if feasible. This structure is fraught with the legal and commercial risks of multiple co-owners and numerous powers of attorney, as well as stamp duty and registration challenges.

Blockchain. This model is popular in the American investment market where asset ownership is represented through tokens and the sale/purchase and ownership of tokens is traced through a blockchain network. The property is managed by a property management company on behalf of the token owners.

Structural issues

At first glance, fractional ownership appears to be a convenient and lucrative model for retail investors to access high-end real estate. Digging deeper, there are some important issues to be aware of.

While presently there are no specific regulations governing the various fractional ownership models, there are regulations attracted to:

• Pooling of investments by multiple investors for a particular purpose;
• FOPs acting as real estate agents; and
• The stamp duty and registration requirements for ownership of immovable property.

Some implications are discussed below.

Due diligence. As potential investors will make decisions based on an FOP’s disclosures and diligences, it is extremely important for investors to understand the diligence procedure, outcomes and implications, and any title-related issues. If possible, they should conduct an independent search on the property’s title and marketability. Similarly, the property’s valuation and the adopted methodology would also be very important. As the sector is currently unregulated, there is no written standard of diligence, title and care imposed on FOPs. Investors need to proceed with caution.

Regulatory uncertainty. While the SEBI has guidelines governing collective investment schemes and real estate investment trusts, which the authors will discuss later, these regulations do not cover the nuances of fractional ownership. This is especially so where investors propose to become co-owners of properties. Even the SEBI’s consultation paper has modified the very construct of fractional ownership by equating it with mutual funds. What is needed for fractional ownership is suitable modifications to the Transfer of Property Act, 1882, state stamp laws and registration laws that recognise the concept of fractional ownership, protect co-owners’ interests, and address the logistical and procedural issues of transferring fractional ownership.