SEBI’s micro-REIT proposals can get you a piece of your office

A new discussion paper released by markets regulator SEBI envisages the creation of ‘medium, small and micro’, or MSM, REITs that will enable you to invest in such properties with a minimum investment amount. 10 lakhs. This could be a game-changer for the sector. While the minimum asset size of REITs listed so far was 500 crore, the minimum ticket size of the new MSM REITs will be only 25 crores. This will allow unregulated players in fractional real estate to come under the umbrella of REITs.

Fractional real estate is the idea in which you can invest a small amount of money in real estate in exchange for a smaller portion of the property. This is not possible while buying a property, when the cost generally runs into crores of rupees. In fractional real estate, investors are given shares in special purpose vehicles (SPVs), which in turn own the property. Usually, these are private issues of shares and such SPVs can have a maximum of 200 investors.

Typically, fractional real estate platforms allot shares and compulsorily convertible debentures in such SPVs. Investors get interest on their debentures and can get capital gains on their shares when they sell assets.

concerns

Currently, fractional real estate is not regulated. Startups in this sector have registered themselves as real estate agents under RERA, but this does not provide adequate protection to investors. Investors hold their shares in the underlying SPV, although they rely partly on the real estate firm to actually manage the SPV. If the firm fails to do well, there is no backstop.

Things can get complicated when the 200 or so shareholders in an SPV die and multiple successors come into the picture. There are no proper disclosure norms at the time of raising funds from investors or on ongoing disclosures like renewal of lease. There is no standard investor grievance redressal system and no KYC/AML regulations on partial real estate platforms.

Some platforms make investors execute Power of Attorney (POA) documents in their favor and this may expose investors to legal risks. There are no standard valuation norms for assets held. The platform may acquire the project at a very high price and investors may not understand this.

Furthermore, there is no disclosure of conflicts of interest (for example, if the platform and the asset seller are linked for a new acquisition). Given the complex nature of this asset class, there can be instances of mis-selling.

What has SEBI proposed

According to SEBI’s discussion paper, fractional real estate platforms will have to register with SEBI as MSM REITs. They have to adopt a trust structure. The Trust will hold 100% stake in the SPV (essentially the companies). The SPV, in turn, would own the assets.

The trust will appoint an investment manager to oversee the REIT. The sponsor of the trust must have a net worth of of which at least 20 crores 10 cr should be liquid (in the form of cash, money market instruments etc.).

SEBI has proposed that assets in such micro REITs can range from from 25 crores 499 crores. In contrast, regularly listed REITs must have at least 500 crores in assets. Existing regular REITs are required to distribute 90% of their cash flows to investors. For MSM REITs, the proposals say that 100% of the cash flows are to be distributed by the trust. It is the net distributable cash flow and hence is arrived at after deducting management, administrative expenses. etc.

“Hbits is thrilled with SEBI’s proposal to regulate online platforms offering fractional ownership of real estate assets. We believe this move will be a game-changer for the commercial real estate investment industry, as it will provide increased transparency and capital protection for small investors and easier access to a new asset class for a wider range of investors. will provide. As a leading player in the fractional ownership space, we view this as the first step towards regulatory recognition of our industry. We believe the fractional ownership industry has the potential to disrupt the way India invests, just like mutual funds did 15 years ago,” said Shiv Parekh, founder, hBits, a fractional real estate platform.

Sudarshan Lodha, co-founder, Strata, said, “Sebi’s proposals will enable investors to invest in specific real estate projects for as little as a few lakh rupees. The REIT units will be listed on the stock exchanges and will be held in your demat account. This is game changing for the earlier unregulated fractional real estate space and a big boost for the realty sector as a whole. It is similar to a Category I AIF (Alternative Investment Fund) in that the investment manager shows investors individual startups in which they can invest. Similarly, here, you can invest in an office complex in Bangalore instead of a collection of offices across India.”

Interestingly, SEBI’s proposals do not mandate MSM REITs to invest only in commercial real estate, as is required for regular REITs. This can open the door for investment in residential real estate in India.

Apart from this, MSM REITs cannot make any profit. To be sure, regular REITs can leverage up to 49% of their assets.

Aryaman Veer, chief executive officer of Aurum WiZX, a real-estate platform, said the new regulation is an opportunity to enhance the overall investor and stakeholder proposition, but is a limiting provision not allowing players to take advantage. “Real estate is an interesting asset class as one can leverage against future cash flows. This is a very important aspect in real estate and should definitely be explored by the regulator in the future as it can improve returns to investors. Will help a lot.”

Note that, leverage or debt can boost returns, but it can also hurt returns if the rental yield falls below the interest rate on the REIT’s debt.

comparison with reits

MSM REITs will be at par with regular REITs for the purpose of regulating and taxing fractional real estate platforms. Veer said, “While this structure is called REIT, it has been adapted to the requirements of regulating the FOP structure. One can say it is a subdivision of REIT, as it is a trust and the units are listed. But it differs in terms of the manner in which it affects investors. Regular REITs come with a diversified portfolio, whereas MSM REITs offer individual real estate assets. The former can invest in an under-construction property and The latter cannot. The minimum ticket size also varies ( 10 lakh for MSM REITs and 10,000 – 15,000 for regular REITs). The holding percentage of the sponsors is also different.”

Nevertheless, SEBI’s intention to extend the regulatory framework to partial real estate platforms is expected to address concerns with such platforms with regard to investor protection.

Taxation

SEBI’s discussion paper is silent on taxation. However, it is likely to be at par with regular REITs as SEBI has proposed a similar trust structure. Dividends distributed by REITs are tax-free if the REIT has not adopted the concessional tax regime. The rent and interest distributed by REITs are taxed at the slab rate in the hands of the investor. Repayment of capital is compounded – it is not taxed if such repayments do not cumulatively exceed the face value of the REIT unit, but such payments are deducted from the ‘cost of acquisition’ while computing capital gains should go.

“The regulator is bringing fractional ownership platforms (FOPs) under the existing REIT regulations, and hence the same tax provisions applicable to the latter should be applicable to MSM REITs as well,” said Puneet Shah, partner, Dhruv Advisors.