Presently, fractional ownership in commercial buildings is being done either through Real Estate Investment Trusts (REITs), directly by developers via direct selling (Strata, a real estate investment platform) or web-based Fractional Ownership Platforms (FOPs). The Strata-sold office stock in commercial buildings accounts for the bulk of fractional ownership stock with about 200 million square feet, accounting for about 28% of the total Grade A office stock as of March 2024. Strata sale office stock in the top six cities in India is estimated to swell to 260-270 million square feet in the next two years, with an estimated market value of around Rs 4,500 billion for investors.
Till now web-based FOPs accounted for a small share in the universe of fractional ownership since they were largely unregulated. Nevertheless, with SEBI’s recent notification dated March 8, 2024, to register FOPs as Small and Medium REITs (SM REITs), a large number of erstwhile unregistered FOPs are expected to get listed as SM REITs. This can effectively have the potential to regularize underlying real estate assets (across all asset classes – commercial residential and industrial & warehousing etc.) to the tune of over Rs 40 billion, in the near to midterm. However, the bulk of these assets are likely to be commercial.
As fractional ownership gains traction and becomes increasingly popular, retail investors must run a few checks before investing in CRE assets via this route. Here are some factors that one must consider.
- Regulatory adherence: As listed entities, REITs and SM-REITs will be better placed to ensure the protection of investor rights. On the other hand, unlisted platforms might lack the standard framework, independent valuation and thorough due diligence. As per the recent guidelines by SEBI, SM REITs are required to ensure that 95% of their assets must be invested in fully completed real estate assets and distribute at least 95% of net distributable cash flows received as regular rental from the invested real estate assets. REITs in India are mandated to distribute the majority of their net operating income to shareholders in the form of dividends, thereby ensuring relatively stable income. If preferring to invest through FOPs, investors should check whether the complete set of activities undertaken by the FOP falls under the regulatory ambit of RERA.
- Potential returns: Before investing, investors should assess the valuation, potential rental earnings, yield and capital appreciation of underlying real estate assets. Currently, commercial properties offered by FOPs yield approximately 9-15%, with a usual minimum investment of around Rs 10-15 lakh. However, being largely unregulated, investing in real estate through FOPs may lack clarity, transparency, and independent review or oversight. Investors should evaluate the operations of FOPs and disclosures related to the valuation of the properties being offered. They must also pre-assess eventual exit and liquidation as much as possible.
- Tenant quality: Investors opting to invest via FOPs can check for lease tenure and expiry for the property they wish to invest in. Longer lease tenures and expiries are imperative in ensuring stable rental income. Typically, lease terms for large conglomerates, Fortune 500 companies and Global Capability Centres (GCCs), are longer ranging from 7 to 15 years, backed by security deposits and company guarantees. Hence, owning a portion of commercial office parks with marquee reduces the potential risk of rental defaults and provides a stable as well as higher income. Simultaneously, buildings with higher occupancy levels, pre-commitments, and longer lock-in periods should be considered before investing.
- Diversification of tenant base: Investors can assess and understand the tenant mix of the properties they wish to invest and make an informed decision. A property with tenants from diverse sectors like technology, BFSI, engineering and manufacturing etc. can safeguard investors from sudden fluctuations in rental income in case of major externalities in a particular sector. Moreover, the geographic distribution of the entity’s portfolio can be considered before making investments. Assets strategically located in metro cities and prominent IT hubs provide strength to income generation. Commercial office spaces in the top six metro cities in India are largely preferred by multinational firms translating into stable returns for investors.
- Sustainable and good quality assets: Post Covid-19, sustainability is at the forefront. Investors investing in fractional ownership through FOPs can invest in green Grade A assets, well-equipped to attract large organisations. In the last few years, occupiers are increasingly looking for green leases for their workspaces that can align with their sustainability goals. Investors should choose the platform with expertise in identifying the premium Grade A assets, that hold green certifications like LEED and GRIHA, to ensure lucrative returns on their investments.
(The author is Chief Executive Officer, Colliers India)