Deep Dive into Fractional Real Estate Investing
Introduction
Real estate is the most sought-after asset class in India. Every person in the country dreams of owning a piece of land, but the high capital requirements often make it inaccessible.
Fractional ownership provides a solution to this problem.
Here is all you need to know about them.
What is Fractional Ownership?
Fractional ownership is an arrangement where a number of individual investors jointly own a single piece of property.
These investors have similar investment objectives, and the joint arrangement allows them to invest in properties that would have been out of budget for them at an individual level.
How Does Fractional Ownership Work?
On the fractional ownership platform, each property is displayed as a private limited company, known as a Special Purpose Vehicle (SPV).
The property is legally registered in the name of the SPV, and the investors are allotted shares of the SPV in proportion to their investment size in the property.
For example, if a property is worth 10 crores and an investor invests 1 crore in the property, he will be allocated a 10% stake in the SPV.
The shareholders of the SPV, or the co-owners, jointly appoint a board of trustees to look after the property.
How is Fractional Ownership Different from REITs?
Those who are familiar with Real Estate Investment Trust (REITs), would be able to draw similarities between the two. But don’t get confused, both are different.
REITs are more like mutual funds. The REIT manager collects money from a number of investors and invests the fund into income-generating properties.
These properties generate returns in the form of rental income and capital appreciation which is then distributed back to the unit holders in the form of quarterly dividends.
Fractional ownership is different from this in many areas:
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Nature
Fractional investing allows you to choose the specific property you want to invest in, whereas, with REITs, you can only select the investment house and have no control over individual property selection.
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Regulation
Fractional investing is largely unregulated. SEBI released a consultation paper last month (May 2023) to regulate the fractional ownership platform, but it will be time before any sort of regulation comes into effect.REITs on the other hand, are fully regulated by SEBI.
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Investment Type
Fractional ownership has no specific restrictions on the type of investments. The SPV can allocate the entire capital to under-construction properties if desired.
REITs, however, are required by the law to invest at least 80% of their capital into income-generating assets.
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Brokerage & Maintenance
Co-owners must collectively contribute towards the maintenance of the property, whereas REIT investors do not bear such maintenance costs.
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Liquidity
Fractional owners often face liquidity issues. They can exit from the investment in one of two ways:
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either the SPV sells the property, or
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they sell their right over the property to a third party.
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Selling the property requires the consent of all the co-owners, which can be a difficult task. And investors often find it difficult to find a potential buyer who is willing to buy the rights without asking for a significant discount on the property.
Publicly listed REITs on the other hand can be sold anytime.
Major Risks involved with Fractional Real Estate Investing
There are some inherent risks involved with fractional investing that an investor must consider before making the investment decision.
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Disputes among the Co-Owners
Important decisions regarding the property are made unanimously with the consent of co-owners. A dispute amongst the co-owners can be very costly and time-consuming.
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Limited Control Over the Property
A co-owner has limited control over the property. An investor might need to make compromises over important investment decisions in case of a disagreement between co-owners. -
Fraud
There have been instances of fraud due to the size of money in the asset class. An investor should check the reputation and licenses of the facilitator before making the investment decision.
Conclusion
Fractional real estate investing can be an attractive option for investors looking to diversify into real estate properties that would otherwise be out of their price range.
However, one should also consider the risks involved with such investment and make the investment decision intelligently.
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