Investment in fractional realty can help you diversify but know the risks4 min read . Updated: 12 Nov 2020, 07:09 PM IST
- Your investment in fractional real estate through platforms may not be liquid compared with REITs
- Take the taxability and other charges, such as property tax, into account when calculating your returns
Investing in high-end real estate properties is usually a costly affair. Several fintech startups, such as Strata and hBits, are now facilitating multiple investors to come together on their platforms to invest in properties jointly. This is known as fractional investing in real estate. Strata was launched in August 2019 and has so far invested ₹180 crore in five properties. hBits was launched in October 2019 and has so far invested ₹15 crore in two properties.
We tell you how fractional investing through such platforms works and if you should go for it.
How it works
The platforms assess a property on parameters such as pricing, location, and the scope for capital and rental appreciation, among others. Currently, most of them invest only in commercial properties. Once the platforms get into an agreement to sell or get a letter of intent from the owners, they list the properties.
Generally these platforms have a minimum investment limit but the amount also depends on the number of investors. For example, Strata and hBits have a minimum investment limit of ₹25 lakh.
Once they get the required number of investors, they buy the property through a special purpose vehicle (SPV). The SPV owns the property and investors own the shares or compulsory convertible debentures (CCDs) of the SPV. CCDs are debenture that have to converted into equities on specified dates. Each property is owned by a separate SPV. “The SPV shares are owned by the investors directly so in a hypothetical situation if the platform goes out of business, investors can hire any other company to manage the property," said Shiv Parekh, co-founder, hBits.
In case, the platform is not able to get the required number of investors, the token money deposited by existing investors is paid back with interest. “We wait for around 30-45 days to get the required number of investors. If we don’t get them, we return the money with an interest of 4% above State Bank of India’s FD rates," said an executive from one of the fractional real estate platforms. But that has never happened on our platform, he added.
Returns: The SPV gets rental income from the property which is generally distributed on a monthly basis to investors, either in the form of interest on CCDs or dividend on shares. The interest income as well as dividend are taxable in the hands of investors as per their slab rates. The income may be subject to tax deducted at source (TDS).
Investors can also benefit from the appreciation in property prices when they exit. “If the investor sells his or her unlisted shares in the SPV after two years, the gains will be taxed at 20% post indexation," said the executive mentioned earlier.
Charges: These platforms generally charge a fee of around 1% on the sum invested by the investors. Apart from this, the platforms can also charge the investors a portion of the capital appreciation. “At hBits, we charge 1% as an annual charge as property management fees, while 10% of the capital appreciation if it is over and above 8%," said Parekh. Then there is property tax to be paid.
Exit option: Investors can exit the property by selling it directly to anyone or by listing it on the platform. In the latter case, you would only be able to sell when there is a willing buyer on the platform. Waiting for a willing buyer could lead to liquidity issues.
Should you go for it?
Fractional investing lets you invest in multiple properties, but you should stay away from it if you do not understand how it works and the associated risks.
To start with, there are regulatory concerns around these platforms which are registered under the real estate regulatory authority (Rera) as brokers. “There is a grey area as far as the regulations are concerned. Investors should check the law for such schemes. Ideally, the fund-raising identity should be registered under Sebi’s alternative investment fund (AIF) regulations or real estate investment trust (REIT) guidelines. Investors should ideally stay away if such investment is not protected under any legal framework of pooling of funds," said Anuranjan Mohnot, managing director and chief executive officer, Lumos Alternate Investment Advisors Pvt. Ltd.
“Typically, investors should look at the regulations to protect their interest in case anything goes wrong. I will try and stick to investments where regulations are much more stringent," said Lovaii Navlakhi, managing director and CEO, International Money Matters Pvt. Ltd, a Sebi-registered investment advisory firm.
You can also look at other fractional investments instead which are more regulated. “As far as fractional ownership is concerned, REITs are a better option as they provide a highly diversified portfolio. Plus, you can move out of REIT at any point of time while liquidity can be a concern here," said Sharad Mittal, CEO, Motilal Oswal Real Estate Fund.
REITs are more diversified as they invest in multiple properties. These platforms also let you invest in multiple properties but the sum required may be large. Besides, exiting from the property through these platforms may be a challenge until you find a willing buyer on your own or on the platform. REITs are relatively more liquid as the investor can exit any time by selling the shares on the stock market.
But it’s important to evaluate the risks and deal with the complexity of REITs and AIFs (read bit.ly/38hnBHd and bit.ly/2Gvaeb5) as well. There are risks of vacancy and non-appreciation of rents, especially given the current economic uncertainty, which can directly hit the returns.
“This type of fractional ownership suits more sophisticated investors who want to generate alpha by investing in a property which is available at a really good price," said Mittal.
Last but not the least, take the taxability as well as other charges, including property tax, into account when calculating returns.