On March 8, 2024, the Securities and Exchange Board of India (SEBI) introduced a much-anticipated framework for Small and Medium Real Estate Investment Trusts (SM REITs). This regulatory amendment addresses the growing popularity of fractional ownership platforms (FOPs) and aims to bring transparency and structure to this segment of the real estate market.
1. Curbing Unregulated Platforms and Filling the Gap
SEBI’s move stems from the proliferation of web-based FOPs in the past 2-3 years. These platforms offered fractional ownership in residential and commercial properties with a minimum investment ranging from INR 10 lakh to INR 25 lakh. However, concerns swirled around their opaque business models, lack of clear exit strategies for investors, and the possibility of violating public offering norms.
The existing REITs framework, established in 2014, catered to large-scale income-generating assets with a minimum value of INR 500 crore. This high threshold left a significant portion of the real estate market untapped by retail investors. SM REITs bridge this gap by introducing a significantly reduced entry point of INR 50 crore for completed and income-generating assets.
2. SM REITs: Structure and Regulations
The SM REIT structure closely resembles traditional REITs, with some key differences. Here’s a breakdown of the essential guidelines:
a) Legal Structure: SM REITs must be set up as trusts, holding the underlying assets through a special purpose vehicle (SPV).
b) Investment Manager: To be qualified, the investment manager needs to have a minimum of 2 years of experience in real estate or real estate fund management. Alternatively, they can employ key personnel with at least 5 years of experience each. A net worth of INR 20 crore (INR 10 crore in positive liquid net worth) is mandatory for the investment manager.
c) Investment Conditions:
i. The size of the acquired asset in an SM REIT scheme must range between INR 50 crore and INR 500 crore.
ii. At least 95% of the scheme’s assets must be invested in completed and revenue-generating properties.
iii. Investment in non-revenue-generating real estate is prohibited.
iv. Up to 5% can be invested in unencumbered liquid assets.
d) Initial Offering:
i. A minimum of 200 unitholders (excluding the investment manager and its associates) is required.
ii. The minimum investment per investor is set at INR 10 lakh.
iii. An initial public offering with a minimum subscription of 25% of the total outstanding units is mandatory. The draft offer document needs to be filed with SEBI through a merchant banker.
e) Leverage: Both scheme and SPV levels can leverage through borrowings and issuance of listed non-convertible debentures (NCDs). Leverage limitations and credit rating requirements are in place to manage risk.
f) Launch and Lock-in: The SM REIT is obligated to launch its initial scheme within 3 years of registration with SEBI. Lock-in periods are defined for the investment manager’s holdings in the scheme, ranging from 1% to 15% depending on the scheme’s leverage and tenure.
g) Distributions: The investment manager is responsible for ensuring that at least 95% of the net distributable cash flows from the SPV are distributed to the scheme, and 100% of the scheme’s net distributable cash flows are further distributed to the unitholders on a quarterly basis.
3. Existing FOPs Get a Window of Opportunity
Recognizing the presence of established FOPs, SEBI has provided a 6-month window for them to apply for registration as SM REITs. This window offers them a chance to migrate to a regulated structure and potentially expand their investor base. Notably, the asset size and minimum investor criteria are relaxed for migrating FOPs.
4. A Look Ahead: Potential and Growth Projections
The introduction of the SM REIT framework by SEBI has been met with positive reactions from industry players who anticipate significant growth in the real estate fractional ownership market. Here’s a breakdown of key takeaways from their perspective:
a) Regulatory Framework Addresses Key Aspects: Industry experts believe SEBI’s regulations address critical areas like:
i. Investor safeguards through minimum experience requirements and net worth for investment managers.
ii. Defined holding periods for investment managers to ensure alignment with investor interests.
iii. Diversification by mandating a minimum 95% investment in completed, revenue-generating properties.
iv. Minimum investment thresholds set at a relatively accessible INR 10 lakh.
b) Increased Liquidity for Developers: SM REITs offer developers a new avenue to monetize smaller completed projects, potentially leading to faster project cycles.
c) A Wider Investor Pool: The framework allows retail and institutional investors to participate in the office and commercial real estate market with a lower minimum investment compared to traditional REITs.
d) Opportunities for New Fund Managers: The minimum fund size of INR 50 crore and manageable minimum holding requirement (5%) for investment managers don’t create a significant entry barrier.
e) Market Size and Growth Projections: A JLL India and PropShare report estimates a tenfold increase in the market size, reaching a value of $5 billion by 2030 (from a current estimate of around $500 million). This growth is attributed to factors like increased transparency and investor protection due to regulations.
Conclusion
The introduction of the SM REIT framework marks a significant step towards addressing the gaps in the real estate fractional ownership market. It tackles the dual challenge of transparency and exit opportunities for investors, previously hampered by unregulated FOPs. The true impact of the framework will depend on the migration of existing FOPs and its attractiveness to them. Nevertheless, the SM REITs hold immense potential to create a whole new asset class for investors seeking exposure to the Indian real estate market. This paves the way for a more structured, transparent, and dynamic real estate investment landscape. Overall, the SM REIT framework is expected to bring more transparency, structure, and liquidity to the real estate fractional ownership market. This, along with the potential for a wider investor base, is likely to drive significant growth in the coming years.
Author Bio
