[Aayush Ambasht and Rajdeep Bhattacharjee are 3rd Year BBA LLB (Hons.) students at Symbiosis Law School, Pune]
In its board meeting on November 25, 2023, the Securities Exchange Board of India (‘SEBI’) approved amendments to the SEBI (Real Estate Investment Trusts, Regulations, 2014) for facilitating a regulatory framework for Small and Medium Real Estate Investment Trusts (‘SM REITs’). Through this development, SEBI’s objective is to induce a spirit of fractional ownership among a larger pool of investors given the lower asset base value (i.e. Rs. 50 crores as against Rs. 500 crores in the existing REIT regime) and opportunities for leveraging separate holding schemes through special purpose vehicle (‘SPV’) structures.
In this post, the authors analyze the burgeoning rationale and key takeaways from SEBI’s amendments concerning SM REIT structures. Further, it also debunks the implications and potential loopholes centric to fractional ownership for participants in the Indian securities market.
SEBI’s Consultation Paper dated May 12, 2023 set a welcoming tone to a robust regulatory framework for governing fractional ownership routes in micro, small and medium REITs (‘MSM REITs’) between fractional ownership platforms (‘FOPs’) and investors. In essence, fractional investment or ownership of real estate through FOPs is an investing strategy wherein the cost of acquisition of real estate is split among several investors. These investors invest in securities issued by SPVs (which are established by the FOP) and such SPVs deal with the acquisition of the real estate assets. The costs of acquisition and upkeep are then divided among the investors in SPVs, who also share the benefits and returns from such assets with respect to appreciations in value or rents received, after adjusting for management and maintenance fees levied by the FOP, its associates, or specified third parties.
Against this background, SEBI clarified that the structure of such offerings would involve migrating from the SPV model to a master feeder structure mirroring the regime of mutual funds or alternative investment funds. It established requisite modalities concerning the regulatory regime and overall management of investments, underpinning the lower ticket size of investment thresholds (i.e. Rs. 10 lakh to Rs. 25 lakh) for such a fund framework, thereby inviting a larger degree of investor participation.
Implications of SEBI’s Approved Amendment
Addressing the interest for equity alternatives on behalf of non-institutional investors in the Indian securities market, SEBI’s FOP approach bridges the opacity between real estate and retail ownership. The approved regulatory framework addresses key facets pertaining to the registration requirements, operational management, disclosure norms, governance considerations and grievance redressal mechanisms for each party privy to such a fund structure. The SM REIT proposal fosters flexibility and greater accessibility of high-yield real estate ownership on behalf of the investors at a significantly lower unitholding requirement, granting FOPs a larger skin in the game than ever before. Tailoring investment discipline amidst a fractional ownership framework predicates collective insight and priority-based fund pooling, contrary to the trends of individual asset management. In light of the same, the broad interplay of listing obligations complementary to this move is much awaited by potential investors.
As the creation of another class of investment shall aid in the expansion of secondary markets in India, regulating index providers would bolster additional support to structuring investments across diversified range of investor interests. Furthermore, instilling confidence and thought leadership among real estate developers through collective dialogue can help attracting engagement following SEBI’s nod for institutionalizing this untapped segment. In all, the broad overview of such multisectoral collaboration would expectedly help amplify accountability, thereby aligning compliance with prescribed obligations.
Knitting a Paradigm for Fractional Ownership: A Critical Analysis
The fundamental rationale of the regulator for allowing fractional ownership of units in a REIT via an SPV is to bolster strategic funding across real estate in the country and diversify the ownership structure of the same. However, the use of the SPV structure can be counterproductive due to the restrictions placed on transferability of shares in such structures, both from a procedural as well as an operational perspective.
Within REIT SPV buy-in structures, fractional ownership is subject to procedural restrictions such as the right of first refusal (‘ROFR’) clauses, adverse lock-up periods and drag along/tag along rights. Firstly, ROFR clauses grant current shareholders the privilege to purchase shares before any new investors, thus restricting newer investors in the cog-wheel mechanism and reducing the availability of shares for trading. Secondly, adverse lock-up periods may hinder the process of claims from acquired assets between the investor base and potential bidders. Thirdly, explicit provisions for drag-along or tag-along rights shall impede investor independence at the cost of enabling synchronised withdrawals.
In so far as the operational and management aspects of such SPV structures are concerned, the presence of multiple fractional owners introduces difficulties in decision-making. This can result in delays coupled with divergent interests during property acquisitions and its subsequent claims of proceeds. Since the potential for insider domination gives rise to problems regarding equity and openness, a privileged few may exert an excessive influence on choices to the disadvantage of minority investors. Further, the presence of ineffective communication, obstacles in implementing exit options, and difficulties in adhering to regulations exacerbate governance problems without any alternative signalling resolve.
In order to mitigate these risks, REITs that have fractional ownership structures must build strong governance frameworks, transparent communication channels, conflict resolution methods and grievance redressal mechanisms. SEBI must clearly define the rights and obligations of fractional owners, guaranteeing equity and safeguarding overall interests in adherence to the commercial misadventures as mentioned above. Furthermore, it is imperative that share purchase agreements pertaining to buy-ins in SPVs be carefully designed in accordance with SEBI’s underlying justification for enabling fractional ownership, striking a balance between investor protection and improvement of secondary market liquidity. By implementing these strategies and delineating the aforementioned apprehensions, SEBI can strengthen the real estate paradigm, promote structural diversification, and create a favourable atmosphere for fractional ownership in REITs at large.
In this regard, the need for balancing such alternative classes of investments with securitization amidst changing tides must motivate transactional transparency and reformatory conscience. Deliberating upon the tenor of SEBI in reinforcing its regulatory features of oversight in the REIT regime, this amendment charts out an established course for fractional ownership through SPVs, in addition to the present trends of asset management in traditional holding structures. Pursuant to such a development, undertaking securities regulatory and anti-corruption protocols shall be deemed necessary by SEBI from time to time. In conclusion, while SEBI’s recent amendment is a commendable stride inviting a broader pool of fund flow on behalf of both institutional as well as individual investors in such SM REITs, revisiting and re-evaluating the proposed regulatory framework is of utmost essence for merited investment discipline in the times ahead.
– Aayush Ambasht & Rajdeep Bhattacharjee