In recent years, the preferences of Indian investors have changed significantly. Call it Financial markets bullishness, as new investors since 2020 have not experienced any significant fall and slowdown since then, or the various fintech platforms which are trying to attract them with all the success stories in various Alternative Investing models , Indian investors have started to see beyond fixed-income instruments like bonds, fixed deposits and equity investment in stocks and mutual funds.
These alternative investment instruments include fractional real estate, Unlisted shares, Cryptos, Angel investing and Private Equity, Real Estate, and more.
The younger population of investors is the one that finds newer investment avenues quite exciting. Anything new and anything that stats higher returns attracts this category of investors, and thus they don’t shy away from exploring these avenues, even if that comes under the high risk category. (Read: Did you Mutual fund deliver 100x return?)
However, the major restriction that these investors face is the higher ticket size. Alternative investments have been an avenue that has been dictated by High Net Worth Individuals (HNIs) but with time and the rise of investment platforms that allow fractional investing, the line between HNIs and retail investors has blurred.
The major concern here is the fact that young investors dive into the alternate asset market with an excitement-driven or return-driven approach rather than a research-driven approach.
The alternative asset class is in itself risky in nature and requires adequate due diligence. While HNIs are vigilant enough or atleast are being served by many professionals, to invest cautiously, whereas retail investors find higher numbers lucrative and fall in love with the stories to save costs, which are enough to pour their money.
These instruments are popular in the USA and the Europe markets, but that does not translate to suitability for Indian investors. Investors must first assess their unique requirements, preferences, portfolio construction, and risk appetite before investing in alternative investments.
To help you with the same, in today’s article we will cover one such alternate investment that has received huge investor traction in recent years – fractional real estate. Let’s understand what it is all about and the dos and don’ts of investing in fractional real estate.
What is fractional ownership in real estate and how does it work?
Let’s take this concept with an example. Sudhir is an engineer in his 30s and has an investment portfolio that includes stocks, mutual funds, and fixed-income instruments such as bonds and fixed deposits. He plans to expand his portfolio with real estate as an alternative asset class. However, with skyrocketing property rates, Sudhir is in a dilemma about the affordability aspect of his investment.
This is a common limitation of many individuals who wish to take part in the real estate market but find themselves restrained due to the large ticket size needed. For those in this same boat, fractional ownership in real estate came up as an option.
As the name suggests, fractional real estate offers fractional or partial property ownership. The property is divided into small fractions with each fraction available separately for investment. This allows retail investors to take part in the real estate market, unlike earlier times when it was available only to wealthy individuals.
As the sales Pitch goes, Retail investors can now invest in posh localities and prestigious commercial projects with low-ticket sizes via fractional real estate. They enjoy the return on investment as well as capital appreciation with time. Should they or not, that’s a separate question.
Let’s continue with the example of Sudhir. He finds a great property in Worli Sea Link but it is valued at Rs. 50 cr, which is beyond his budget. With fractional investment, he can invest in a part of the property for as low as Rs. 25 lakh. On his investment, Sudhir earns a fixed return as well as gets capital appreciation with rising real estate prices. This allows him portfolio diversification.
How does fractional ownership in real estate work?
In India, fractional real estate is available for pre-leased residential and commercial Grade-A properties, but the latter is more common. Multinational companies are the main players in this market as they pre-lease many of these properties. Some properties also offer rental yield.
With residential property in particular, investors may also benefit from enjoying some days of living on the property under the Pay-to-Use or Usage Assignment approach.
These property investments are available on new-age Fractional Ownership Platforms (FOPs) that create Special Purpose Vehicles (SPVs) to manage the property, and Investor’s money and cash flow management.
Investors own shares of these SPVs and when they wish to sell the property, they sell these SPV shares. This means they deal with SPVs. As of now, this investment concept is quite new and thus lacks regulations.
Since Real estate is involved, and money is being collected for a specific RE project not sure how RERA looks into it.
However, SEBI is trying to bring this investment tool under its radar. It has issued new guidelines under which SEBI will regulate and monitor platforms offering investment in this instrument. According to SEBI, these platforms will be considered as small and medium real estate investment trusts but it is unclear as to which platforms will fall under this classification. You need to consider this factor while investing along with the tax treatment.
Now that we know the underlying concept, let’s understand what you need to look after while investing in this alternative instrument.
Dos of investing in fractional real estate
Here is what you must consider while making an investment decision.
1. Research available options
With so many apples on the tree, it can be a task to choose the shining one. The key is to research your options. In India, fractional real estate is still a growing avenue. Though some of the basic level research must be done by the Platforms, when they list the projects on their website, still you will be investing in Real estate and thus, you need to check the details on the issuer which include, the profile of the issuer, background check on financial stability and past projects, profitability ratio, whether they are backed by financial institutions, legality of the project, exit opportunities, overall experience, etc.
Many platforms in India offer investment in real estate which makes it more crucial for you to research as it is still a less talked about investment instrument compared to equity or fixed-income. With SEBI Regulating it, maybe going forward you will find better transparency and disclosure rules coming up.
2. Check for lock-in, costs, and returns
For any investment, these three factors are very crucial. For fractional real estate, the lock-in varies based on the project. However, you get capital appreciation and rental income in many cases as per your proportionate investment amount. You may also receive a fixed return which can range between 8% to 12%, depending on the project you had invested in.
However, Your Return on Investment also depends on the total costs of property management and the platform fees. Though you may not be required to pay for the costs directly, the IRR will be impacted by the same.
Investment returns on fractional real estate attract capital gains tax. It is different from Regular Real estate investment. If the shares of SVP are held for more than 36 months, a Long-Term Capital Gain (LTCG) of 10% is applicable for any gains exceeding Rs. 1 lakh. If it is sold within 36 months, Short-Term Capital Gains (STCG) at 15% is applicable.
Also, any rental income arising from the property is added to the taxable income which is treated as per the tax slab.
When you sell this property, you sell your shares of SPV. You don’t get indexation benefits. You can claim benefits under sections 54, 54F, and 54E, but for that, you need to invest the entire sale proceeds into a residential property or capital gains bond of specified institutions.
Please note that for the latest applicable Tax laws, do consult a Tax expert.
Don’ts of investing in fractional real estate
Now let’s look at the major don’ts of investing in this tool.
1. Making decisions solely based on returns
Yes, fractional real estate can yield fixed return, capital appreciation, and sometimes, rental income, too. Also, real estate investing may give you some high too, but along with returns you need to consider many different factors. This tool also demands longer tenure and there is associated market risk.
The flexibility bar is on the lower side for fractional real estate investment. For example, unlike fully-owned property, you cannot mortgage this property. Additionally, you need to rely on how well the property is managed and the growth prospect of the area where the property is located. You need to consider all these factors while investing rather than just numbers.
2. Not considering the liquidity risk
Liquidity is an important factor for real estate investment due to the unique demands and preferences of each individual.
Unlike REITs where you can easily share your units, for fractional real estate, it can be difficult to find a buyer. You can use available fractional ownership platforms, but that comes with its charges. All in all, this can take time and effort on your end.
3. Overexposure and short-term investment
If you already have great exposure to real estate as an alternative investment class, it is better not to overdo the same. This is not a short-term investment and will take time to grow. If you are expecting capital requirements in the near term, it is better to invest in REITs than to go all out in this fractional real estate.
Also, better spread your investment across different geographies and areas to avoid the concentration risk.
Are fractional ownership in real estate and REITs the same?
This is a common question for many investors wishing to pursue real estate investment. No, they are not the same. While fractional real estate and REITs (Real Estate Investment Trust) may seem similar, they are different investment tools.
REITs are regulated by SEBI and are very similar to mutual funds. On the other hand, fractional ownership is yet to be fully regulated by SEBI.
In fractional ownership, investors have the flexibility to choose the property type which is not something that REIT investors enjoy. Also, there is a huge difference in ticket size and liquidity for both instruments. REITs have higher liquidity and their ticket size can be anywhere around a few thousand. Fractional real estate ownership can be difficult to liquidate and its minimum ticket size differs based on the project but it can be anywhere around Rs. 5 lakh to Rs. 25 lakh.
So, while both these tools invest in real estate, they function differently.
There is no doubt that fractional ownership in real estate has become the talk of the town with its market size likely to touch $8.9 billion in 2025 from $5.4 billion in 2020. However, investment is a decision which needs careful consideration of different factors. It is better to consult an expert on the matter than to choose a DIY approach as half-knowledge can be more gruesome than none at all!