Continuing the discussion from All about REITs/InVITs : A Reckoner:
What is Fractional Real Estate (RE) Investing ?
Fractional Real Estate investing is a new trend in commercial real estate where platforms offering this investment option create a Special Purpose Vehicle (SPV), a form of private limited company for every commercial property listed for investment. This SPV then collects and pools funds from investors to the tune of property value and purchases & manages the property.
While Fractional RE investing has been around for a while in developed markets like the US, it is comparatively a recent phenomenon in the alternate Investment category in India.
How does Fractional Real Estate investing work?
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Investors get equity and compulsory convertible debentures (CCDs) to the proportion of their investment.
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Minimum Investment amount generally starts at 25 Lacs
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There is no regulator overseeing for Fractional RE investing
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Some of the platforms that offer fractional real estate investing in India are; Strata, hBits, PropertyShare and bhive, amongst others.
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A trustee company oversees and provides custodian, escrow and trusteeship services
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Rental yield is high comparatively ranging between 8-12% but returns can be zero incase of vacancy or default by the tenant .
Exit route:
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Selling in the secondary market on platforms that facilitate trading in Fractional REs.
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If 75% or more investors vote in favour of the sale and when the SPV finds a buyer for the property.
Key Risks Involved:
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Extremely Low liquidity in most cases: In case, one wants to cash out of their investment if it is performing poorly, there is a high risk of not getting an exit at the desired levels as the liquidity is too low and as the companies or other participants have no obligation to buy your portion, it is very likely that they will try to get the best deal out from you. In a nutshell, it is like investing in a penny stock but with a potential of stable returns.
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Higher Minimum Investment: While it is fractional investing, but the minimum investment value is at least 25 lacs in most of the cases, making it extremely concentrated and risky for a small investor. Such high investments can potentially risk the lifetime savings of the Investor - with our per capita income still below 1.5 lacs per annum (per capita income: India's per capita income remains below pre-Covid level in 2021-22 - The Economic Times). This is almost an unviable proposition for a small investor.
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Not regulated: Even with all the regulatory oversight, there are instances of mis-selling in other investment options. With no regulation in fractional RE investing, the chances of small investors bearing the brunt of dubious investments, ponzi schemes goes up manifold.
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Volatility in returns : The risks that an investor has to undergo for investing in fractional RE should be compensated at least by higher returns, even that is not the case as returns are generally between 8-12% in an year which can even to “Zero” if there is any vacancy or tenant defaults on rent.
How does taxation work?
Rent income is treated as interest and taxed at slab rates. Whereas profits made on the sale are treated as capital gains and taxed at 20% when the investment is held for two or more years and at slab rates otherwise.
Source: Mint
Comparison with REITs
| Parameters | REITs | Fractional RE Investing |
|---|---|---|
| Regulation | Strictly regulated by SEBI | No regulation |
| Minimum Investment by | Can be as low as 15-20k | Very high : 25 Lacs and above |
| Liquidity | Highly liquid as these are listed on stock exchanges | Extremely low liquidity as there are unlisted and can be sold on online platforms or to buyers directly |
| Returns | Comparatively consistent | Highly volatile if tenant vacates or defaults |
| Due diligence | Fund managers do the job for investors | Investors have to research and find the property |
| Selection/ Choice of property | REITs must have at least 80% of their investment in income-generating properties. | Can invest in both completed projects or projects under construction |
| Minimum Value of property | 500 Crore | No minimal value |
Taxation:
| Particulars | REITs | Fractional RE Investing |
|---|---|---|
| Dividend Income | Exempt ( If SPVs have not opted for concessional Tax regime) | Treated as income and taxed at slab rates |
| Interest/Rental Income | Taxable for unitholders at slab rates | Taxable for unitholders at slab rates |
| Sale of Units | STCG @ 15%, LTCG @ 10% (>3 Years) for amt > 1 lac | Capital Gains (Slab rates <2 years , 20% for > 2 years) |
What are your views on Fractional RE Investing?