Can Fractional Ownership In Real Estate Be a Wealth Creator for Retail Investors? Along with diversification, the smaller ticket sizes of a premium investment class make it attractive for retail investors

A mainstream asset class in Western economies, 'fractional investment' or partial ownership in large properties, is today finding more takers in India as well. Though a fairly new trend, the asset class has already shown significant growth in the last few years. The market size of fractional ownership in India was $ 5.4 billion in 2020 and is projected to reach $8.9 billion by 2025, growing at a CAGR of 10.5%, says a report by Knight Frank.

The segment has seen the entry of many startups that are leveraging technology to find the right product-market fit and create effective business models in the space. Some of the active players in India include Hbits, Strata, Asset Monk, Property Share, ALYF, AURUM WISE X, among a few others. The prominent names in the US and UK include Roofstock, CrowdStreet, RealtyMogul, LexMarkets and London Fractions, British Pearl respectively.

Rise of fractional ownership: The key drivers

It is exciting for retail investors to gain "ownership" of premium properties that are well beyond their budget and it helps in the diversification of their investment, say experts from the sector and VCs closely watching it. Further, the small ticket sizes allow retail investors to take a bet on a small sum, thereby reducing the risk. This explains the heightened interest among retail investors. "It provides diversification and the smaller ticket sizes make it attractive for retail investors. Separately, platforms that enable this investment take care of the diligence and other formalities, making it easy for the end investor," says Ratna Mehta, an ex-Everstone executive director and an experienced VC investor.

"The key factors behind this phenomenal growth are the emergence of the Indian economy as the global manufacturing and IT hub, growth of the e-commerce sector, promising returns and a bullish outlook for the overall corporate real estate (CRE) space in the country," adds Sudarshan Lodha, Co-founder and CEO, Strata, a fractional ownership platform.

Finally, technology has made it easier for startups to launch fractional ownership platforms, which has made them more accessible to investors. Aryaman Vir, CEO of Aurum WiseX, an independent unit of Aurum Proptech, dedicated to offering retail investors access to fractional ownership of commercial real estate, sums up all the factors leading to the rise of this new asset class:

• High Returns: Commercial real estate typically provides robust returns of 12-17%, including both rental income and capital appreciation, making it an attractive asset class.
• Lowered Entry Barriers: Fractional ownership platforms have made it easier for retail investors to enter the capital-intensive commercial real estate market by allowing smaller investments.
• Access to A-Grade Commercial Assets: It provides an avenue for retail investors to invest in high-quality, A-Grade commercial properties, which were traditionally limited to institutional or high-net-worth investors.

Role of startups and rising business models

The most common business model used by fractional ownership startups is creating an aggregator platform for connecting investors with owners. They onboard high-quality asset owners in diverse locations and earn fees on various aspects of the transaction. They typically also handle tenant management, rental collection, maintenance, and overall property management on behalf of the fractional owners. Companies earn revenue by charging a management fee of 1-2% on the rental returns. This fee goes towards operational costs like property management and maintenance.

For instance, platforms like hbits, Strata identify these assets and then showcase them to investors for a potential fractional ownership of the asset. They help investors with all preliminary processes such as due diligence, procurement of title documents, overall asset analysis and peer group comparison. They do this for a 1-2% management fee, explains Mehta.

There is also a performance fee on sale. "If a property is sold and its value has appreciated beyond a set hurdle rate (often 10% to 12%), companies charge a performance fee. This fee is usually 15-20% of the amount by which the property's value has exceeded the hurdle rate," says Vir.

To explain further, platforms facilitating fractional ownership in the CRE space often first shortlist on the premium pre-leased Grade- A properties. Post that a Special Purpose Vehicle (SPV) is formed and raise the investment from the investors against the share in the created SPV. "After the investment is raised, the investors are paid returns in the form of rental incomes until the exit. These returns are often pre-decided and paid at regular intervals. At the end of the tenure an exit is provided by the platform to the investors, often at a premium, thereby helping them gain further returns through capital appreciation," explains Lodha.

Overall, in this entire journey all the key activities like shortlisting the asset, carrying the due diligence, creating SPV, managing the asset during the tenure is done by the platform facilitating the investment. Startups also use a variety of other business models to facilitate their operations. Some of the most common models include crowdfunding, ticket size, and REIT-like models.

"Crowdfunding allows investors to pool their money together to buy a property. REIT-like models are similar to real estate investment trusts, which are companies that own and operate income-producing real estate. The specific business model that a fractional ownership startup uses will depend on a number of factors, such as the type of property being offered, the target market, and the regulatory environment," says Shiv Parekh, founder and CEO, hBits.

VC interest in the business models

Are venture capitalists (VCs) ready to back these startups? Or, is regulation or the lack of it a hurdle? "VC are vary of these models as they are not tested under regulatory and statutory rules. The legal issues on a deal gone bad have no quick solution for the underlying asset is not so liquid for salvage value. Disputes among co-owners, limited control over decisions, market risks, management and conflict risk, legal obligations are some of the risks involved," says Ashwani Singh, Managing Partner, 35North Ventures, India Discovery Fund

However, entrepreneurs in the space believe VCs are interested in the segment and the recent discussion paper from SEBI on fractional ownership regulations is a positive development that aims to strengthen the foundation for both investors and companies in this space. "This move towards regulation adds an extra layer of legitimacy and could make VCs even more comfortable with backing such startups. VCs are keen to invest in industries and startups that promise high returns on investment, and fractional real estate ownership is increasingly fitting that bill. The growing popularity of this investment model signifies its potential to become a mainstream investment vehicle. Adding credibility to this is the fact that regulatory bodies like SEBI are taking notice," says Vir.

Agrees Lodha. "Fractional ownership as an industry is becoming a favorite avenue for the retail investor community due to the promising returns, stable nature and bullish outlook. This has created a positive and credible environment for the startups/platforms facilitating these investments in the VC community. Even during the funding winter, the winds have been in the favor of this industry," he says.

The risks involved for retail investors

Investing in fractional ownership of commercial real estate has its own set of risks. "While real estate as an asset class is expected to be one of the most stable avenues, there are always some unforeseen risks like market collapse, calamity or economic slowdown. However, more often than not, tenant lock-ins are provided to insulate the investors against any such defaults," says Lodha.

A key flaw in fractional real estate investing has been the absence of set regulations, leading to inconsistent practices among various industry players. "While established companies have followed best practices and compliances, the influx of a few new entrants has seen compromise on integrity. SEBI's recent discussion paper on Fractional Ownership Platforms is a welcome move to standardize and regulate the industry," says Vir.

Additionally, if investors are seeking short-term gains, this avenue might not be a best fit for them as real estate investment performs best when left untouched for a long term, adds Lodha.

However, investors should be cautious of fraudulent operators claiming to invest their money in the assets. Conducting a thorough scrutiny of the platform before investing is always recommended. They need to remember that credible fractional ownership platforms provide detailed and verified information of the asset at the listing stage including the type of asset, location, details of the vicinity, area, amenities, rate per sq.ft. expected Internal Rate of Return (IRR), gross rental yield, etc.

The entrepreneurs in the space also say that good platforms conduct thorough due diligence to determine the legalities and the safety of the asset. Investors can always contact the respective FOP should they require any further details before investing and the information would be furnished, says Lodha.

Summing up, with caution and with regulation coming in, this can be an effective asset class for retail investors. It can also become a profitable space to be in for entrepreneurs and investors alike.

Before we wrap up, here are some of the upcoming trends in the space:

• SEBI's consultation paper on regulating the fractional ownership avenue which was released in May has brought a renewed perspective to the space, say experts
• The optimistic reception of this investment avenue has led to a proliferation of new companies emerging in the fractional ownership space.
• Booming co-working spaces have made them a key part of this segment
• Digital technology and e-commerce are driving a significant uptick in warehouse demand, making it a hot investment sector.
• A rising focus on sustainability and advanced technology is attracting investor interest in green and smart properties.
• Lastly, an uptick in geographic diversification. The appeal of fractional ownership is extending beyond top-tier cities to include emerging markets in Tier 2 cities.