The Brick to Click Evolution is Here: SEBI notifies the Small and Medium REITs Framework

Introduction

The Securities & Exchange Board of India (SEBI) on 08 March 2024 notified the much anticipated Small & Medium Real Estate Investment Trusts (SM REITs) regime by way of an amendment (SM REITs Amendment) to the SEBI (Real Estate Investment Trusts) Regulations, 2014 (REITs Regulations). The SM REITs Amendment seeks to regulate, the hitherto unregulated fractional ownership platform (FOP) that offer fractional ownership to investors in underlying income generating real estate assets.

Background

In May 2023 SEBI issued a consultation paper on the “Regulatory Framework for Micro, Small & Medium REITs” (Consultation Paper). The Consultation Paper observed that in the past 2-3 years, there has been a proliferation of web-based platforms offering fractional ownership of real estate assets. These factional ownership platforms (FOPs) provided investors with the option to invest in residential, commercial buildings and office spaces with a minimum investment ticket size ranging from INR 10,00,000 to INR 25,00,000. As per the Consultation Paper, such FOPs were often operated by real estate agents who after purchase of the property also acted as its manager. SEBI highlighted the risk of such structures violating the public offering norms and operating opaque business models without any clearly defined exit opportunity for investors.

Existing REITs Framework

Fractional ownership of rent yielding assets is currently governed by the REITs Regulations which is a listed investment product primarily targeting income generating real estate asset with a minimum value of INR 500 crores. REITs as an asset class was envisaged for retail investors, consequently, only large values assets were permitted to be acquired by the REIT and the minimum investment ticket size for an investor was kept at INR 10,000. The high asset size threshold kept a vast majority of rent yielding real estate asset from being available for monetisation amongst retail investor under extant REITs framework, leading to burgeoning of unregulated FOPs.

The SM REITs Amendment introduces a significantly reduced entry threshold of INR 50 crore for completed and income-generating assets, thereby, unlocking the monetisation potential of small and medium size income generating real estate asset.

Conditions for setting up SM REITs

The SM REITs Amendment provides for a similar legal structure for SM REITs as is provided for REITs, albeit with a fundamental difference viz., doing away with the requirement of having a separate sponsor entity. Some of the key conditions for setting up of a SM REITs are as under:

Migration of Existing FOPs

Existing FOPs have been provided a 6 (six) months window to move an application for registration as an SM REIT. FOPs will be required to complete the migration within 6 (six) months from the date of grant of registration or within such period as may be specified by SEBI.

Since the underlying purpose of the SM REITs Amendment is to bring all exiting FOPs under SEBI’s regulatory supervision, the asset size and minimum number of unitholder criteria applicable to new SM REITs have not been made applicable to FOPs migrating as SM REITs.

Analysis

Recognising the keen interest of Indian towards real estate as an asset class and the attendant systemic risk posed by FOPs, SM REITs Amendment address the twin challenge of bringing transparency in the manner in which the real estate asset is acquired and operated by FOPs and offering seamless exit opportunity to investors. The operational challenges relating to listing of Schemes, the cost of set up as well as the compliance cost are yet to be evaluated. While the requirements to onboard only completed assets may not bring cheer to stuck real estate projects or for those who look at this FOPs also as a growth investment but could certainly help the developers to monetise their completed inventory. Also, the requirement of doing away with the requirement of a sponsor and letting first time property managers engaged professionals to meet the experience criteria is likely to encourage both traditional property managers as well as new age Prop-Tech entrepreneurs capitalise on the regulatory innovation offered by SEBI.  

Conclusion

The proposed framework of SM REITs Amendment appears to address a regulatory vacuum that was felt to exist with the proliferation of FOP structures. The attempt to bring these under regulatory purview, recognizing the need for this asset class for investments by High Networth Individuals while retaining some flexibility, is surely a welcome move. We may need to wait and watch whether existing FOPs are willing to move to this structure or may consequently wind those down, which will indicate how appealing the framework is. Clearly, this has the potential to create a whole new investment asset class for investors interested in the real estate sector. The move to allow un-sponsored REITs through this form may also encourage professional fund managers to tap into this opportunity without necessarily having to bring an asset into the REIT as a sponsor under the larger REIT framework.

• Siddharth Shah (Partner); Shikhar Kacker (Counsel) and Mansi Agarwal (Associate)

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