Real estate is one of the favourite asset classes of investors. However, with the increase in the cost of real estate and sky-high home prices, different investment options that aim to deliver returns of underlying real estate have come up.
Fractional real estate is one such concept where people can invest in a fraction of a real estate property. The investors are owners of that fraction of the real estate. It has been seen that realtors are pushing for fractional real estate in an aggressive manner, but people don’t seem that interested.
Founder and CEO, Shiv Parekh of hBits, feels that lack of demand for fractional real estate can be attributed to three aspects.
“Firstly, fractional ownership of commercial real estate concept is relatively new, unlike traditional investment vehicles such as mutual funds that have been prevalent for decades. This unfamiliarity could contribute to hesitancy among potential investors. Secondly, there seems to be a lack of awareness about the product and a limited understanding of its advantages. Investors may not be fully informed about how commercial fractional real estate can serve as a strategic financial instrument, providing exposure to real estate while offering diversified benefits. Additionally, the challenge lies in the fact that commercial fractional real estate is essentially a financial product backed by tangible assets (real estate). Realtors, who typically engage directly with physical properties, may find it challenging to grasp the nuances of a financial product designed to achieve diversification goals through real estate exposure,” said Parekh.
Co-ownership
Co-ownership is another issue with fractional real estate.
“Co-ownership means sharing decision-making with others and relying entirely on a property manager, limiting control over the property. Until the system becomes more investor-friendly and clear legal guidelines are established, risk-averse investors may be hesitant to pursue this investment approach,” said Pratik Kataria, Director, Sainath Developers.
Liquidity
According to Parekh, liquidity is a major risk for investors.
“Holding of fractional ownership is managed through a special purpose vehicle (SPV); one must rely on a fractional ownership platform (FOP) for resale opportunities or exit opportunities. The entire secondary market is currently managed by these FOP players which can delay liquidity,” he said.
He added that liquidity will be enhanced after forthcoming SM REIT regulations come into place, and all products are set to be traded on the stock exchange.
Legal framework
Ambiguity in the legal framework can be another risk associated with the legal framework.
“The legal framework surrounding fractional ownership is still under construction, leaving investors in uncharted territory. This ambiguity can breed uncertainty about co-ownership structures, exit strategies, and dispute resolution mechanisms,” said Mr. Sourabh Bansal, Co-founder and Managing Director, Magicrete.
Exiting
Investors might face challenges when wishing to exit their investments due to the absence of a readily available secondary market to absorb their share of investment. Additionally, since this area remains unregulated, the secondary market is entirely maintained and operated by FOP players. A buyer is found among the various registered users on that platform.
“At hBits, we have a dedicated secondary market team which helps facilitate these exits.
However, so far, we have noticed that less than 1.5% of the investors have taken an early exit and hBits has facilitated 100% of them. Since the price discovery is usually between the buyer and seller, the time is subject to negotiation. At hBits, we take an average of 3 weeks to facilitate the exit,” said Parekh.
Sourabh said that exiting fractional real estate investments in India involves navigating challenges such as liquidity constraints and time-consuming transactions.
“Options include platform buybacks, seeking buyers through designated marketplaces, exploring buyouts with co-owners, and rigorous due diligence on exit strategies. While challenges exist, a prudent and well-informed approach, coupled with a realistic expectation of timelines, is crucial for investors seeking an exit,” said Sourabh.
Tax treatment
Another issue investors face with fractional real estate investment is the tax laws, as specific regulations are not clearly defined.
Experts say that the income from such investments, including rental income, is taxable.
Rental income is taxed according to the investor’s income slab, with local municipal taxes also applicable. Capital gains tax applies to the sale of fractional shares, with a 20% tax on long-term capital gains (if held for more than two years) and tax according to the income slab for short-term gains (if sold within two years). Each fractional owner bears responsibility for their share of taxes, adding to the property’s maintenance costs.
Sourabh feels that a financial advisor’s expertise is required for the nuanced treatment of income tax, capital gains tax, and inheritance tax to avoid unwanted surprises and optimise returns.
To sum it up, Pratik said that in the unpredictable world of fractional real estate in India, keeping abreast of market trends is essential.
“Investors should stay vigilant about regulatory changes, ensure platform transparency, and comprehend market dynamics. Conducting thorough due diligence, diversifying portfolios, and anticipating challenges in this evolving landscape are crucial for navigating future uncertainties. As the market evolves, being proactive in adjusting investment strategies and staying informed about the dynamic nature of fractional real estate will be key for investors aiming to navigate and capitalise on potential shifts in the market,” said Pratik.
Padmaja Choudhury is a freelance financial content writer. You can reach out to her at [email protected].
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