Fractional platforms lower barrier for investing in commercial realty

It is a relatively new avenue though and carries high concentration risk

With corporates asking their employees to return to office, or work at least partly out of office, occupancy levels are rising. This bodes well for commercial real estate (CRE). According to ANAROCK Research, net absorption of office space was 34.06 million square feet (sq. ft.) in FY2021-22 across India’s top seven cities, up 60 per cent over FY2020-21, and at almost 80 per cent of the pre-Covid-19 level of 43 million sq. ft. in FY2019-20. Besides real estate investment trusts (REITs), an upcoming route that retail investors can take to participate in CRE is fractional platforms.

How they work

These platforms enable investors to own a portion of a grade A office property, usually situated in a prime location. The investor gets to purchase a share in a special purpose vehicle (SPV), which holds a single property.

“The ticket size for buying a share in our SPV is Rs 10 lakh, which lowers the entry barrier for retail investors,” says Shesh Rao Paplikar, chief executive officer (CEO) and co-founder, BHIVE Group. One grade A office building can cost Rs  30-60 crore.   

hBits, another fractional platform, gives shares and compulsory convertible debentures (CCDs) in the SPV, a private limited company. “Each month the rent flowing into the private limited company is paid out to investors,” says Shiv Parekh, founder, hBits.

If the property is at a prime location, it could be held in perpetuity by the management. Sometimes, it is sold after four-six years and the capital gains are distributed among shareholders. Investors can sell and exit their holdings anytime.

The management levies an annual fee of one per cent. If the property is sold, and total return (rental yield plus capital gains) exceeds the hurdle rate (usually around 8 per cent), the management gets a performance fee of about one per cent of the return in excess of the hurdle rate.

Access to prime CRE

Returns from CRE can be attractive. “The rental yield can be 8-9 per cent or more, about three times the yield offered by residential real estate. Add capital appreciation and an investor could end up with an annualised internal rate of return (IRR) of 15-odd per cent,” says Rao.

The investor doesn’t have to worry about day-to-day management, which is handled by a professional property management firm.

“Typically, these platforms take care of several critical aspects of investing – from discovery to liquidation. Moreover, they help investors with all preliminary processes such as due diligence, research to zero-in on the best options, and procurement of title documents,” says Anuj Puri, chairman, ANAROCK Research.

Digital platforms also make investing seamless. “All the processes—signing of documents, payment, and tracking of the portfolio—can be done online,” says Parekh.

Nascent segment

Fractional platforms are a relatively new investment avenue. “There are no really established players. Rules and regulations, specific to this segment, are yet to be formulated and announced,” says Puri.

Moreover, there are no standardised processes to depend on. “At both entry and exit, multiple investors can give rise to disputes regarding usage of the property, expenses, etc. Individual defaults also tend to rise in a challenged economy, and this could affect all co-owners,” adds Puri.

Points to check

Check the property held by the SPV to understand its potential and risks. Also, enquire about the management. “It must have experience of managing leased CRE and should be able to handle the challenges that will inevitably arise,” says Rao.

Puri suggests that investors do the due diligence vis-à-vis the paperwork (related to ownership of the property).  

“Get clarity on who will buy the units when you want to sell them and whether there is an impact cost,” says Arnav Pandya, founder, Moneyeduschool.

Enter only if you have a horizon of at least five-six years. “Only investors with large net worth, who can tolerate the risk of a concentrated investment in a single property should invest in this avenue,” adds Pandya.

Taxation of earnings from fractional platforms
 

1). The SPV usually has pass-through status, so income generated and distributed by it to shareholders is deemed to be of the same nature and proportion in the hands of unitholders
 

2). This means income will be taxed in the hands of shareholder under the same head: If SPV earns rental income, it will be treated as rental income in shareholder’s hands and taxed accordingly
 

3). Gain on sale of commercial property falls under capital gains
 

4). It is treated as long-term if the property is held for more than 24 months; such gains are taxed at 20 per cent
 

5). If the property is sold before 24 months, the gains are termed short-term capital gain and taxed at investor’s slab rate
 

Source: Clear