When we compare rental yield for real estate in Mumbai – high-end residential real estate ranges anywhere between 1% – 3% plus capital appreciation, whereas high-end commercial real estate ranges from 5% (usually banks & retail showrooms) – 12% (usually commercial offices, IT parks & warehousing) plus capital appreciation. Primarily investing in pre-leased properties should be done with a portfolio perspective to benefit from a steady stream of income and more importantly to benefit from diversification of risk into the real estate asset class. Real estate is one of the most capital-intensive asset classes in the world. Conventionally, only the wealthy few had the opportunity to own & successfully manage a real estate property. Finding & maintaining a good pre-lease asset is a tedious process, unless you have had an experience in dealing with it previously. There is an enormous amount of due diligence that is required before finding a good deal. A number of factors have to be taken into consideration from location of the property, tenant profile, return on investments, liquidity risk, property maintenance, supply v/s demand economics, legal due diligence to name a few.
Fractional ownership of properties refers to when multiple investors come together and each investor invests a fraction of the investment into the property. The intentions of the investors holding such assets are to generate rental yields, capital appreciation and benefit from diversification of risk from the exposure to the property in their portfolio. The management company that facilitates the investment into the property, is responsible for the title due diligence & also identifying the right investment for the investors. They tie up with data companies, banks, third party consultants and real estate brokerages for their services in the process. The information is then collected & listed on their portal for prospective investors. Once the asset is fully funded by multiple investors – the ownership rights are transferred from the existing owner to a SPV (special purpose vehicle). A special purpose vehicle is a legal entity that is made for a specific purpose, in this case the purpose is to hold the asset to generate rental yields & also gain from capital appreciation. All the investors own pro-rata shares in the SPV & have voting rights. The management company appoints a custodian for record keeping of all of the important documents – usually a bank. They also appoint a trustee that is in charge of administering the functioning of the business. The management company charges a fixed percentage per annum (usually 0.25% to 0.5%) of the AUM (asset under management) and is deducted from the rental yield. The investors can access information like the tenant details, return calculations, lease details, via a digital dashboard on the website. Fractional shares in real estate is different than investing in REITS. REITS are like a company that own & manage a pool of real estate properties like malls, offices, warehouses, shopping centers, etc. Information asymmetry is one of the common draw backs of REITs – investors don’t have access to the any property or lease details. Investors usually invest in REITs of companies with strong track record & historical performance, in India one such company is Embassy Group.
Investing in Fractional Shares:
Pros
- Accessible investment avenue – Anyone with the ticket size of Rs. 10L can have access to the investment class.
- More transparent – Since the entire process is digital, the investor has access to the financials & every detail online on the investor dash board as compared to reits
- Diversification benefits – Like Real Estate – investors can benefit from diversifying risk from a portfolio perspective.
- No management – The asset is managed by the asset management company and the investor has no say in management. Although the asset management company can be replaced with majority votes at any given point of time.
- Regular Cash Flow – Investors can benefit from a stable source of income.
Cons
- Liquidity Risk – Although you can transfer the share to a third party, it is very difficult to quantify the time & demand of the same.
- General Market Risk.
- Tenant Risk – Companies in any industry can be disrupted.
- Agency Risk – Asset Management Company may be incapable to perform.
- No leverage – As of today, no one can take leverage against the shares in a fractional investment.
The property market had anyway been going through a liquidity crisis before the covid-19 pandemic. In the recent past, a hand full of startups have rose up to the occasion to solve this problem of the liquidity crunch in the market specifically for such income generating real estate assets. Fractional Ownership has gained much traction in markets in both Europe & USA. Asset under-management alone in the US this year is around 7 Billion US Dollars. Although the fractional ownership market is quite fresh in India, it will be quite interesting to see how it gains traction amongst the public at large. It can be a new source of investment for the people who traditionally were not able to access such opportunities but at the same time since the concept is yet budding, investors should be cautious & invest in fractional ownership based on their risk appetite.