Don’t overlook the risks of fractional investing in real estate

Fractional ownership is a way for small investors to own physical real estate through an alternate investment route. Online platforms like Strata, hBits, PropertyShare, bhive, etc., allow individuals to invest 25 lakh and above in pre-leased Grade A commercial properties and earn an average 10% rental yield.

How does it work

For every commercial property listed for investment, a private limited company, also known as a Special Purpose Vehicle (SPV), is created by the platform. This SPV pools in funds equivalent to the property value from investors through the listing and once done, it buys the property. This means the property registration happens between the seller and the SPV, while each individual investor becomes a shareholder in the SPV.

“Investors get equity and compulsory convertible debentures (CCDs) to the proportion of their investment made in the SPV,” said Nihar Shah, director, investments & sales, Strata Property Management. Documents related to the incorporation of the SPV as well as the listed property are provided to the investor during registration on the platform.

No regulator oversees this alternative investment product per se. “This industry is governed by the Companies Act of 2013 and the platforms facilitating such investments are RERA registered,” said Shiv Parekh, founder, hBits.

To safeguard investors’ interest, these platforms appoint a trustee company that provides custodian, escrow and trusteeship services. “The money collected from the investors goes into an escrow account and from there it is sent to the seller of the property. At no point does the funds come to us (Strata) which ensures that we or any other platform following this structure can syphon off the investor’s money,” said Shah.

What do you earn

Rental yield in the range of 8-12% annually is generally pre-determined and is paid on a monthly or quarterly basis.

If the tenant defaults on paying rent or vacates the property during the lease contract, the investor does not get the rent. “We thoroughly check the balance sheets of the tenant company as a risk mitigation measure. Additionally, we don’t pick properties where vacancy in the micro market is very high or rent is inflated as tenants could easily move out in such conditions,” said Shah.

Investors can exit their investment in two ways: one, selling in the secondary market on the platform itself; or second, when the SPV finds a buyer for the property. “Complete asset sale happens only after 75% or more investors vote in favour of the sale,” said Parekh.

For taxation purposes, rent income is treated as interest and taxed at slab rates, whereas profits made on the sale are treated as capital gains and taxed at 20% when the investment is held for two or more years and at slab rates otherwise.

Subscribe to Mint Newsletters

* Enter a valid email

* Thank you for subscribing to our newsletter.