This article discusses the regulatory framework in relation to real estate investment trusts (REITs) and small and medium real estate investment trusts (SM REITs) that was notified by the Securities and Exchange Board of India (SEBI). This article analyses the gaps that persist in the present framework and provides solutions to bridge them. It highlights the differences between the regulations applicable to REITs and mutual fund schemes. The article also discusses fractional ownership platforms (FOPs), the need to regulate them, and SM REITs.

The SEBI (Real Estate Investment Trusts) Regulations, 2014 (REIT Regulations) were introduced in September 2014. Since then, the potential of Indian REITs continues to be largely untapped with only 4 listed REITs. Market players are instead increasingly opting to raise funds through FOPs and other alternative routes of public financing, as discussed in our article titled, “The Evolution of Fractional Investment Modes in the Real Estate Sector,” which is accessible here. 

In the last few years, the Indian real estate market has witnessed the emergence of web-based FOPs, which allow investors to invest in a variety of real estate including office spaces, warehouses, shopping centres, conference centres, etc. FOPs benefit real estate developers, as these can raise money in small ticket sizes and stay out of regulatory oversight without any burden of ensuring compliance with the REIT Regulations. As a result, unregulated FOPs have proliferated, and led SEBI to establish a framework to encourage FOPs to transition to SM REITs.

Regulatory frameworks for REITs and SM REITs

A REIT is a trust that raises funds to be invested in real estate assets. The capital raised is against units issued to investors (called unit holders). Investment in such assets can be made directly in the property or through a special-purpose vehicle or a holding company of the REIT. REIT Regulations prescribe the requirements and procedure of registration of REITs. The structure of a REIT is based on the segregation of responsibilities among a sponsor, a trustee, and a manager. A sponsor, typically a builder or developer, establishes the REIT and transfers owned real estate to it. A trustee holds REIT assets in trust for unit holders, while a manager oversees asset management, investments, and operations. A REIT must have an asset base of INR 500 crores and should declare its net asset value at least once every six months. Further, the minimum offer size of any issuance is required to be INR 250 crores. It is also mandatory for units of all REITs to be listed on a recognised stock exchange having nationwide trading terminals, whether issued publicly or placed privately. Lastly, at least 90 percent of the income of a REIT must be distributed to the unit holders.

One of the reasons behind the slow growth of REITs is the high asset base and the steep minimum offer size prescribed under the REIT Regulations. To address this and the rise of unregulated FOPs, in March 2024, SEBI amended the REIT Regulations to introduce a framework for the governance of SM REITs.

The structure of a SM REIT is similar to that of a REIT — it is required to have an investment manager and a trustee. An investment manager is a company incorporated in India, which sets up the SM REIT and manages the assets and investments, while also undertaking operational activities. To accommodate a smaller pool of investment, the required minimum net asset value for SM REITs has been reduced to INR 50, while the upper limit is INR 500 crores. Additionally, like mutual funds and unlike REITs, a single SM REIT can launch multiple schemes for investment in real estate assets. Thus, a single SM REIT can have multiple real estate assets under different schemes in its portfolio and each scheme can have a distinct set of unit holders. Unlike SM REIT, a REIT pools investor funds, giving all unit holders a shared beneficial interest in the entire asset portfolio. SEBI aims to broaden access to real estate investments, democratizing a sector dominated by a select few. However, these efforts have yet to significantly expand the audience for SM REITs.

Further, the updated REIT Regulations allow the FOPs to transition into the SM REIT framework in adherence with a migration plan for existing entities or structures. While existing FOPs usually allow small-sized individual investments ranging from INR 1 to 2.5 lakhs, the SM REIT framework prescribes a minimum individual investment of INR 10 lakhs for a unit. The public comments received by SEBI on the consultation paper for SM REITs also suggested that the minimum subscription size should be around INR 1 lakh to accommodate young, small, and retail investors.

SEBI set a high minimum subscription size to reduce concentration risks, as most fractional investment platforms typically invest in a single property or a highly concentrated portfolio. However, the current minimum price for a unit is likely to discourage existing FOPs from transitioning into the SM REIT framework. While SEBI has indicated that the minimum subscription can be reviewed from time to time based on experience in the market, it may be necessary to lower the unit size to encourage more investments in SM REITs. The REIT and SM REIT frameworks also mandate the listing of units on a stock exchange. This requirement extends to FOPs who wish to register as SM REITs. However, the increased compliance requirements associated with a public listing may deter many platforms from opting for migration to the SM REIT framework.

FOPs have gained popularity by enabling investors to own real assets, often through joint ownership of the target property, with title deeds held collectively by the investors, or ownership of shares of a special purpose vehicle that owns the target property. The SM REIT framework states that a special purpose vehicle that is a wholly owned subsidiary of the SM REIT must ‘directly and solely own all assets that are acquired or proposed to be acquired under any scheme of the SM REIT’. As a result, unit holders of an SM REIT scheme do not directly own the target property or shares in the special purpose vehicle but only hold units of the SM REIT scheme. This form of fractional ownership differs from the typical offerings of FOPs, creating a potential obstacle for FOPs transitioning to the SM REIT framework

Mutual Funds and REITs

While mutual funds and REITs share structural similarities, they differ significantly in their underlying assets. Mutual funds invest in company shares and debentures, whereas REITs focus solely on real estate assets. Emerging investment models like FOPs do not overlap with the established mutual fund market, prompting SEBI to introduce the REIT and SM REIT frameworks.

Retail investors have traditionally favored mutual funds as a safe investment due to their diversified portfolio across various companies. In contrast, REITs focus on a select set of real estate assets. While mutual funds offer high returns and diversification that cushion against the failure of any single company, REITs, though providing steady returns, are vulnerable to sector-specific downturns, which can lead to a decline in the value of REIT units.

The REIT framework provides exit options to dissenting unit holders in situations including change of sponsor, change in control of the sponsor, or conversion to self-sponsored manager. The option is similar to that provided for under SEBI’s framework for mutual funds, wherein the unit holders are given an option to exit on the prevailing net asset value without any exit load. While the exit loads in mutual funds generally range from 1 to 2 percent of the net asset value, REITs typically do not have any exit loads.

Way Forward

Given the reasons outlined above, FOPs might be discouraged from adopting the SM REIT framework. As a result, a significant portion of the market could remain unregulated, undermining SEBI’s objective in introducing the SM REIT framework. To facilitate the transition, SEBI could consider lowering the minimum subscription size, enabling small and retail investors from existing FOPs to invest in SM REITs. Additionally, it might explore structures allowing investors to either hold a title to the target property or own shares in the special purpose vehicle. While the revised framework enables innovative investment avenues through SM REITs, its feasibility and alignment with Indian investors’ behavior will take time to be fully tested and validated. Of note, is that India’s first SM REIT was recently listed at a discount but the overall performance of SM REITs against FOPs remains to be seen.

SEBI has issued a Consultation Paper on Ease of Doing Business for SM REITs in October 2024. In its paper, SEBI proposes dividing the scheme offer document into two parts: key information of the trust, detailing the SM REIT, its investment manager, and trustee, and key information of the scheme, focusing on specific details of each scheme and its corresponding assets. The separate offer documents aim to enhance transparency and strengthen investor confidence. Additionally, SEBI seeks to address the uneven growth of REITs and has invited public feedback on proposed measures to improve ease of doing business and ensure investor protection in the REIT sector.

As SEBI continues to consider stakeholders’ concerns, measures such as the flexibility to operate multiple schemes under the SM REIT Framework can be a catalyst for the growth of the prop-tech sector in India. To further this objective, SEBI must encourage and incentivise FOPs to migrate into the SM REIT framework to democratise the real estate market and prevent unscrupulous players from exploiting end-customers.

Bharucha & Partners – Vivek Mishra and Vatsal Srivastava