Unveiling India's Small And Medium Real Estate Investment Trusts Regime: Opportunities And Challenges

The SEBI amendment to REIT Regulations dated March 08, 2024 should be hailed as an innovative and investment-friendly regulatory solution that undraws the curtains of vagueness from the FOP regime and bolster investments in real estate sector, thereby unlocking immense value and furthering capital appreciation.

Operated and managed under the aegis of SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”), a real estate investment trust (“REIT”) is an investment vehicle which is settled as a private trust under the Indian Trusts Act, 1882 by a settlor, i.e., the ideator, with an intent to undertake investments in real estate assets. The REIT is settled in favour of a trustee, being a professional trusteeship company, and is managed by an investment manager, as a fiduciary of the investors in the REIT (“Unitholders”). The trust raises money through an initial public offering of units to Unitholders and applies the monies so raised to hold and manage real estate assets. Returns from the real estate assets are passed on as distributions to the Unitholders.

Small & Medium Real Estate Investment Trust – Different from a REIT?

The Securities and Exchange Board of India (“SEBI”) notified an amendment to REIT Regulations dated March 08, 2024 (“Amendment”) by which the provisions for small and medium real-estate investment trusts (“SM REIT”) were enforced. An SM REIT, while remains same as a REIT in substance, it does differ in form to cater to, as the name suggests, the small and medium real estate sector. Some key differences are identified below:

Snapshot of Eligibility Criteria

Need for SM REIT Regime – Examining the WHY?

The Amendment was preceded by a consultation paper issued by SEBI on May 12, 2023 (“Consultation Paper”). The said Consultation Paper, in unequivocal terms, sets forth SEBI’s objective of registering and regulating fractional ownership platforms (“FOPs”). Fractional investment or ownership of real estate through FOPs is an investing strategy in which the cost of acquisition of real estate is split among several investors, who invest in securities issued by a special purpose vehicle established by the FOP. Such special purpose vehicles purchase real estate asset (“SPV”). Thus, FOPs allow investors to own a certain percentage / fractional share in the real estate asset through the securities issued by the SPVs.

In line with its mandate under the SEBI Act, 1992 of protection of investors and advancement of public markets, SEBI took cognizance of the growing number of FOPs and notified the Amendment. The Amendment is squarely aimed to rein in the FOPs by prescribing regulatory oversight, common uniform standard disclosure practices, mandatory liquidity by way of listing and other procedural measures by extending the REIT framework to FOPs. SEBI, to its credit, has a adopted a pragmatic and pro-market approach by attempting to regulate an investment sector that has gained significant traction in India, instead of taking conservative steps like cracking down on FOPs.

Opportunities – What lies ahead for investors?

It is said that a playground without rules leads to chaos; however, with the advent of the Amendment, the fog surrounding the erstwhile nebulous FOP structures has been dispelled to a significant extent. Regulation, especially a commerce-friendly one, is always welcome specifically in real estate which is capital intensive sector. As such, the SM REIT regime is likely to attract several non-institutional investors who were hitherto be wary of the FOP structure for several reasons including information asymmetry and huge capital requirements. Now, such non-institutional investor will be able to hold a fraction of a real asset by investing in corresponding unit issued by SM REIT. Furthermore, with the requirement of mandatory listing comes the flexibility to liquidate, which makes the units of an SM REIT a significantly attractive investment instrument. Lastly, the tax pass-through status accorded to SM REITs, is a cherry on top for the Unitholders.

Much like REITs, an investment opportunity in SM REIT is likely to appeal to foreign investors as well. In this regard, it may be noted that the extant exchange control laws categorically permit foreign investment in the units of REITs, paving the way forward for foreign institutional investors to invest in the real estate landscape in India.

Challenges – Regime answers questions, but also raises some?

The Amendment has enabled the existing FOPs to migrate to the SM REIT regime at their sole discretion, however the Amendment is silent on certain critical aspects like consequence of non-migration by existing FOPs or treatment of the existing investors in the FOPs. Would such FOPs run the risk of being categorized as a collective investment scheme under the SEBI Act, 1992 read with the SEBI (Collective Investment Scheme) Regulations 1999, remains to be seen.

Then, there is question of related party transactions; the Amendment restricts the ability of the investment manager of SM REIT to undertake related party transactions. As such, an investment manager of an SM REIT who is also a developer of a real estate project may not be able to transfer the said project to the SM REIT (its underlying SPVs) managed by such investment manager. Similarly, the related party transaction restriction may also impact transfers where an investment manager of an alternative investment fund invests in an under-construction / land acquisition stage project and upon completion, proposes to transfer the said project to the SM REIT (its underlying SPVs) or that is also managed by the same investment manager.

Conclusion

In conclusion, the Amendment should be hailed as an innovative and investment-friendly regulatory solution that undraws the curtains of vagueness from the FOP regime and bolster investments in real estate sector, thereby unlocking immense value and furthering capital appreciation.