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real estate investment

Shilpi

5 months ago

Legal Considerations for Fractional Real Estate Investors

 

Fractional real estate investment has made the real estate field an easy-to-enter kingdom even for the unprivileged investors. Although it has changed the concept of real estate investment with its convenience and cost-effectiveness, it still has some legal implications to follow.
This post is about such legal implications and regulatory compliances involved in fractional ownership of real estate. At some points, a legal framework becomes necessary for investors to protect them from any unexpected complications. Let’s see how this factor impacts fractional real estate investors as well as the entire investment process.

 

Rise of Fractional investment in Real Estate

 

The rise of fractional investment in the real estate industry, both in India and worldwide, is quite impressive. The entry of fractional investment in the commercial real estate and luxury residential real estate fields has made real estate an asset with remarkable investment potential.

 

There are reasons behind that. Features like portfolio liquidity, good passive income opportunities, and diversification in fractional real estate investment have made this investment mode even more attractive for investors. But before them, many individual investors looking to invest in real estate became suddenly aware and interested in fractional real estate ownership with the removal of the main limitation of real estate investing, which is a high capital requirement, with fractional real estate ownership.

 

The emergence and rise of fractional ownership platforms have accelerated this rapid rise of fractional ownership in real estate. FOPs, through SPVs, have made this investment journey quite convenient for all types of investors.

 

Fractional real estate investment is a way to own high-value real estate assets, though not a whole asset, while at the same time, you don’t have to take the entire burden of property management. Sharing everything including the property, the profit and loss, and the responsibilities together with a group of multiple shareholders is much more relieving compared to traditional property ownership.

 

With all this, fractional real estate ownership has found its way towards willing investors. According to a report published at Knight Frank, the market size of fractional real estate investing in India is estimated to grow by 65 percent at an annualized rate of 10.5% — to $8.9 billion in 2025 from $5.4 billion in 2020.

 

Essential Legal Framework for Fractional Ownership in Real Estate

 

Certain legal considerations are remarkable for fractional real estate investors. But, this field has not been included under any regulatory body yet. However, recently in May 2023, the Securities and Exchange Board of India (SEBI) proposed to regulate FOPs. Till now, no regulation has been passed regarding that.

 

Notwithstanding that, there are some other legal frameworks applicable to fractional ownership in real estate. Let’s have a discussion about them in detail.

 

SEBI Act, 1992

 

This act, along with the Collective Investment Schemes Regulations 1999 of SEBI (Security and Exchange Board of India) works as the basic guidelines for the working process for FOPs. In section 11AA of the SEBI Act, the operations and the operational behaviour of the company along with the shareholders are regulated.

 

Real Estate (Regulation and Development Act), 2016 (RERA)

 

The RERA Act conveys great importance in terms of the real estate industry. Fractional real estate investment is not regulated by any regulatory body yet. Still, RERA covers this segment of the broader real estate domain to ensure investor protection and transparency of the process. Under the provisions of this act, FOPs as ‘real estate agents’ to proceed with fractional real estate investment. However, this is not a hard and fast rule.

 

Indian Contract Act, 1872

 

The Indian Contract Act legally validates contracts between the FOP and the investors of a particular fractional investment property. This way, the terms and conditions, rights and responsibilities are ensured.

 

Companies Act, 2013

 

The Companies Act 2013 sets guidelines regarding how SPVs work. These guidelines reflect on the formation of SPVs along with their operational and administration-related perspectives. The Act permits a maximum of 200 shareholders for an SPV, which is incorporated by an FOP as a private limited company.

 

Transfer of Property Act, 1882

 

The legal considerations for fractional real estate investors also remind of the Transfer of Property Act. It is related to transferring property ownership rights and the interests involved with the properties.

 

This act indicates different transferring modes including sale, mortgage, and gift. The Act also explains the processes of property registration, title, and documentation as legal requirements for the transferring of a property. Since the transfer of fractional shares is an inevitable part of the entire fractional real estate ownership process, this act comes in relevance in this respect to ensure the legality as well as the validity of such transfers.

 

Regulations Related to Registration and Stamp Duty

 

Registration requirements and stamp duty compliances come along with the process of fractional ownership. The relevant laws might vary depending on the locality or the state. These laws are essential to ascertain the legality and validity of fractional investment, and to ensure hassle-free operation of the entire investment process.

 

Apart from these, some other regulations like the Limited Liability Partnership Act 2008, Companies Act 1956, and The Registration Act 1908, have also mentioned fractional real estate investment, thereby controlling how the process works.

 

Things Investors Need to Be Careful About Before Investing

 

The FOPs are not directly regulated by any financial body. So, along with the legal considerations for fractional real estate investors, investors need to be careful about certain other things too to ensure the safety and security of their investments.

 

Legal Structures for Fractional Real Estate Investment

 

According to the fundamental criteria based on which the factional real estate investing process is working in India, Fractional real estate investment can be availed through fractional ownership platforms.

 

The FOPs establish an SPV, through which, all the proceedings related to fractional ownership of real estate are carried. SPVs pool funds from multiple investors to buy a premium CRE asset.

 

Now, being a responsible investor, it is necessary to analyze the legal structure of the SPV along with the restrictions regarding the transferability of shares taken on by the SPV.

 

Regulatory Compliance for Fractional Real Estate Investment

 

In India, a fixed and organized legal regulatory framework for fractional real estate ownership is still in its developing state.

 

SEBI is considering to regulate FOPs though. According to section 11AA[4] of the SEBI Act, being collective investment schemes, FOPs arguably need to register likewise and should come in compliance with the regulatory framework set out in its Collective Investment Schemes (CIS) Regulations.

 

But, factional ownership in terms of real estate has not come under any fixed regulatory framework yet. So, it is the responsibility of investors to confirm that the FOPs work in compliance with the required regulatory laws. It is like ensuring their investment security along with the potential future of their fractional real estate investment.

 

Compulsory Due Diligence and Disclosures

 

Your due diligence is essential when choosing the right investment platform. It is always recommended to select a platform with a good trail of successful investments. So, a fractional real estate investor must ensure the license and legitimacy of the chosen platform.

 

The same thing applies to the company too. While selecting the CRE asset for the investment, it is essential for the fractional real estate investment property to undergo a legal due diligence and disclosure process by a well-acknowledged lawyer. Since it is the responsibility of the company (SPV), it is also necessary for an investor to evaluate the quality of due diligence undertaken by the company while selecting an asset for investment.

 

Investor Protection and Dispute Resolution

 

In the first place, there are no strict laws or regulations the FOPs must abide by. Secondly, due to the collective investment procedure, there are high chances of disputes among the shareholders of an SPV. Hence, investors must be careful about their investment security as well as resolving such prospective disputes.

 

Tax Implications in Fractional Real Estate Investment

 

The inherent fee structure of the company including any lock-in period, taxation laws involved in the transaction process, and other charges imposed by intermediaries also need to be considered. Investors looking to get registered with a particular fractional ownership platform must be very careful about any hidden costs along with the upfront fees structured on the platform.

 

Exit Strategies and Liquidity

 

The liquidity factor is relatively lower in fractional real estate investment compared to other investment assets. This is the reason that you need to be careful before starting your investment journey with a particular FOP. It is remarkable that many fractional ownership platforms are not transparent about their exit strategies.

 

Conclusion

 

Legal frameworks and regulations are important to establish the safety and security of a particular organization. Since no strict and fixed regulatory process works behind FOPs or the fractional real estate investment process in general, awareness is crucial to ensure investor protection and the proper working of the system.

 

So, your awareness is the key. With proper care and due diligence, you can grab a decent cash flow with fractional ownership in the real estate industry.

 

FAQs

 

What is fractional real estate investment?

 

Fractional real estate investing is a way of real estate investment, where investors pool funds collectively to escape the high financial burden on individual investors. A group of investors invest in one single real estate asset here. In this investment mode, investors enjoy shared ownership of the invested property where incomes and responsibilities are also divided.

 

What are the legal considerations for fractional real estate investors?

 

Fractional real estate investors primarily need to consider the proper regulatory frameworks the FOPs are complying with, the legal fractional real estate ownership structures followed by the investment provider company, due diligence undertaken by both parties, investor protection guidelines, fees and taxes, and exit strategies applicable on the platform.

 

How can I conduct due diligence on a fractional real estate investment?

 

Fractional real estate investment due diligence can be conducted by performing detailed and proper research regarding the background, investment history, investment-related guidelines, fee structure, and the investment strategy applied by the particular platform chosen by you.

 

What are the tax implications of fractional real estate investment?

 

The tax implications of fractional real estate ownership may vary depending on the type of invested property and the purpose the property is used for. However, to mention some, taxes on rental income, capital gain tax, property taxes, cross-border tax implications, etc. are some of the broadly used taxes.

 

What is the future of fractional real estate investment?

 

Considering the immense popularity of fractional real estate investing, the future of fractional real estate investment seems to be hopeful and full of potential. Real estate investing is highly expensive. In such a situation, fractional ownership opportunity in this field has opened a way for individual investors along with the ones looking to invest in real estate with a limited budget to turn their investment dream into reality.

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