FOPs explained: Why Sebi feels the need to regulate these pooled realty investments

The market regulator has flagged the ambiguous or even absent regulatory oversight of these realty-based products. (Representational image)

On May 12, the Securities and Exchange Board of India (Sebi) released a consulting paper to regulate increasingly popular fractional ownership platforms (FOPs).

What are FOPs?

They allow people to pool money and invest in real estate, which may otherwise be too expensive for an individual investor. For example, take the example cited by Sebi: an office property worth Rs 100 crore pre-leased with a steady cash flow; an investor with Rs 20 lakh may not be able to invest in such a property. But along with other interested investors, this investor can own a share of its revenue.

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How do they function?

A special purpose vehicle (SPV) is formed and it purchases the real-estate assets. The investors are given shares in the SPV.

The property is first identified by the platform, listed on it, and an expression of interest is sought from investors, who can start with a token amount as low as Rs 10,000. Once the platform receives 100 percent expression of interest (which may be a percentage of the total), investors are notified about the creation of the SPV that will own the real-estate asset. The investors then transfer their money to an escrow account, where it is held till the entire amount is received. Shares of the SPV are then allocated to each investor.

What are Sebi’s concerns?

The market regulator has flagged the ambiguous or even absent regulatory oversight of these products.

While some of the FOPs are operated/managed by real-estate agents who are registered under the RERA Act and therefore can be held accountable, there is no certainty that all FOPs are managed by such actors.

The lack of uniformity and transparency also extends to various other aspects of FOPs, such as disclosure standards, the valuation matrix, management fees, and the investor-grievance redressal mechanism.

Investors could also be shortchanged if they want to liquidate their holdings and there is no market for the unlisted units. Under the current system, investors are wholly dependent on the FOP to find a buyer, do the due diligence to convince the buyer, and transfer the assets. On the other hand, real estate investment trusts (REITs) are mandatorily listed, providing an easy exit option for investors.

Another “major concern” that investors should be mindful about is being held responsible for lapses in meeting statutory requirements. That is, they might be holding securities of an unlisted company (the SPV) that is required to make regular filings with the Ministry of Corporate Affairs. If the SPV or the people appointed by it fail to do so, the investors could be held responsible.

Besides risks to investors, the FOP mechanism poses regulatory challenges as well. The SPV structure could be used to get around regulated structures, such as public issue and collective investment schemes (CIS).

For an issue to be considered a public issue, it has to allot securities to more than 200 people in any financial year. To avoid being classified as such, FOPs may register separate SPVs for the same property and keep investor numbers below 200 for each SPV.

Being unregulated also means that the FOPs do not follow the know your customer (KYC) and anti-money laundering (AML) norms uniformly. This also opens this model of investing to abuse.

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How will they be addressed?

Sebi has proposed that any person or entity that makes such fractional investments possible should be registered with the market regulator as an Micro, Small and Medium (MSM) REIT. These entities will then have to fulfil regulatory requirements from time to time. If any person/entity fails to meet such criteria, they will need to wind up their operations and provide investors an exit option.

According to the regulator, the net worth and deposit requirements prescribed for the sponsor and manager will ensure that these platforms have sound and stable financial health. The applicability of the code of conduct mandated for managers will ensure fairness in their dealings with clients, and their being subjected to regulatory inspection and oversight will instil more confidence in investors and bring more of them into the asset class, it added.

There will be more distribution channels for these assets through other regulated entities.

With the listing of units, there will be a robust risk management and surveillance mechanism, fair and transparent pricing, guaranteed settlement, and exit opportunities for investors, among other things.