Talk about investments and real estate has long been the playground for the rich and well connected, considering its long term potential and risk-reward ability. Commercial real estate, in particular, has been a popular asset class for the HNIs and institutional investors owing to its tangible nature, stable income, steady returns, and collateral value.
On the other hand, it has been an aspirational asset class for retail investors since they are mostly unaffordable, highly illiquid and difficult to administer and manage. For instance, if you buy a property, you'll need to maintain it, pay property taxes, find tenants, and is not the most liquid form of investment. If purchased or managed poorly, a potentially lucrative investment property too can quickly devolve into a money pit.
But, thanks to technology and new-age investment platforms available today, investors are adding real estate assets to their portfolio without actually having to own, operate, or manage a physical property.
They have been diversifying their funds in real estate by investing via REITS or directly through tech-enabled platforms that list, manage and sell income-generating assets on an entirely online platform through a fractional investment model whilst making premium real estate accessible.
For instance, prime commercial property in BKC, Mumbai will range anywhere starting at 25k per square feet, which means a 3,000 square feet office space will cost around Rs. 7 crore and above.
Properties of these type generate good rental yields besides being extremely promising from a capital appreciation perspective. However, they remain inaccessible to a retail investor, considering the average ticket size of the investment it requires. Fractional model or REIT allows one to invest in these premium commercial properties and earn a monthly rental yield thereby helping build long-term wealth.
So if you are considering to invest in either, keep the following things in mind.
Transparency and diversification
Adding REITs to a diversified investment portfolio increases returns and reduces risk since REITs have little correlation with the S&P 500. However, the latter offers a portfolio with a set number of assets and the investor has no control where his money is being used.
It works just like a mutual fund; which means you can choose the basket of goodies, but not pick the candy you want to eat. This makes REIT a bit less reliant as underperformance or inefficiency of any asset will have a negative impact on the cumulative yields. On the bright side, impact on individual holding will be less as it will be spread across an array of REIT investors instead of few large active investors.
Fractional ownership on the other hand offers complete democracy of the asset based on the investor’s choice. This enables the investor to make a choice from across multiple assets basis location, investment needs etc.
Ownership and asset requirement
In the case of fractional, an asset is selected post rigorous due diligence and after ascertaining the returns so there is no minimum value that needs to be adhered to. Besides, there is no lock-in period involved which means an investor has the freedom to sell his ownership of the asset portion to the interested parties.
REIT, on the other hand, has a minimum asset requirement of Rs 500 crore which makes REIT’s offerings limited with regard to the number of properties that it can undertake and in addition to that REIT neither offers transference of ownership nor the rights to sell the stake involved.
According to Sebi regulations, 80 percent of the real estate portfolio held by a REIT must consist of developed and income-generating properties.
Up to 20 percent of the value of assets can be invested in under-construction properties, completed but not rent-generating properties, or listed or unlisted debt of real estate firms. However, on the flip side, being a highly regulated trust fund it limits the expansion of innovative growth models.
Fractional being self-regulated enables expansion of investment structures across balanced to high income-generating assets which eventually offers higher returns in the long term. Besides, a continuous pipeline of prime properties offers investor multiple options to invest.
Asset entry and cashflow distribution
One factor that really works in favour of REIT is the entry cost which is quite low and once listed, the units can be traded on the exchanges, which helps you avoid the liquidity issue.
However, REIT mandates the distribution of not less than 90 percent of the net distributable cash flows, subject to applicable laws, to its investors. On the other hand, while the fractional model may seem to be a little on the higher end in terms of the average ticket size, it offers a complete distribution of distributable cash flows, calculated post deducting statutory fees, taxes and the asset management fees.
Ownership model and legal implications
In both models, there is a special purpose vehicle (SPV) created while purchasing the property. The SPV owns the property and investors own the shares or convertible debentures (CCDs) of the SPV. Each property is owned by a separate SPV so that if ever a situation comes where the platform goes out of business, investors can hire any other company to manage the property and their money is safe.
While fractional investment platforms are RERA registered as brokers, REIT is framed and monitored by SEBI. Hence investments in REIT are regulated closely by SEBI where even a single REIT unit traded is monitored.
Real estate continues to be the most coveted yet complex asset classes and therefore valuation is integral to investment decisions. Stringent valuation methodologies, supplemented with a deep understanding of market dynamics is what helps build reliable assessments.
Therefore tracking and scaling your investments whilst consistently looking out for better opportunities is extremely critical in real-estate. While the fractional model offers continuous monitoring of valuations at regular intervals, in case of REIT, a full valuation is carried out at least once a year besides half-yearly updates to the same.
Investment in anything carries risk. Both REIT and fractional allow investors to take exposure to high-quality rent yielding properties, which may be otherwise unaffordable. Besides one of the key advantage of investing through these tech-led platforms is that they have little or no volatility as they are not traded or traded in much smaller lots privately while being extremely transparent.
Offering real-time data on the asset price, details of the tenants and lock-in period helps investors make informed decisions.
To sum it up, both investments are lucrative; however, real estate investing is all about a strategic well-informed decision factoring in investment goals, term, cash flow, risk appetite and the opportunities it will bring to the table.(The author is co-founder, Strata)