While both instruments are relatively new to investors, they are quickly gaining in popularity because they have finally given retail investors access to commercial real estate.
One thing is for sure; within a few years, commercial property is going to dominate the Indian investment market. And it’s two new-age investment formats — fractional property and REITs (Real Estate Investment Trusts) — that are ushering in this new age in the financial world in India.
To those unfamiliar with these terms, here’s a crash course. Fractional property refers to a group of investors pooling their funds together to jointly purchase real estate. This reduces the cost burden on the investors, who also share the rental income in proportion to the size of their investment.
On the other hand, the concept of REIT is very similar to that of mutual funds — it gathers money from several investors and then invests those funds in income-generating properties. The returns are paid out from monthly rent from the properties invested in.
While both instruments are relatively new to investors, they are quickly gaining in popularity because they have finally given retail investors access to the most exciting asset class — Commercial Real Estate (CRE), an asset that has immensely attractive returns, but also used to come with high ticket prices. Both forms of investment have now reduced the entry cost in CRE, functioning almost like crowdfunding for real estate.
Fractional ownership of real estate (FA) is already anticipated to grow to $5 billion in India within three years, while the nation’s first three REIT offers have cumulatively raised Rs 8,925 crore ($1.2 billion) during their IPO in 2020 and 2021.
Financially-savvy investors should aim to stay ahead of the curve and grab a slice of the CRE pie now. But which is the right investment for you? Here a series of questions all prospective investors should ask before they take the plunge:
Do you want more control over your funds? Just like with mutual funds, REIT investors have no control over where their money is used; that decision lies entirely with the fund manager. With REIT, there are chances that the fund manager might decide to deploy the funds in under-construction projects, residential property, or other underperforming assets.
In fractional investment, however, investors can take their pick from any number of Grade A office spaces that are on offer. This is the section of CRE that is outperforming all others and earns the highest returns (8% to 10%). Even during the pandemic and the ensuing slowdown in 2020, the net absorption of Grade A office spaces was 25 million square feet. This year, the number is expected to climb over 30 million sq ft.
Do stock market fluctuations make you nervous? Based on the explanation above, it’s easy to think of REITs like mutual funds, and fractional ownership as a direct investment in stocks. However, it’s REITs that have risks connected to the stock market; since REITs are publicly listed, their pricing is also subject to the fluctuations of the stock market. In that respect, fractional ownership is just like good old traditional property investment — it has close to zero correlation with public markets. This makes fractional property a true diversification away from the stock market (it’s more accurate to compare fractional to debt instruments about stability).
Is it important to you to be able to monitor your investment periodically? Savvy investors like to be more hands-on and periodically check on their investments to see how they’re performing. Fractional platforms ensure complete transparency and real-time tracking of the asset and its valuation, and all the information is available on the online dashboard. Meanwhile, REITs publish a full valuation once a year, along with semi-annual updates.
Do hidden charges annoy you? Did you know, regulations mandate that REITs must distribute no less than 90% of the net distributable cash flows to their investors? But what about the remaining 10%? With fractional property, there is a complete distribution of the net distributable cash flows (post taxes, etc). This is because the fractional company does not levy any hidden charges. It does charge a modest fee for its services as a property manager, however.
Are you looking for a short-term or long-term investment? Two of the biggest advantages of REITs are that the entry cost is quite low, and exit is relatively easy as the units can be sold on the stock exchange. Just like stocks, it’s possible to make some quick money with REIT, but there’s also a chance that the returns and even the resale value might fall if conditions are not favourable. In comparison, the fractional property has a higher entry cost — between Rs 10 lakh and Rs 25 lakh per investor. But it also more stable over time. It makes more sense to look at fractional as a medium- to long-term holding, to grow wealth until the investment horizon in 5-8 years, at which time the asset is sold off. Investors who wish to cash out before this period will still have the freedom to do so, by selling their share of the asset on the same platform they bought it.
The bottom line, of course, is to do due diligence on the asset class before investing. Fractional property and REITs both work in very different ways and can give investors different benefits. Ultimately, it all depends on your goals for your investment.
(By Aankush Ahuja, Director of Business Development and Investments, hBits)