Over the last few years, India has witnessed significant growth of certain unregulated fractional ownership platforms (“FOPs”) that offer investors with an option to invest relatively smaller amounts, jointly with other investors, to gain co-ownership in the high value commercial real estate assets. In a typical FOP structure investment, multiple investors pool funds to acquire equity shares in the special purpose vehicle (“SPV”), which SPV then acquires the rights, title and ownership of certain revenue generating real estate assets (“FOP Structure”). Each investor, having acquired certain percentage of the equity shares of the SPV, gains indirect ownership rights in the undivided portion of the real estate assets acquired by the SPV, which entitles the investor to earn rent/ yield on their investment in commercial real estate, pro-rata to the number of equity shares of the SPV subscribed by the investor.

Though the Securities and Exchange Board of India (Real Estate Investment Trust) Regulations, 2014 (“REIT Regulations”) have already been in place since the year 2014, however, the FOP Structure could not come under the purview of REIT Regulations, since the real estate assets/ properties comprised in the FOP Structure did not meet the minimum asset value threshold of Rs. 500 Crores prescribed under the REIT Regulations. Hence, until the notification of the 2024 Amendment (as defined hereinafter), the FOP Structures remained unregulated investment structures that lacked the organised mechanism of investment including security of the funds invested, methodology of decision making, exit and grievance redressal for investors, and such FOP Structures surely required certain level of monitoring to safeguard the investment.

Recognizing the potential risk of the unregulated pooling of funds and the need to regulate the FOPs including investment made by the investors through the FOP Structure, the Securities and Exchange Board of India (“SEBI”) has, vide SEBI (Real Estate Investment Trusts) (Amendment) Regulations, 2024 (“2024 Amendment”) issued on March 08, 2024, notified the new regulatory framework governing the Small and Medium Real Estate Investment Trusts (“SM REITs”) by amending the REIT Regulations. Since the SEBI intended to bring all the existing FOP Structures under the ambit of the regulatory framework, hence, the minimum asset value threshold and the number of unitholders requirement has not been made applicable on the existing FOP Structures proposing to migrate.

Pursuant to the 2024 Amendment, the definition of ‘REIT‘ has been amended, the key elements of which are as follows:

• A person that pools Rs. 50 Crores or more;
• for issuing units to at least 200 investors;
• to acquire and manage real estate assets or properties;
• entitling the investors to receive income generated from real estate assets or properties,
• does not give the day-to-day control over the management and operations of the assets; and
• includes ‘SM REIT’ but excludes a company that acquires and manages real estate asset(s) or property(ies) and offers or issues securities to the investors.

Further, as per the 2024 Amendment, a new term ‘SM REIT‘ has been introduced in the REIT Regulations to mean the following:

• A ‘REIT’ that pools money from the investors under one of more distinct and separate scheme of SM REIT for owning real estate assets or properties through special purpose vehicles;
• to acquire completed and revenue generating properties under the scheme of SM REIT having a value of at least Rs. 50 Crores and not more than Rs. 500 Crores; and
• has a minimum of 200 investors (as unitholders of the scheme of the SM REIT), other than the investment manager, its related parties, and associates.

The key distinguishing factors of a traditional REIT and the SM REIT are as follows:

Some of the key conditions and requirements, as prescribed under the 2024 Amendment, for setting up SM REIT are as follows:

1. Structure of the SM REIT: SM REIT is to be set up in the form of a trust. The trust deed will be executed between (i) a trustee registered with SEBI under the SEBI (Debenture Trustee) Regulations, 1993; and (ii) an investment manager, satisfying the eligibility criteria set out in Regulation 26J(2)(d) of the REIT Regulations. Such trust deed is required to be registered under the provisions of the Registration Act, 1908 and specify the responsibilities of the trustee and its main objective as undertaking the activity of SM REIT, through one or more schemes;
2. Investment management agreement: The investment manager and the trustee are required to execute an investment management agreement, which shall set out the responsibilities to be undertaken by the investment manager, in accordance with the REIT Regulations;
3. Incorporation of SPV: Each asset comprised in the scheme of SM REIT is to be owned by a company (being a special purpose vehicle (SPV)), which will be a wholly owned subsidiary of the scheme and will not have any other capital or ownership interest in it;
4. Registration of trust as SM REIT: An application for registration of trust as SM REIT is to be made by the investment manager (on behalf of the trust), in the format prescribed under REIT Regulations along with the prescribed non-refundable application fees, and the investment manager is required to ensure that the considerations set out in Regulation 26J of the REIT Regulations are satisfied;
5. Migration of existing FOPs: The REIT Regulations have provided a window to the existing FOPs (operating in the nature of SM REIT) to apply for registration with SEBI as SM REIT, within a period of 6 months from the date of the 2024 Amendment being notified. Hence, the applicant is required to ensure that the migration of existing structure to SM REIT is completed within 6 months from the date of grant of registration certificate by SEBI;
6. Initial Public Offer: SM REIT is required to undertake initial public offer (IPO) of a scheme within a period of 3 years (extendable by upto 1 year, if SEBI deems appropriate) from the date of grant of registration certificate by SEBI, failing which the SM REIT will be required to surrender its certificate of registration and cease operations;
7. Minimum public shareholding: At least 25% of the total outstanding units of the scheme of SM REIT are required to be offered and allotted to the public, failing which SEBI may take action against the SM REIT and the stock exchange may undertake to delist the units as prescribed under the REIT Regulations;
8. Allotment and listing of units: Upon receipt by SM REIT of the sum payable on application, the investment manager will be required to allot units to the applicants in the dematerialized form within the time prescribed under the REIT Regulations. Such units of the scheme are required to be mandatorily listed on the recognized stock exchange;
9. Distribution of income: The investment manager is required to ensure that the distribution made by the scheme of the SM REIT and the SPV is in the following manner:

i.)  95% of the net distributable cash flows of the SPV are distributed to the scheme of the SM REIT. Such distribution shall be declared at least once every quarter of the financial year and not later than 15 working days from the end of the quarter; and
ii.)  Out of such net distribution transferred by the SPV to the scheme, 100% of the net distributable income of the scheme of the SM REIT shall be distributed to its unit holders. The distribution shall be paid to the unitholders within 7 working days of such declaration;

10. Fund raising by scheme: A scheme of SM REIT may raise funds from Indian and foreign investors through issuance of units of the scheme to the investors, subject to any applicable conditions or approval requirements pursuant to any guidelines for foreign investment prescribed by the Reserve Bank of India and, or, the Government of India. Such scheme of SM REIT may also opt to raise debt through borrowings or issuance of debt instruments under SEBI (Issue and listing of Non-Convertible Securities) Regulations, 2021;
11. Fund raising by SPV: The SPV is permitted to raise funds (i) by way of capital infusion only from equity instruments from the scheme of SM REIT; (ii) by way of borrowings from the scheme of the SM REIT. If a scheme of SM REIT opts to utilize leverage as per point (10) above, then the SPV under such scheme may opt to raise debt through borrowings or issuance of debt instruments under SEBI (Issue and listing of Non-Convertible Securities) Regulations, 2021; and
12. Delisting of units: In case the investment manager proposes to undertake delisting of the units of the scheme as per Regulation 26ZI of the REIT Regulations, then the approval of the unitholders of the scheme shall be required, where the votes cast in favour of such resolution shall not be less than one and half times the votes cast against such resolution.

The 2024 Amendment marks a pivotal shift by introducing a distinct category of REIT called SM REIT, which comprises of a substantially smaller asset value i.e., at least Rs. 50 Crores and not more than Rs. 500 Crores, compared to the traditional REIT where the asset value is required to be at least Rs. 500 Crores. Further, SM REIT would empower the small investors and provide them with the investment opportunity which was previously reserved for large scale investors.

The new regulatory framework though prescribes for certain stringent norms for investment by the investors, however, such norms would definitely boost confidence of the investors and protect them from various investment related risks including but not limited to the risk of completion of the projects and generation of income therefrom and siphoning off investors’ money, as the 2024 Amendment, in addition to the other prescribed norms, prescribes for circumscribed usage of the cash flows and mandatory distribution of funds to the investors. In addition, the transition to SM REIT will also allow retail investors to benefit from valuation and disclosure requirements and asset categorization norms. Having said that, the investors would still need to proceed with caution, beware of the risks involved in investment, and consult professionals before making an investment. While SM REITs will certainly help unlocking values of commercial real estate across India and allow investors widespread participation in the same, nonetheless in our view, the threshold of minimum 200 investors should have been, in future at-least should be lower to 100 or lesser, considering a potential small or medium sizes of such SM REITs.

Recently, one of a fractional ownership platform, has received the SM REIT license from SEBI, which may become the 1^st SM REIT of India. There are many more in the pipeline.

Watch this space for more as we continue tracking further developments on SM REITs…