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By enabling strong investor protection, the ratings agency believes, these regulations are expected to broaden investor base. However, prudent management of operational risks remains key to popularising the vehicle.
So far, fractional ownership platforms (FOPs) did not follow uniform guidelines. The SEBI move is intended to address this by bringing existing FOPs under the regulatory ambit.
Some of the key regulatory guardrails are mandatory investments in operational assets, restrictions on related party transactions, compulsory listing on the stock exchange and distribution of minimum 95% surplus from special purpose vehicles.
“The SM REIT regulations should inspire investor confidence by protecting them against two key risks. One, project completion and leasing risks would be mitigated as investments cannot be made in under-construction assets. Two, risk of diversion of funds will reduce due to ring-fencing of cash flows and mandatory distribution of funds on a quarterly basis. Further, the regulations should improve transparency and governance,” said Mohit Makhija, Senior Director, CRISIL Ratings.
Other regulations include the need for at least 200 retail investors that will provide liquidity. Minimum liquidity requirement at the investment manager (IM) level to provide a buffer against temporary mismatches. Further, experience-linked eligibility criteria for the IM will foster strong governance.
“The regulations are more stringent for SM REITs given the smaller ticket size of schemes, higher asset or geographical concentration risks, unlike traditional REITs that tap large-scale investments. Therefore, the IM’s skills in identifying the right properties and operating them professionally will remain critical for the success of SM REITs. Additionally, lean cost structures will be essential to protect investor returns,” said Anand Kulkarni, Director, CRISIL Ratings.
As per CRISIL Ratings' assessment, SM REITs target a distinct and differentiated market as compared to conventional REITs. Schemes under SM REITs can target niche assets ranging from Rs 50 crore to Rs 500 crore which is an untapped opportunity as conventional REITs focus on large scale assets with consolidated asset value over Rs 500 crore.
Investment in SM REITs is similar to the traditional form of ownership of real estate assets, with the difference being pooling investor money for fractional ownership under a trust structure.
SM REITs will float different schemes under a trust, each of which will specify assets to be invested in. Investors can pick schemes that are better aligned with their philosophy of investing in a certain micro-market or asset type.
Each scheme will be ring-fenced from other schemes under the SM REIT. Contrary to this, the conventional REIT structure enables investors to invest in an identified pool of assets, which may be dynamic, depending on the REIT strategy.
According to the ratings agency, the opportunity to invest in niche real estate assets, along with aforesaid investor protection and liquidity mechanisms, should attract a new set of investors and thus, broaden the overall base.
To begin with, the market for SM REITs is likely to see listings and registrations of existing FOPs. Successful listing and acceptance of these instruments by investors will be critical to pave the way for entry of new players. In the milieu, strong regulatory oversight will go a long way in popularising the investment vehicle.
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