How Small And Medium REITs (SMREIT) Are Transforming The Indian REITs?

SEBI's new regulations for Small and Medium REITs (SMREITs) opened fractional ownership (FOP) of yield-based real estate assets to a broader pool of retail investors, which is helping democratize investments in Indian real estate. The new norms are gradually driving the landscape to become more inclusive, as they are aimed to offer existing Fractional Ownership investors increased protection and liquidity in the public marketplace.

According to projections by ICRA, this reform is helping unlock real estate monetization opportunities valued between Rs.67,000 and Rs.71,000 crore, allowing the broader investor segment to capitalize on the sector's untapped potential through fractional ownership. Notably, approximately 530 lakh square feet of office spaces in the top 7 cities qualify for listing under SM REITs, and rent-earning residential properties are being increasingly included, increasing the choices and attractiveness of co-living spaces.

The new norms have already prompted a shift within the investment space, as seen by several platforms such as Strata, Propshare, and Asset Monk's decision to move their existing FOP portfolios into SMREITs, which is creating avenues for retail investors to directly participate in the real estate's growth. SEBI's move to establish uniform guidelines backed by the following traits, scope, and features of SMREIT is expected to continue garnering the retail investors' interest, driving significant momentum in the Indian REIT space.

Transparency in Structure

SMREITs are structured as Trusts managed by Trustees, an Investment Manager (IM), and Special Purpose Vehicle(s) (SPVs) that hold the assets. This clear setup is helping assure transparency and a sense of governance among unit-holders, installing more confidence among investors.

Notably, shares of the SPVs are owned by the Trust and are converted into Saleable Units. The IM plays a vital role in the creation and overall management of the SMREIT and is required to hold a minimum of 5% (Un-leveraged) or 15% (leveraged) of the total units issued by the scheme. They must also maintain a minimum net worth of Rs.20 crores. While there is no cap on the fees for the IM, they are prohibited from earning performance-based fees or carrying interest.

Additionally, there are mandatory holding requirements for units issued under the scheme, with specific lock-in periods. However, norms for IMs to hold a substantial stake and maintain a minimum net worth are emerging as barriers, limiting the scope for more SMREITs.

Notably, at least 200 individuals shall invest in an SMREIT scheme, given none are related to the Investment manager, and not more than 25% of a scheme can be held by a single investor. Any income-earning assets of the value of Rs.50 crores to Rs.499 crores qualify for coming under SMREITs. These aspects are playing a key role in democratizing the SMREIT structure.

Multi-pool Asset for Stabilized Returns

SMREITs feature a multi-pool asset structure, akin to mutual funds. One SMREIT can open multiple Schemes of with a minimum of Rs.50 crores and a ceiling of Rs.499 crores each. This trait helps stabilize returns on investment and prompts growth through multiple Schemes and through the inherent value increase of the invested assets.

Since the minimum unit size in SMREIT is Rs.10 lakhs, it is a deterrent for Investors compared to low Unit size in investing in REITs. Lowering the Unit size will make SMREITs more inclusive and will enable many retail investors to own a fraction of Grade A property in prime locations such as Whitefield Bengaluru, Bandra Kurla Complex, Mumbai or Golf Course Road in Gurugram, allowing them to generate earnings in the form of rent income or capital appreciation.

Liquid Investment Schemes and SPV Ownership

Investment Managers can raise funds in SMREITs by issuing units and leveraging at the scheme or SPV level, with a leverage cap of 49% of the scheme assets. Each scheme must represent one or more assets of at least Rs.50 crores in value, held within a single or multiple SPVs. Also, SMREITs can invest a minimum of 95% of the funds mobilized by a scheme in fully developed, revenue-generating assets, with the remainder in liquid assets and deposits. This trait ensures stability and helps generate a steady income stream for investors, offering them more liquidity than direct investments in real estate.

Besides these, reliefs for existing FOPs to transition into SMREITs, including exemptions from the minimum unit holding requirements and asset size regulations are enabling investors who previously could not get sufficient liquidity to get more liquidity in Units. Similarly, smaller real estate portfolios are now being included in SMREIT, making them accessible to investors.

Wrapping up

The introduction of SMREITs has prompted a significant innovation in the REIT sector that has broadened the real estate investment opportunities for retail investors. However, reforms to lower the minimum unit value and simplify the net worth and lock-in requirements for Investment managers could help ensure the long-term success, growth and accessibility of Indian SMREITs.