Fractional Ownership Vs REIT

Investing in commercial real estate is lucrative and rewarding. Between REITs and fractional ownership, which should you choose and why?

Sep 10, 2020 4 min read
Photo by Swapnil Potdar on Unsplash

When speaking of Commercial Real Estate as an investment option, the more commonly heard term might be REIT, for those who do not want to buy a property outright and become the landlord. The lesser-known, but fast-evolving fractional ownership might sound alien, but it comes with its own batch of advantages. To begin with, let us first try to understand why real estate should be looked at as a viable investment option and why commercial real estate is the better sibling you should pick.

Real Estate Investment – Commercial vs Residential

Real estate is much more than your house and your office. Commercial and residential estates are different on a lot more aspects than your 8-hour shift. Residential real estate can include houses, flats, villas, condos, cottages, and the like. Such places come normally with an annual rental contract if you do not own them. These are places people live in. Commercial real estate involves places of work, shopping, entertainment, leisure, et al. Offices, warehouses, parking lots, malls, industrial floors, SEZs belong to this category. Very few commercial properties will be owned by an individual. They are mostly offered out on lease periods that can be 5-15 years long.

Compared to residential real estate, commercial real estate has stricter terms of lease and tenant agreement. Details of maintenance, upkeep, power consumption, and many other factors form the crux of the agreement. Considering all this, investment in commercial real estate is handled by companies, rather than individuals. One can invest in CRE via REITs or fractional ownership since a single CRE asset might be unaffordable for the general investor. Now let us look at what these options are, and which one is a better choice for you.

REIT – Real Estate Investment Trust

If you understand mutual funds, REIT will be a piece of cake for you. It is a real estate company that operates on principles like a mutual fund. Mutual funds pool money from many investors to purchase financial securities like government bonds, direct equity, stocks, et al. REITs pool money from many investors to invest in income-generating real estate properties. These properties are mainly occupied by businesses and companies through lease agreements. The investment returns paid to the investor come from the monthly rents and the interest on the security deposit paid by the tenant. However, the investor cannot control where his money is being used, just like in a mutual fund. You can choose the basket of goodies, but not pick the only candy you want to eat.

Fractional Ownership

The way the fractional ownership model works is a bit different. An asset or a CRE property is listed or advertised to be open for investment. Based on the total investment required, a minimum ticket size is allocated as a portion of the property. Your investment can be in multiples of the same ticket size. Based on your investment amount, you legally own a percentage of the property. Based on the percentage of ownership, your returns are a mix of monthly rentals and interest on the security deposit paid by the tenants.

Fractional Ownership vs REITs

There are aspects in which fractional ownership is different and better than REITs. They are mentioned in the following table –

Fractional OwnershipREIT
Access & TransparencyComplete democracy of the asset based on investor’s choiceNo freedom of choice regarding asset selection
DiversificationChoose to invest across multiple assets over different times, locations and needsOne portfolio that has a set number of assets
Transference of OwnershipFreedom to sell your ownership of the asset portion to interested partiesNon-transferrable and can’t be sold
Property TypeAssets can be upcoming or under construction, so no fear of missing outAt least 80% of the assets should be completed and must be revenue-generating properties
Investment ConstraintsIt is self-regulated, enabling expansion of the investment structures for investor requirements from balanced to income-generating assetsA highly regulated trust fund which limits the expansion of innovative growth models
Asset RequirementNo minimum value that a property has to meet. Instead, the property is selected post rigorous due diligence and after ascertaining the returns A minimum asset requirement of INR 500 Cr makes REIT’s offerings limited w.r.t the number of properties that it can undertake
Division of FundsA continuous pipeline of prime properties are offered giving multiple options to investors to investIt can invest in at least 2 projects with not more than 60% of the value of assets invested in one project
Cash Flow DistributionA complete distribution of distributable cash flows, which is calculated post deducting statutory fees and taxes along with the asset management feesMust distribute not less than 90% of the net distributable cash flows, subject to applicable laws, to its investors
Valuation IntervalsContinuous monitoring of valuation of properties through data analyticsFull valuation to be carried out at least once a year and half-yearly updates to the same have to be carried out

Investment in anything carries risk. However, CRE is much more insulated from market fluctuations and volatility. This makes CRE investment a wise choice to make if you are interested in a stable source of returns. Fractional ownership gives you all the benefits of REITs and more. If you wish to know more about fractional ownership and how it can benefit your investment portfolio, please visit