By Vishes Kothari (vishes@vinodkothri.com)

Real estate suffers from the paradox of being a much sought after mode of investment which is at the same time illiquid, has high investment threshold and is difficult to adminster and manage. However technology can provide newer and more efficient ways of investing smaller amounts into co-ownership of property.

Property sharing is a concept which has caught in various developed economies and is now beginning to gain traction in Indian markets. The startup sets up a portal where individuals can get together to buy a property, enjoy the rentals it generates and finally be able to sell their share when they want, thus enjoying capital gains. The management of the property has to be done by the startup itself.

Various models can be constructed to devise a method whereby a group of individuals collectively owns a property, divides the rental revenues among its members and nominates a single entity to manage and adminster the property on it’s behalf.

Of course, there already are vehicles which have been envisaged for shared property investment- namely Real Estate Investment Trusts (REITs). However REITs are suited towards large scale investments in commercial real estate.. REITs must be publicly listed.The minimum issue size for a REIT is 500 crores. Thus REITs are not suitable for shared investment in say, a small office or a 2 BHK. Hence a business model using an alternative instrument must be devised.

What must be the features of such a business model?

The nomination of another entity to manage and adminster the property is a sensitive issue legally. The model must be so devised that only the management and adminstration of the property is handed over to the entity. The moment the management of moneys is handed over to the entity and/or a certain rate of return on this money is promised, it would classify as investment activity. Any such entity which is taking on investment activity on behalf of others would fall under the regulatory purview of SEBI and would require prior registration as Alternative Investment Fund (AIF) or a Collective Investment Scheme (CIS).  These are defined by SEBI as follows:

“Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.”

“Any scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised with a view to receive profits, income, produce or property, and is managed on behalf of the investors is a CIS.“

Thus the three critical features of an AIF are: (a) pooling of money; (b) entrustment of money to someone such that the investors are not the ones who are managing their own money; and (c) Contribution by investors with a view to receive profits[1].  A CIS is, in addition, publicly offered.

A possible business model could be as follows:

• A particular property is listed, say for, Rs. 1 crore on a portal.
• 10 buyers are required, each paying Rs. 10 lakh.
• Once 10 such buyers indicate their willingness to invest on the portal, they together form an LLP/ Company with each buyer holding equal stake/partnership interest in the entity. Let us call this entity E. The incorporation process has to be facilitated by the portal itself.
• E now acquires the property.
• E must hand over the management and administration of the property to the portal, via, say a Power of Attorney arrangement.
• The portal now manages the property on behalf of E, rentals flow upstream to E and are divided equally among its stakeholders.
• If at any point of time any of the stakeholders wishes to sell his stake and is able to find a potential buyer for his stake at a mutually agreeable price; then the equity/partnership interest gets transferred to the new buyer.

The questions arises- does the portal fall under the definition of an AIF/CIS ? We now analyse each of the 3 conditions to qualify as an AIF separately:

1. Pooling of Money:  AIF involves pooling of money by the investors for a particular property collectively owned by the investors themselves. In the present situation, entity E owns the property, while the Portal manages/administers the property. Hence the Portal does not hold the funds itself during any part of the process.
2. Distancing of ownership and management of the funds: The Portal is being appointed with the sole intention of managing the apartments in the interests of the shareholders of the entity E, and is not involved with the making of any investment decisions or administration of investor funds. The investment decision has already been made by the owners when they decide to invest in the property.
3. No guaranteed profit or rate of return: There is no guaranteed profit or rate of return. Revenues come from rentals as well as from sale of apartments. Both these revenue streams are market dependent and the portal will not make any promise or advertisement concerning rates of return.

Thus the portal is not going to fall under the definition of an AIF. While the portal is a publicly accessible website, since at no point does the portal take control of the funds, it would not qualify as a CIS.

The notion that property ownership can flow from holding equity/partnership interest in a company/LLP finds validation in the Hill Properties Ltd vs Union Bank of India (1975) ruling pronounced by the Supreme Court, if the Articles of Association of the Company provide for this. Moreover, this right can be sold, hypothecated or mortgaged. Thus, it follows that owners of equity/partnership interest in the Company/LLP will become fractional owners of the property. Moreover they can resell their share, hypothecate it or mortgage it.

Stamp duty Issues

1. Stamp duty is applicable when the property is bought by E.
2. If the property owners’ interest is regarded as fractional ownership interest in the property, then the fractional interest itself amounts to immovable property. Note that the definition of immovable property as given in Stamp Act includes any interest in immovable property as well. On the contrary, if E is a body corporate, and the fractional owner is transferring the shares/ownership interest in the body corporate, there is no question of any stamp duty as applicable to immovable property. At best the stamp duty applicable on sale of shares/ownership interest may be applicable, which also may be avoided if the shares are in demat format.
3. Should the entity E decide to sell the property in its entirety, then stamp duty will be applicable.