Tokenising Real Estate through Fractional ownership: SEBI’s intervention in the Real Estate Project Investment

26th September, 2024 - 7:26 am Categories: RERA 0 Comments

Introduction

Real estate regulation authority came into existence in 2016 with the objective of ensuring regulation and promotion of real estate sector alongside protecting the investors from investing in unsafe projects. Investors had a varied measures to invest in projects such as by Crowd funding wherein the money of various different investors is pooled together and then invested in various different projects, giving investors an opportunity to diversify their investments and the most prevalent investment method is through Real Estate Investment Trust or as Collective Investment Scheme wherein investors who are unit holders pool their money in form of trust and trustee on behalf of investors deals with the assets and also ensures that REIT is complying with all the statutory requirements. In recent past, there has been growth of platforms providing fractional ownership over the investment made in real estate projects through issuance of tokens which evidence the vesting of fractional share in the purchased land.

Blockchain Technology in Real Estate Investment

Blockchain technology is defined as distributed ledger technology which involves blocks that are securely linked together by cryptographic hashes. It stands out as unique from others because of features such as immutability and transparency. Blockchain technology involves data mining & profiling to ensure that the data is updated in form of blocks, which can’t be tempered by any unauthorised person. Tokens were introduced as the outcome of such data deep-mining and profiling, as one of the concerns related to digital currency is that no security is attached with them, so fractional ownership in land for project be considered that security underlying digital tokens but since real estate land & project are underlying assets of such digital tokens, which may address the fear of investors hesitating in investing in such digital tokens.

Historically, real estate project involves the physical assets which can’t be divided because of its nature but with the technological growth around the globe, it has made possible to convert the physical assets into digital assets through tokens wherein several investors particularly retail investors can have fractional ownerships over the real estate projects. To gain the confidence of investors, real estate agents started to gamify real estate through fractional ownership & that too tokenising the fractional ownership, i.e., evidencing fractional ownership through digital tokens generated out of blockchain technology. The rise of fractional ownership platforms or schemes faces a regulatory challenge due to the absence of specific legislation, potentially leaving investors unprotected. Additionally, when tokens are assigned value in form of assets, they may be classified as securities, thus falling under the jurisdiction of the Securities and Exchange Board of India (SEBI) and subjecting them to regulatory oversight.

SEBI’s Consultation paper on Fractional ownership Platforms

In past few years there has been a tremendous growth of platforms offering fractional ownership in real estate assets as showcased by SEBI by releasing Consultation paper in May 2023 on “Regulatory Framework for Micro, Small & Medium REITs”. The SEBI consultation paper explains that fractional ownership platforms allow investors to hold fractional interests in assets, such as real estate or tangible assets. Tokens model of pooling investments, which are then used to finance and manage the projects through which multiple investors can invest in a single project. such tokens also offer transferability and liquidity, allowing investors to buy and sell their fractional interests. Through SEBI’s consultation paper, an amendment was made in the SEBI (Real Estate Investment Trust) Regulations of 2014 in March 2024 to include Investment Trusts (SM REITs Amendment), which effectively allowed fractional ownership in real estate transactions by regulating platforms that offered it. It makes it easier for current structures—Fractional Ownership Platforms—to transition to SM REIT. It requires that units on the SM REITs’ scheme be listed on specific stock exchanges. Only completed, revenue-generating properties may be purchased; undeveloped or non-revenue-generating real estate will not be the subject of investment. Investments to be made only in completed and revenue generating Properties; investments will not be in under-construction or non-revenue generating real estate assets. Prior to amendment, it was unclear whether investors who have acquired fractional ownership in real estate assets be considered as Co-owners of the assets, but SEBI’s amendment has brought an unregulated area into its jurisdiction, providing protection to the investors and more investment opportunities ensuring the regulatory oversight. But now the main legal issue which arises in managing such fractional ownership platforms is whether this fractional ownership over real estate projects & land gives title to investors over such assets. This issue arose because the rights of investors are not sufficiently protected by such fractional ownership platforms. Suppose investors acquire fractional ownership through FOPs issuing tokens on a real estate project & later the land is sold to a third party without taking consent of investors, violates the rights & interests of investors. Such complex matters are still not resolved by the existing laws even after amendments.  Another legal complexity is that many of such FOPs generally get them registered under RERA but after this amendment, they are under the purview of SEBI & hence, they need to get their securities listed under SEBI. But currently there are a few FOPs which didn’t get their Securities like digital tokens under SEBI & are working under veil of RERA registration engaging in fraudulent activities, thus leading to violation of rights of investors. Additionally, investors are unable to exercise due diligence because this developing landscape is altogether new & are not sufficiently addressed by laws.

Tokens as Securities subject to jurisdiction of SEBI

Any Public company which is dealing in Real Estate Transactions in form of tokens has to mandatory comply with the listing requirements as held in the case Sahara India Real Estate Corporation Ltd. v. SEBI (2013)..When we classify any assets as security it must satisfy the Howey Test, a test laid forth by the US Supreme Court in S.E.C. v. Howey that was endorsed by the Allahabad High Court in Paramount Bio-Tech Industries Ltd. v. Union of India to ascertain if a specific transaction qualifies as an investment contract and, thus, as a security. Tokens can be classified as security if it satisfies the Howey Test. There are certain criteria such as the investment of money, expectation of profits from such investment, it has to be part of a common enterprise which means that money is pooled by the investors and lastly The requires profits to be generated primarily from the efforts of a promoter or third party, rather than the investors themselves and if tokens satisfying this element of the test, makes it as a security. Further, the SCRA Act, 1956 defines “securities” as units or other instruments issued by any pooled investment vehicle under Section 2(h) of the Regulation Act, 1956. Tokens grant holders rights and interests in real estate assets, like how GDR holders have rights in underlying shares. Further we must check that Tokens are of marketable nature, they provide rights and interests in underlying security, vesting fractional ownership through Tokens in real estate.

Even after REIT amendment of 2024, it is still unclear that whether fractional ownership is permitted in the present legal landscape or not. A real estate investment in form fractional investment or ownership through FOPs (Fractional Ownership Platform) distributes the cost of real estate acquisition among a number of investors who purchase securities from FOP. Therefore, through the securities that the FOP issues, investors are able to possess a specific percentage or fractional stake in the real estate asset. It is impossible to declare that a single individual is the owner of property when it is owned by multiple people. No one can sell the full property on their own in such a situation. The property can be sold, but it remains owned by several owners, a distinction from absolute ownership. In the case of Fractional ownership neither any fractional owner becomes sole owner of the land; nor would they be co-owners. Each is sole owner of a separate estate or interest in the land. One is the owner of his/her property. Fraction of a property is 100 percent share for an owner to the extent of her fraction.  Each owner of a share in property has the right, regardless of the value of that interest, to own all of the property in joint with others, and each has an infinite small interest in each aspect of the subject matter. This form of ownership entitles them to benefits such as a share in proceeds from any sale and rights under the fractional ownership model.

Conclusion & Way Forward

The emergence of fractional ownership platforms has brought about regulatory hurdles, particularly in terms of categorizing these tokens as securities under the jurisdiction of the Securities and Exchange Board of India (SEBI). SEBI’s latest amendments are intended to oversee these platforms, but there are still notable legal challenges. These tasks involve establishing the scope of ownership rights granted through fractional ownership and safeguarding investors from fraudulent behaviour. As platforms adhere to both RERA and SEBI regulations, the legal environment for fractional ownership in real estate is changing, raising concerns about ownership and the effectiveness of existing laws in protecting investors. Some measures can be implemented to address these issues. SEBI and RERA should work together to create a joint legal framework to make sure that FOPs adhere to both securities and real estate regulations. Every FOP must register with SEBI and adhere to both RERA and SEBI rules. Fractional ownership providers must perform thorough due diligence on the properties they make available for ownership shares. Investors must be able to obtain clear and extensive details regarding the property, such as its legal status, valuation, potential risks, and title disputes. Blockchain technology needs to be employed not just for issuing tokens, but also for upholding a clear, unchangeable record of every transaction, change in ownership, and adherence to regulations. Investors should be educated about the risks and rewards of investing in fractional ownership through tokens via awareness campaigns. Thus, the main motive should be investors protection without creating any hurdles in technological innovation & practices.

Author: Shivam Singh, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.