Fractional Ownership: Overview

Fractional ownership is the new buzzword in the real estate market. Fractional ownership is nothing but owning a piece (‘strata’) of a larger real asset. The concept of strata selling has existed for several decades. Proprietors and owners of micro, small and medium enterprises, and mom and pop retailers have traditionally bought offices, retail shops, and warehouses for running their businesses or to build annuity.
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Let us explain fractional ownership with a simple example- one of the largest real estate developers in India builds a 3 million (30 lac) sq ft IT park in Bangalore. The developer decides to sell 2 million (20 lac) sq ft to individual buyers, and thus demarcates 1000 units of 2000 sq ft each. A buyer has an option to buy one or more units in multiples of 2000 sq ft. Priced at INR 6000/sq ft, a buyer can own a piece of the IT park with just INR 12 million (INR 1.2 Cr). The benefit of fractional ownership is that a buyer gets access to a top quality asset with a smaller investment that, otherwise, would have been accessible to HNIs/UHNIs and institutional investors only.
A top quality asset is likely to attract more creditworthy tenants and command better lease terms. The developer may keep the leasing and maintenance rights which essentially makes fractional ownership a passive income generation strategy. Otherwise, the tenancy risk (finding and closing a lease with a tenant) has to be borne by the buyer. In this case, the developer would have the leasing rights and expect to touch INR 40/sq ft in rentals for a bare shell unit, exclusive of maintenance and car parking charges. A back of the envelope calculation suggests a rental yield of 8% before adjustment for occupancy. With yields of more preferred safe investment vehicles such as government treasury and bank deposits on a continuous decline, an increasing number of investors are evaluating fractional ownership options in search for higher yields.
Fractional ownership has its cons as well. An increasing number of corporate tenants, especially global companies, prefer leasing from single owners as doing so mitigates chances of disputes among landlords, and between one or more landlords and the tenants. In the above case, a corporate tenant that leases 200,000 sq ft (say) will probably have 10-100 landlords. As a consequence, the replacement risk in a strata sold property becomes very high.  It also becomes tougher to find an exit (sell the piece) compared to a standalone asset for the aforementioned reason.
From the supply side, with REITs coming into play, top developers are looking to hold assets to go public. Consequently, the availability of legally constructed, good quality properties (Grade A/A- properties that command good lease terms) from top developers is going to be flat or decline.
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