Fractional investment in commercial property is a low-risk option

Do Due Diligence

Fractional investment in commercial real estate (CRE) stands out as a lower-risk option, primarily due to the tangible nature of the underlying assets backing the investment. The overall returns in CRE investments result from two key factors: rental yields and capital appreciation. While capital appreciation only materialises during exit, the rental returns provide periodic income, increasing annually based on lease agreements. While, the CRE investments might seem like a no-brainer choice, it's the process of due diligence that separates wise investments from potential pitfalls. 

The process of conducting a comprehensive investigation and analysis of a property before finalising a purchase not only helps evaluate risks and rewards but also ensures that all aspects of the property align with an investor's goals and financial capabilities. Essentially, due diligence empowers investors to take informed decisions, mitigating potential risks and maximising returns. However, there are several key considerations that must be taken into account before committing to fractional CRE investments. 

Prior to investment, a property should undergo a proper legal due diligence by a reputed lawyer, ensuring clear and marketable title. A freehold asset with no encumbrances is ideal for investment. A comprehensive assessment must include title flow, encumbrance checks, and statutory clearances. All relevant documentation, such as property titles, permits, leases, and financial statements, should be thoroughly examined.

Understanding the growth potential of an investment property, in terms of capital appreciation and rental cash flows, is contingent on micro-market analysis. Economic activity and geopolitical conditions in the location and surrounding areas significantly influence growth potential. A stable geopolitical scenario and healthy economic growth contribute to a property's appeal. Thoroughly evaluating the rental market, rental rates, and potential cash flow is vital for assessing income potential.

Evaluating a tenant's financial stability and longevity is critical. A reliable way to assess this is by reviewing their financial track record and nature of business. Additionally, indicators such as talent availability and financial institutions willing to grant loans based on rental cash flows can offer valuable insights. 

The conservative valuation of an asset is crucial. Most fractional CRE investments are valued based on rental yields (capital rates). However, a more objective method involves assessing the balance between demand and supply or valuing the asset based on land and building value minus depreciation. Ensuring alignment between technical and capital rate valuations is crucial for investors. While the latter is a utopian situation for an investor, getting an asset at these rates is tough, as the developer has slogged to produce an asset that provides the safety net of stable long term rental cash-flows to the investors. One needs to monitor that there's no huge gap between the technical and cap rate valuation. A thorough assessment ensures that the purchase price aligns with the property's actual worth, providing a solid foundation for future returns.

Going ahead the fractional CRE investment presents an enticing opportunity for investors seeking lower risk and reliable returns. The tangible assets and consistent rental yields make it an attractive choice too. However, the linchpin to successful investments lies in meticulous scrutiny and due diligence at every step to ensure both security and profitability. By attentively considering these critical factors, investors can make informed decisions, unlocking the potential of commercial real estate while mitigating risks.

This asset class is further expected to gain prominence with the Securities and Exchange Board of India (SEBI) introducing a proposed regulation for fractional ownership in real estate, aiming to further democratise and streamline this sector, by the micro, small and medium real estate investment trusts (MSM-REIT) policy.  This development shines a new ray of hope on the fractional real estate landscape, offering exciting prospects for the future. With SEBI’s oversight, governance, and regulations, this avenue will likely see increased retail involvement and long-term wealth creation.

Overall the fractional ownership real estate market is expected to reach $8.9 billion by 2025 in a report by Knight Frank. However as the market matures, we can anticipate additional legal and regulatory guidelines and developments to emerge, all geared towards ensuring investor protection and transparency.

(The writer is Founder & Chief Executive Officer, Assetmonk)