OWNING A SLICE OF THE PIE: TOKENIZED LAND & FRACTIONAL OWNERSHIP RIGHTS
Introduction
Real estate has traditionally been a high-value, illiquid asset accessible to major investors and institutions. Historically, investment in A-grade commercial buildings in India was limited to rich or large-scale institutional investors due to high capital requirements and extensive management requirements. However, the introduction of fractional ownership and tokenisation has made real estate investing more accessible to smaller investors.[1] Fractional ownership allows multiple individuals to co-own a property, whereas tokenisation allows for the digital representation of each of these ownership interests on a blockchain. By bringing together various investors, these investment platforms enable individuals to participate in sections of commercial buildings, making them less capital intensive and more accessible to a wider audience. Furthermore, these systems make it easier to manage all compliance-related work and renters, which may be a time-consuming procedure for commercial property owners. This extra benefit simplifies ownership while also increasing the possibility for earning with convenience. Investors may now invest in commercial real estate with more confidence and convenience thanks to increased transparency. Although this innovative concept makes real estate investing more accessible, it also poses significant legal issues with property ownership, securities regulation, taxation, and dispute resolution
Legal & Structural Dynamics of Fractional Ownership in Real Estate tokenisation
Fractional investment or ownership of real estate through FOPs (Fractional Ownership Platform) is an investing strategy in which the cost of acquisition of real estate is split among several investors, who invest in securities issued by FOP.[2] Each investor owns a piece of the title and is entitled to a proportional share of any money gained as well as proportionate responsibility for costs. In a fractional ownership structure, the property is divided into smaller fractions or shares. Each share indicates a percentage of ownership, and investors may acquire one or more shares. A management firm or homeowners’ association manages the property, ensuring that it runs smoothly and is properly maintained. The token issued by such FOPs/SPVs/Trusts in form of corporations/firm/associations evidences the fractional share in the land which act as a asset underlying the tokens. This land acts a security under these tokens, which used to be the major fear & drawback that digital tokens lack security underlying them. Fractional ownership is often used in condos and cooperatives, giving investors access to high-value urban assets. In co-ops, investors hold shares in the corporation that owns the property, but in condominiums, they own a percentage of the physical property. In the former form, it’s the form of security as Shares of a company described under Securities Contracts (Regulation) Act, 1956, but in the later form, its quite difficult to give it a form & legal structure of a Security under the act, which makes it a huge risk for investors’ security & legal checks on it.
Thus, FOPs enable investors to own a percentage or fractional share of a real estate asset through the securities issued by the FOP. In the case of Fractional ownership neither any fractional owner becomes sole owner of the land; nor would they be co-owners. Each token holder is sole owner of a separate fraction of interest in the land. Each owner of a share in property has, in jurisprudence of property law, an interest in every infinitely small part of the subject-matter, and each has the right, regardless of his share of his interest, to possess every part and parcel of the property jointly with others. Fraction of a property is 100 percent share for an owner to the extent of her fraction. Thus, devoiding the complete owner of land from absolute & complete ownership rights of land. When a property is owned by more than one individual, no one of those individuals can be claimed to be the owner. In this circumstance, no one can sell the entire property on his own. The property can be sold after every fractional owner’s consent, but it remains owned by several owners, a distinction from absolute ownership.
SEBI’s Intervention in Tokenised Fractional Ownership & related concerns
Now there are several owners of the same property. The likelihood of fraud increases with tokenised fractional ownership arrangements, especially when due diligence is missing. Without strict regulatory controls and extensive background checks, tokenisation platforms may expose investors to unscrupulous schemes. In order to protect interests of investors’, the Securities and Exchange Board of India (SEBI) made a critical step in its 203rd board meeting on November 25, 2023, by approving the establishment of a regulatory structure managing fractional ownership of real estate assets. The SEBI has recommended changes to the Real Estate Investment Trust (REIT) Regulations 2014, allowing Fractional Ownership Platforms (FOPs) to be registered and listed under the Micro, Small, and Medium (MSM REITs) category of REIT in its Consultation paper released on May 12, 2023.
In layman’s terms, REITs are trusts or enterprises that purchase real estate or mortgages. The changes allow REITs with assets of at least 50 crores to create mechanisms for real estate asset ownership via Special Purpose Vehicles (SPVs) created as enterprises.[3] This move aims to provide investor safety measures and support orderly expansion in the real estate sector and market, as proposed in a Consultation Paper. Not only REITs, but certain FOPs may function like that of CIS (Collective Investment Scheme). And the units issued by REIT or CIS are securities under Section 2(h)[4] of SCRA & thus, digital tokens issued by such trust evidencing fractional ownership in holders can be categorised as securities as under Sec 2(h)(ida)[5] as units of REITs & Sec 2(h)(iii)[6] as rights & interests in form of fractional ownership of land attached to units of REITs. Not only this, if tokens satisfy Howey test as laid down in S.E.C v. Howey[7] & Paramount Bio-Tech Industries Ltd. v. Union of India[8] then such tokens can be categorised as investment contract because the 4-Steps test largely mirrors to characteristics of a REIT, i.e, to pool a corpus of money from investors, investors expecting a return of profits & investors having no direct control or management of corporation. Once they are categorised as Security then SEBI has direct control under Sec 11[9], 11AA[10] & 12[11] of SEBI Act 1992 r/w Sec 24[12] of Companies Act, 2013 to govern such platforms & SPVs & impose its regulations & penalties on them in case of violations. Thereby, protecting investors rights & interests. But, legal acceptance of digital tokens as a valid form of ownership interest is still evolving & the current status that these are not categorised as Securities, leading to exploitation & violation of investors’ rights as they don’t have any enforceable rights for their any violations.
Further, another complication is the involvement SPVs, often private limited companies, in fractional ownership, which may violate regulations under the Companies Act, 2013, by engaging in Deemed Public Issues without proper prospectus filing and registration with SEBI. The FOP’s fractional ownership of real estate does not prima facie require uniform & mandatory necessary disclosures, potentially leading to financial losses for investors. This might be due to incorrect information, the sale of real estate assets/securities by SPVs without correct valuation awareness, or other circumstances. The method of purchasing or acquiring real estate is ambiguous, and when there is no mandated independent review procedure. The proposed amendment seeks to minimise complexity, protect investors from misselling, and create a comprehensive regulatory process for grievance redressal. FOPs, despite functioning as real estate agents or property managers, do not get registered as real estate agents under the Real Estate (Regulation and Development) Act of 2016. This may lead to the deemed public issuance of securities, breaching the maximum shareholder limit as per the Companies Act, 2013 (200 shareholders). Additionally, FOPs lack an exit mechanism, KYC compliance with PMLA, and lack transparency & disclosures, potentially leading to investor losses due to mis-selling.
Legal Complexities in ownership rights of tokenised fractional ownership
Most legal systems currently recognise co-ownership or joint ownership of real estate. In this regard, fractional ownership is not a revolutionary notion. However, when ownership is represented digitally through tokens, additional legal issues arise, notably in terms of ownership registration, transferability, and enforcement of rights. It was held by apex court[13] that it is incorrect to claim that a co-owner of a property is not the owner. He owns all of the composite property alongside others, and he cannot be described as a part-owner or a fractional owner of the property. Thus, it can be inferred that fractional owner is not equivalent to co-ownership, rather it’s below the legal status of co-ownership. Co-owners share equal rights in the property, but this is not the case with fractional ownership. Hence, in fractional ownership, the rights associated with absolute ownership, aren’t vested with fractional ownership. The fractional ownership rights acquired through this token are proportional to their token holdings. So, the rights that will come with this ownership would be very similar to that of beneficiary ownership & partial ownership. Generally, the rights would be encompassing to share in rental income generated by the property, receiving gains out of property & having voting rights on property related issues like selling or managing the property. And any further sale of property must be valid only if informed free consent would be sought from all fractional shares because now the complete ownership of property is being divided into fractions.
The simple rule in transfer of property is ‘Nemo dat quad non habet’[14] i.e, no one can transfer what he doesn’t have. So, the then complete owner of property is devoid of his absolute ownership & hence, he can’t transfer what he doesn’t own absolutely. Tokenised ownership enables simpler transfer and liquidity because tokens can be purchased and sold on exchanges. However, legal systems have to recognise these token transfers as comparable with traditional property conveyance, ensuring that ownership changes are properly recorded. The ownership of fractional shares varies from traditional real estate ownership. While tokens may signify ownership of a property, they provide fewer rights than complete ownership. Not only that, but protecting their rights successfully against fraud or unauthorised activities is complicated and unclear.
Challenges in Current & Proposed regulations for tokenised fractional ownership
SEBI’s proposed reforms, which require FOPs to register as MSM REITs and comply with KYC rules, aim to reduce the possibility of money laundering and financial malfeasance. However, industry concerns regarding the viability of these measures, notably the restriction on debt raising and the eligibility requirements for sponsors, indicate that SEBI’s framework may need to be refined to ensure it does not hinder innovation within the sector. One noteworthy advantage of tokenisation and fractional ownership structures is the increased liquidity provided by digital platforms. However, SEBI’s plan restricts exit options to stock exchanges or specific situations such as change of control or inability to fulfil qualifying requirements. Tightening these exit alternatives may alienate individual investors who want the liquidity benefits of fractional ownership. However, there are also questions about how dispute resolution systems would work in the setting of tokenised ownership. Legal systems must evolve to guarantee that token transfers and ownership issues may be properly addressed, especially in cross-border transactions. As digital tokens become more widely used to represent ownership, courts may need to address how blockchain-based ownership records are recognised and enforced under traditional property laws as in Indian Jurisdiction, the land registry records & verifies the ownership records but keeping the track of fractional ownership through smart contracts coded in blockchain is way too difficult & makes process of title verification & due diligence difficult as it makes the requirement of public availability of fractional land records impossible.
Conclusion
According to a recent JLL report, the Indian fractional ownership market is expected to grow significantly, perhaps reaching over $5 billion in AUM by 2030. This estimate emphasises the sector’s strong growth and the positive outlook for SM REITs.[15] As the market matures, regulatory monitoring is expected to increase its appeal by providing levels of protection and transparency. Fractional ownership of commercial real estate is becoming a popular investment strategy. With the advent of SM REITs, this sector will become more organised and accessible, creating significant prospects for investors. However, SEBI needs to find a balance between regulation and innovation. While formalising FOPs under the MSM REIT framework is a significant move, the regulator must ensure that the compliance overhead does not limit the flexibility and accessibility that have made fractional ownership platforms so appealing to smaller investors. A sophisticated regulatory strategy that protects investors while encouraging innovation will be critical to this sector’s long-term success.
Author: Priyanshi Jain, Student at Dharmashastra National Law University, in case of any queries please contact/write back to us at support@ipandlegalfilings.com or IP & Legal Filing
References
- Securities Contract Regulation Act, 1956, No. 42, Acts of Parliament, 1956 (India).
- The Securities and Exchange Board of India Act, 1992 (As amended by the Securities Laws (Amendment) Act, 2014), No. 15, Acts of Parliament, 1992 (India).
- The Companies Act, 2013, § 24, No. 18, Acts of Parliament, 2013 (India).
- Transfer of Property Act, 1882, No. 4, Acts of Parliament, 1882 (India).
- Mulla, The Transfer of Property Act, 232 (Poonam Pradhan Saxena, Lexis-Nexis, 13rd ed. 2019).
- SEBI Consultation Paper, Regulatory Framework for Micro, Small & Medium REITs (MSM REITs), May 2023.
- PJ Fitzgerald, Salmond on Jurisprudence, (Sweet & Maxwell 12th Edition, South Asian Edition, 2021).
- Aniruddha Ghosh, Fractional Ownership: Recommendations for Regulation, IndiaCorpLaw Blog (July 22, 2021), available at https://indiacorplaw.in/2021/07/fractional-ownership-recommendations-for-regulation.html
- Nidhi Sinha, Real Estate: How Fractional Ownership Is Redefining the Rules of Investing for Small Investors, LiveMint (Mar. 20, 2021), available at https://www.livemint.com/money/personal-finance/real-estate-how-fractional-ownership-is-redefining-the-rules-of-investing-for-small-investors-11714721825502.html
- ET Wealth, How to Safely Invest in Real Estate via Fractional Ownership Platforms, The Economic Times (Dec. 15, 2023), available at https://economictimes.indiatimes.com/wealth/invest/how-to-safely-invest-in-real-estate-via-fractional-ownership-platforms/articleshow/110165523.cms?from=mdr
[1] ET Wealth, How to Safely Invest in Real Estate via Fractional Ownership Platforms, The Economic Times (Dec. 15, 2023), available at https://economictimes.indiatimes.com/wealth/invest/how-to-safely-invest-in-real-estate-via-fractional-ownership-platforms/articleshow/110165523.cms?from=mdr
[2] SEBI Consultation Paper, Regulatory Framework for Micro, Small & Medium REITs (MSM REITs), May 2023.
[3] Ibid.
[4] Securities Contract Regulation Act, 1956, § 2(h), No. 42, Acts of Parliament, 1956 (India).
[5] Securities Contract Regulation Act, 1956, § 2(h)(ida), No. 42, Acts of Parliament, 1956 (India).
[6] Securities Contract Regulation Act, 1956, § 2(h)(iii), No. 42, Acts of Parliament, 1956 (India).
[7] S.E.C. v. Howey, (1946) 328 U.S. 293, (Supreme Court of U.S.).
[8] Paramount Bio-Tech Industries Ltd. v. Union of India, (2004) All L.J. 2552.
[9] The Securities and Exchange Board of India Act, 1992 (As amended by the Securities Laws (Amendment) Act, 2014), § 11, No. 15, Acts of Parliament, 1992 (India).
[10] The Securities and Exchange Board of India Act, 1992 (As amended by the Securities Laws (Amendment) Act, 2014), § 11AA, No. 15, Acts of Parliament, 1992 (India).
[11] The Securities and Exchange Board of India Act, 1992 (As amended by the Securities Laws (Amendment) Act, 2014), § 12, No. 15, Acts of Parliament, 1992 (India).
[12] The Companies Act, 2013, § 24, No. 18, Acts of Parliament, 2013 (India).
[13] Ramdas v. Sitabai, JT 2009 (8) SC 224.
[14] Transfer of Property Act, 1882, § 54, No. 4, Acts of Parliament, 1882 (India).
[15] Nidhi Sinha, Real Estate: How Fractional Ownership Is Redefining the Rules of Investing for Small Investors, LiveMint (Mar. 20, 2021), available at https://www.livemint.com/money/personal-finance/real-estate-how-fractional-ownership-is-redefining-the-rules-of-investing-for-small-investors-11714721825502.html
