Propsharing and fractional real estate investment

Propsharing and fractional real estate investment

April 19, 2022
Financial Markets Bulletin

5 minute Lily

Insight

Private equity real estate funds and real estate investment trusts or “REITs” have long been the preferred investment vehicles for North American portfolios of many real estate assets. Recently, a new investment vehicle has appeared on the market; “propsharing”, online platforms allowing investors, particularly individuals, to access fractional ownership of individual real estate assets. Condominiums are subject to low minimum investment thresholds, making them particularly attractive to Gen Z and Millennials, who are vastly overpriced in the booming Canadian real estate market. There is also a sense of unity and community associated with accessory sharing, widely evident on the websites and marketing materials of accessory sharing companies. Propsharing and fractionated represent another example of the booming PropTech sector in Canada. To learn more about PropTech, see our three-part series – Part 1, Part 2, Part 3.

Opportunity

What opportunities do propsharing and fractional real estate investment represent? For small- and mid-cap fund managers and private equity, the opportunity to bring tried and tested real assets to market in a sleek, marketable new package. For retail investors, a low financial barrier to an investment product that may not otherwise be available, the ability to select each investment property instead of investing in a pre-selected portfolio of properties, and a sense of community online direct investment.

Structure

While investors in private equity and real estate funds and REITs participate in an underlying portfolio of properties, investors in propsharing companies select the asset(s) they wish to purchase and acquire shares directly in each ownership instead of having a stake in a portfolio of multiple assets. Unlike REITs which theoretically have an infinite number of units that can be issued to investors, propsharing securities generally have a fixed number of units so that investors know exactly how much of each property they own and will not subsequently be subjected to a dilution. To date, the few Canadian accessory sharing titles on the market are structured as limited partnerships and corporations. Unlike REIT units, interests in these unit sharing entities, whether shares of a corporation or units of a limited partnership, have not been “qualified investments”. » for registered plans, including RRSPs and TFSAs under the income tax law. To learn more about REITs, see our article Practical Considerations for Structuring Private REITs.

Although propsharing is very different from private equity real estate funds and REITs, many characteristics of its predecessors remain. Management identifies assets to be purchased, facilitates acquisitions, and manages assets once acquired (although it is worth noting that there are propsharing entities in the United States that allow investors to select assets). For its role, management receives fees such as acquisition, asset management and disposal.

Crowdfunding Prospectus Exemption and Dealer Requirements

Since one of the main elements of car sharing is to raise capital from a large number of investors, the Canadian securities regulators consider this activity to be a trade and, therefore, the securities of the entities shares must be distributed through a registered securities dealer or an exempt market dealer or otherwise exempt from this requirement. Such registration may be obtained by the Accessory Sharing Entity itself or the Accessory Sharing Entity may retain the services of a duly registered third party reseller.

In order to distribute securities, private REITs generally rely on the “accredited investor” and “offering memorandum” prospectus exemptions under National Instrument 45-106. Prospectus Exemptions (“Regulation 45-106”) and private equity funds generally rely on the “private issuer” prospectus exemption under NI 45-106. Although propsharing entities distribute securities under the “accredited investor” and “offering memorandum” prospectus exemptions, the model is also a natural fit for the rarely used seed crowdfunding prospectus exemption (the “prospectus exemption »Crowdfunding exemption“) and the exemption from the dealer registration requirement (the “Dealer Exemption”) for portals facilitating online distributions by issuers relying on the crowdfunding exemption under NI 45-110 Startup Crowdfunding Registration and Prospectus Exemptions (“Regulation 45-110”).

Prior to the implementation of NI 45-110 in June 2021, the previous framework of crowdfunding prospectus exemptions available to issuers through provincial blanket orders was rarely used. First, the amount of capital that issuers could raise was minimal, both per individual investor and on an aggregate basis. Second, the costs associated with raising capital (including creating or accessing a registered portal, brokerage fees, and legal fees) were high relative to the amount of capital issuers could raise.

Propsharing, Crowdfunding Exemption and Dealer Exemption are however well suited. First, propsharing capital raising targets a large number of community investors looking to invest, on average, small amounts of capital in a single asset. Under NI 45-110, issuers can raise up to $1.5 million over a 12-month period provided certain NI 45-110 criteria are met. Investors may invest a maximum of $2,500 per distribution or up to $10,000 if the investor is advised by a registered dealer that the investment is suitable. Second, a core element of fractional real estate investing is that it is facilitated by an online platform. Unlike other businesses with physical infrastructure simply looking to access an online capital raising portal, propsharing is essentially a portal. Its target demographic is tech-savvy investors demanding an online user interface that is simple and accessible. Second, although creating an online investment portal is high upfront cost, once implemented, it provides an established capital raising framework to leverage for subsequent funding at a low cost per subscriber. Third, from a purely marketing point of view, propsharing and crowdfunding are young, fresh and innovative. Both capture media headlines and investor attention.

It is important to note that issuers relying on the crowdfunding exemption may also use traditional prospectus exemptions (accredited investor and offering memorandum, for example) to raise capital above the $1.5 million cap. dollars/12 months under the crowdfunding exemption and can work with registered securities dealers. as well as exempt market brokers outside the portals to raise capital. As a result, issuers can view the Crowdfunding Exemption either as a genuine opportunity to raise a small amount of capital on a project-by-project basis, or as a complementary marketing element to raising capital on a larger scale.

Tokenized Fractional Real Estate Investment?

In addition to traditional representations of equity interests in the form of shares of a company or units of a limited partnership, ownership sharing entities may instead issue virtual tokens using blockchain technology to represent participations. In the split real estate investment token model, the virtual tokens are backed by the value of the underlying real estate asset and the earnings are distributed to the digital wallet containing the virtual token. Virtual tokens can provide increased liquidity to investors as they can be traded between peers, provided they comply with applicable Canadian securities laws. While there have been many token offerings of propsharing products in the United States, such offerings are in their infancy in Canada, although there is an existing infrastructure for such offerings, including properly recorded.

If you have any questions regarding structuring a Canadian co-sharing entity, raising capital or listing brokers, members of McMillan’s Capital Markets Group will be happy to assist you.

by Alex Bruvels and Jeffrey Gebert

Caution

The above provides an overview only and does not constitute legal advice. Readers are cautioned not to make any decisions based solely on this material. Rather, specific legal advice should be obtained.

© McMillan LLP 2022