RERA and the rise of Co - Living and Serviced Apartments : Can Hybrid Hospitality Residential Models fit a sale based statute ?

Introduction : The urban rental market has over the past decade generated a unique hybrid asset class co-living homes and serviced apartment complexes that are a blend of residential architecture and a hotelized business model. Co-living operators rent or own an entire building and rent out furnished apartments under flexible, often monthly, agreements with young professionals and students, including the services of housekeeping, Wi-Fi and community programming. Similar to a bundled stay, serviced apartment operators, often tied to a brand in the hospitality industry, provide a combination of accommodation and services to corporate travellers and medical tourists for a few nights up to several months.

They are usually financed in two ways: through a lease by the operator from the one institutional land owner or through sale of individual units to investors, which then transfer them back to the operator under a lease or management agreement, or on a revenue share basis, with a guaranteed return. It is this second path of an investor that gives rise to the most glaring regulatory query: what is a “real estate project” as per RERA? What are the disclosure, escrow and possession obligations that need to be met by the promoter in such a project as compared to a conventional residential sales project? In this blog, we explore that question, the commercial risk allocation of co-living and serviced apartment structures, the difference between promoters' expectations and statutory protections offered by RERA, and the classification challenges that are easily encountered by promoters, before providing some structuring advice.

Legal Provisions

A. The RERA Framework

According to Section 2(zn) of RERA, the term "real estate project" refers to the construction of flats, apartments or other types of accommodation in the form of plots or colonies, as well as the common spaces in them. Similarly, Section 2(e) defines the term "apartment" quite broadly, as it refers to any independent unit of a property which is used or can potentially be used for residential or business purposes, which means that co-living or serviced apartment units may fall under this definition. According to Section 3, registration is mandatory if the promoter wants to conduct a marketing campaign engaged with advertisement or booking of apartments in the project developed. It should be noted that the projects that do not exceed 500 square meters or eight units do not require registration.

RERA clearly defines the term "allottee" in Section 2(d) and states that it refers to anyone who got an apartment allocated, however it excludes those who personally rent their apartments. The obligations that arise from RERA legislation for promoters and also a requirement about having an escrow account provided under Section 4(2)(l)(D) and remedy options for allottees described in sections 12, 14, and 18 are concerned with purchase and not with renting or licence arrangement.

B. The Hospitality Regulatory Layer

In addition to RERA, the operation of serviced accommodation and hotels are governed by the state Shops and Establishments Act, local trade and health regulation, state tourism classification guidelines, and fire and building related approvals, all of which differ from those relating purely to residential operations. The classification of a building's use whether residential, commercial, or hospitality  determines its entitlement in terms of floor space index, water, and power tariff, and occupancy certificate.

C. SEBI's SM REIT Framework

Multiple providers of co-living and serviced apartments are acquiring investment capital via fractional ownership setups, as per the newly released SEBI (Real Estate Investment Trusts) (Amendment) Regulations 2024. These regulations enable the establishment of Small and Medium REITs, specifically explaining the fractional ownership platforms that collect funds exceeding INR 50 crore from at least 200 investors, making it compulsory for them to seek a minimum invoice and to secure listing. In cases where a co-living and serviced apartments scheme is executed through such a platform, SEBI's announcement and governance requirements apply independently and in conjunction to the existing obligations of the RERA Act.

D. Assured Returns and the BUDS Act, 2019

If a promoter guarantees fixed, periodic payments to investors, the Business of Unregulated Deposit Schemes Act, 2019, may come into effect, and such payments may be treated as an enforceable obligation in accordance with both RERA and law, as long as the underlying transaction is otherwise a real estate allotment.

Legal Analysis

A. The Classification Threshold: Sale, Lease, or Service

The definition of a co-living project or serviced apartment project will depend on the nature of the underlying transaction not the physical nature of the building itself as per RERA. An operator who takes an entire building on rent from the owner and sub-lets furnished apartments to tenants does not constitute sale of apartments to allottees and therefore, the mandate of RERA's registration is not triggered as per Section 2(d) of the RERA Act, 2019 which excludes rental arrangements from the definition of allottee. Where, however, the individual units within the project are offered to a number of investors and the promoter separately engages the operator to manage and let the individual units and the servicing/leaseback is a layer placed on top of this, the sale component in its essence is a real estate project and promoter's obligations under RERA will apply to the sale and not the servicing/leaseback.

It's not just a theoretical one. The Bombay High Court has clearly ruled that the substance of a transaction and not its label is what regulators will have in mind, implying that a 999 year lease framed as an allotment will be covered within the ambit of RERA since it is actually a lease transaction, if its substance would be interpreted as such. A co-living or serviced apartment building, which poses as a purely rented facility but is actually a disguised sale-and-leaseback, may be subject to the same challenges.

B. Occupancy Promises Versus RERA's Possession-Based Architecture

The remedial measures of RERA are based on possession and completion: RERA Section 18 provides an allottee the right to receive a refund of money including interest, if a promoter cannot hand over possession within the agreed time; and RERA Section 19 requires the promoter to complete the project as per the sanctioned plans. In this architecture, there is no assumption of any future operational assurance, like a sales figure, occupancy rate or monthly yield from a co-living or serviced apartment business. The term assured occupancy or assured returns implies in substance a prediction by the developer on assured occupancy or assured returns that is in the nature of a prediction of a hospitality business, which RERA does not have any mechanism to enforce after possession has been given. A buyer of the property will have to rely on the remedies available under the normal contract, or on the RERA's rare willingness, as will be explained below, to recognize an assured-return clause attached to the original allotment as enforceable.

C. Commercial Risk Allocation

In a typical transaction that is regulated by RERA, the promoter shoulders the risk of completion, while the allottee assumes ownership risk once possession is given. But a co-living or serviced apartment takes this a step further; it has a third layer of risk involved, which is operating risk. All aspects such as occupancy levels, average daily rates, staff expenses, and the level of fluctuation are the responsibility of the operator, and all of these are out of the purview of RERA as well as its supervisory capabilities. When the operator and promoter are linked entities, it is easy for investors to be involved in operating risk without going through the proper disclosure process that applies to those making hotel-fund investments which are covered by the securities law.

D. The Investor Expectation Gap

Investors in units of a co-living or serviced apartment project generally desire RERA type safety of escrow backed construction and specified possession schedules. The investors want the legal title of ownership as well as the kind of guaranteed performance of a hotel. But that may not happen. If the agreement is deemed a lease to keep the operator out of RERA, the investors lose the protections provided by the law for the sale because the sale did happen in substance. If the assurance of yield is considered to be a forecast and not an obligation, the investors will not be able to get the payment of the guaranteed yield.

E. Classification Pitfalls

Three common pitfalls are seen in practice. Therefore, the first one arises when developers label a project as “commercial” in order to facilitate municipal approvals while trying to sell it to investors as something residential at the same time. Secondly, it is important to know that if the developer sells units to investors under the guise of hospitality while being aware of the fact that lodging units and commercial real estate do not require RERA registration, this could mean that he broke the law. Finally, if a developer uses fractional ownership and tries to gather investments from many different investors, he might forget about the fact that SEBI’s SM REIT rules and RERA’s registration requirement must be applied to the same project.

Relevant Case Laws

Proceedings of Lavasa Corporation Ltd (Bombay High Court) (order dated 7 August 2018): RERA also does not exclude long term lease agreements used as a substitute for sale of allotments, as the Bombay High Court held in the above case. The argument is immediately applicable to the structures of co-living and serviced apartments where lease/licence documentation is used to define, in substance, a sale of units to investors.

Newtech Promoters and Developers Pvt. Ltd. Vs. State of U.P., The Supreme Court upheld the retrospective and retroactive applicability of RERA, and granted an indefeasible right to the allottee against a promoter for refund with interest in case the promoter fails to handover possession under Section 18 of RERA. The judgment's focus on the duty to have a "close relationship" with the promoter reinforces the fact that regulators will not tolerate structure based workarounds, such as 'hybrid' labels for hospitality and residential properties, where there has been a true sale.

Orders confirming a periodic payment promise made in connection with an allotment of real estate is an enforceable contractual obligation, even if it is a payment in lieu of a deposit, since it is required under a regulated real estate transaction and is therefore not covered by the Banning of Unregulated Deposit Schemes Act, 2019: These orders confirm a periodic payment promise associated with an allotment of real estate is deemed to be an enforceable contractual obligation and, if challenged as an unregulated deposit scheme, is held to not fall within the ambit of the Banning of Unregulated Deposit Schemes Act, 2019, because it is required as part of a regulated real estate transaction and thus is not a payment in lieu of a deposit. This thinking suggests a way to uphold the yield commitment of co-living and serviced apartment investors in instances where the commitment is directly tied to an underlying allotment and not a discretionary business return.

Practical Implications

From a developer and/or an operator's perspective, it means that from the start, whether they are selling individual units, leasing a whole building, or combining capital through a fractional ownership platform, they will determine what regulator they need to register with and what kind of disclosure they have to follow. So if the end use of the property is "hospitality-adjacent", the investor should not treat RERA registration as optional as it leaves them vulnerable to penalties and more seriously, by not registering they forfeit any escrow or possession protection that they had hoped to have.

For institutional and retail investors, co-living and serviced apartment pitches should be reviewed to see if the instrument is a sale (RERA), a lease (beyond the ambit of RERA but under ordinary contract regime) or a security (SEBI oversight regime). Remedies available in cases where the occupancy or yield targets are not met are affected. It is unfortunate that most of the state RERA authorities have not a co-living specific circular yet and promoters/investors are required to extrapolate from existing lease transaction-based jurisprudence that has been built in a different factual context, which is not sustainable over the long term for a rapidly-expanding asset class.

Conclusion

Hybrid hospitality residential schemes are not at ease in a legislation that was conceived to address the sale of apartments to homebuyers, and RERA's language does not provide a specific solution to co-living or serviced apartment schemes. For any promoter that is planning to raise funds from various investors from such a scheme, the best way to structure the deal would be to assume from the outset that the scheme would be a real estate project, even if there was an operating leaseback layer in place, for in the eyes of a regulator or court, it would be treated as such. Where the promoters' actual purpose is to lease the building from one owner for use for hospitality based purposes, care should be taken to ensure that they do not use any marketing terminology that suggests ownership of individual buildings or allotments as this would lead to the lease being reclassified as a disguised sale.

Any commitment made to investors regarding yield or occupancy must be in a quantified, specific, contractual manner and must be expressly tied to the allotment agreement, and not be a general business forecast, as that has not proven to be enforceable in front of RERA. For promoters where capital is being pooled under a fractional ownership model, they need to evaluate the SEBI thresholds on their own and proceed with compliance on this path alongside RERA registration. Lastly, promoters need to ensure that the building's classification according to its use under the municipal authorities is aligned with the classification assigned under the RERA registration process before launch, as a difference in classification at the time of the occupancy certificate will not affect the building's use, but may result in the municipality's imposition of liability under Section 18 of the RERA. Disciplined, substance-based structuring is the primary line of defense for both promoters and investors in co-living and serviced apartment projects until the state RERA gives more clarity about the structuring requirements for these projects.

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

References

1. Real Estate (Regulation and Development) Act, 2016, s. 2(zn) (India).

2. Real Estate (Regulation and Development) Act, 2016, s. 2(e) (India).

3. Real Estate (Regulation and Development) Act, 2016, s. 3 (India).

4. Real Estate (Regulation and Development) Act, 2016, s. 3(2)(a) (India).

5. Real Estate (Regulation and Development) Act, 2016, s. 2(d) (India).

6. Real Estate (Regulation and Development) Act, 2016, s. 4(2)(l)(D) (India).

7. Real Estate (Regulation and Development) Act, 2016, ss. 12, 14, 18 (India).

8. SEBI (Real Estate Investment Trusts) (Amendment) Regulations, 2024, notified 8 March 2024 (India).

9. Banning of Unregulated Deposit Schemes Act, 2019 (India).

10. Lavasa Corporation Ltd., Bombay High Court order dated 7 August 2018, on the applicability of RERA to long-term lease transactions.

11. Newtech Promoters and Developers Pvt. Ltd. v. State of U.P., Civil Appeal Nos. 6745-6749 of 2021 (Supreme Court of India).

12. Shasi Vats & Anr. v. M/s Imperia Structures Ltd., Haryana Real Estate Regulatory Authority, on enforcement of assured-return commitments.

13. Real Estate (Regulation and Development) Act, 2016, s. 59 (India).

14. Real Estate (Regulation and Development) Act, 2016, s. 18 (India).