As a way of investing in real estate without borrowing money to buy an entire piece of property, fractional ownership has its upsides and is comparable to investing in REITs in terms of requiring a smaller up-front investment and less labor than purchasing an entire property. Whether people know about fractional ownership as a way to get a stake in a luxury vacation home there are plenty of interesting opportunities to purchase an interest in a property without committing to management responsibilities or sweat equity.
Fractional ownership is a broad term that describes direct property investment as a percentage share instead of buying the whole property. It allows multiple unrelated parties to share ownership of a real property asset. Let’s take a look at how it works.
Fractional ownership of personal properties vs. commercial
In fractional ownership where some personal use is included, this can be arranged by time occupancy access is allowed for a certain amount of weeks — or space occupancy, where parties split up the area of a property and each owner can access a certain part. This would be the model in a co-living space that people buy into instead of renting.
Fractional ownership opportunities with time assigned for each owner to access and enjoy the property are very common in resort real estate, since they allow several parties to purchase part of a high-value asset and use it a few weeks of the year. It makes sense in this category because most people can’t live in a vacation resort the entire year.
If someone invests in fractional ownership of a commercial real estate property, whether it be a multifamily building or an office or some other category, they may not have any access rights at all. However, they will have the right to share in rents collected and profit from appreciation once a property is sold.
If you’re a fractional owner, what are your responsibilities?
Typically a company manages a fractionally owned property with several unrelated owners. The company would be responsible for construction related to renovation/repurposing the building, property management duties (or contracting a manager), and brokering an eventual sale.
In the fractional ownership model of a tenancy-in-common, where there may be fewer owners and no company in charge, it might be up to one owner to handle these duties or they may be split. Thus, while tenancy-in-common might seem more casual and friendlier than investing through a company, one could also say it carries substantially more risk.
If you’re a fractional owner, what are your rights?
Looking at the bundle of rights that comprise every real estate title, it’s pretty clear that buying fractional ownership might only buy a few of them. In personal fractional ownership, you might have limited rights of enjoyment; in others, none at all. You may have right of control, which is the right to decide what to do with it, if it’s a co-tenancy ownership arrangement, but if an LLC or LLP controls the property, you probably won’t have that. You will have limited rights of disposition, meaning you can push to sell a property and take your share of the profits.
Basically as a fractional owner of a commercial property, you only have purchased the right of possession on a limited basis. You own a slice of the property but may not be able to physically control it. That’s the up side as far as some people are concerned. Many people don’t want to be responsible for controlling, aka managing, a property. They want someone else to do it while they partake in passive income.
Why do developers and builders offer fractional ownership interests?
They offer it for the same reason that potential buyers might purchase it: because it’s less expensive than buying the entire property. Whereas a $10 million multifamily midrise building might only be affordable to a small number of institutional investors and wealthy individuals, splitting ownership of the building into 30 portions allows many more entities to purchase a share. Furthermore, with luxury vacation developments that go the fractional route, the feeling is that each owner will probably only want to spend a few weeks of the year there, so having many owners means the resort will be occupied more of the year as opposed to mostly empty.
Are fractional ownership deals financed?
A minority of fractional ownership deals are financed, but it’s much more common that fractional owners pay for their share in cash. Mortgages for all or part of a fractional ownership opportunity used to be available and can still be found, but lenders are wary of them.
Is an LLP or LLC necessary?
It’s not strictly necessary to form an LLC or LLP in order to set up fractional ownership of a property. The alternative would be a tenancy-in-common form of concurrent ownership.
What taxes is a fractional owner responsible for?
Fractional owners are responsible for their share of property taxes, including increased property taxes in jurisdictions where fractional sales trigger tax reassessment and increase.
Fractional ownership vs. REIT investment
When you invest in an equity REIT (real estate investment trust), you’re investing in several different income-producing real properties that are all in one asset class. Investors who prefer a certain type of property, such as storage complexes or data centers, can invest indirectly in several that are already operating and collecting rents. The investors then share the rental income. They cannot dictate what properties the REIT will buy or what capital improvements might be made or when the property might be sold.
Fractional ownership vs. timeshare
There is confusion about the difference between these two ownership models, but the key difference is that someone who buys fractional ownership in a vacation property actually owns shares in the title to a property — a stake in the property itself, not just the right to use the property a certain amount of time.
Fractional ownership: opportunity made more accessible
For investors who have a decent amount of cash to invest and don’t want to sink all of it in one property, fractional ownership has several benefits. The key questions to answer before investing:
- What do you want to invest in?
- Do you want to enjoy the property or just derive passive income from it?
- How much do you want to spend?
- Is direct investment right for you?