Is Fractional Real Estate Ownership a Good Option for You?
Fractional real estate ownership allows investors to diversify their portfolios across multiple secured loans. Learn if this might be right for you.
Some types of investments involve owning a fraction of a larger asset. When you own corporate stock, for example, you own a fraction of that business. One share of stock in a publicly traded corporation typically represents a tiny fraction of ownership, depending on the total number of shares the company has issued. Privately held corporations tend to have fewer outstanding shares, so each one represents a larger portion of the business.
Fractional ownership is also possible in real estate. Perhaps the most well-known example is the timeshare, where multiple people own a home or condominium and take turns using it.
Real estate debt investors can also take advantage of fractional ownership. Rather than making a single loan to one borrower, an investor can spread their funds over multiple loans, holding a fractional interest in each and receiving a portion of the returns.
This article will describe fractional real estate ownership, its pros and cons, and ways for prospective investors to learn more.
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What is fractional real estate ownership?
In fractional real estate ownership, multiple people or business entities contribute to a loan. Each investor has a defined fraction of that loan and its security interest, also known as a lien. As the borrower pays interest on the loan, each investor receives a pro-rata share based on their fractional ownership.
For example, three investors might pool their resources to loan money for a real estate project. Each would hold a one-third interest if they all contributed the same amount. Otherwise, ownership might be split in proportion to each person’s investment. If the three investors pool a total of $450,000, possible ownership fractions include:
One-half ($225,000), one-third ($150,000), and one-sixth ($75,000)
Two-fifths ($180,000), two-fifths ($180,000), and one-fifth ($90,000)
Two-thirds ($300,000), two-ninths ($100,000), and one-ninth ($50,000)
Fractional real estate investors can create a business entity, such as a limited liability company (LLC) or limited partnership (LP), to hold the property. A sponsor or manager can also form an entity and invite investors to purchase equity shares.
Using an LLC or LP for fractional ownership can be useful for liability protection. It is important to note, though, that the investors would not directly own fractional interests in the lien. The entity would hold the note and lien, and the investors would own fractional interests in the entity. The result would be the same though. Profits and losses would flow to the investors according to their fractional ownership.
Investors can loan money directly, meaning that the lien is in their individual names. Deeded fractional ownership is clearer in the public record, but it offers the investors no protection from liability for debts related to the loan.
Image by him lam van phuc luxury residence from Pixabay
How does fractional ownership of a condo work?
For debt investors, the kind of property securing the note can affect their rights as lenders and lienholders. The difference, however, is not between single-family homes or condominiums, but rather between properties that belong to a homeowner’s association (HOA) and those that do not.
To understand how these are different, it can be helpful to review how owning a condo is different from owning a home:
Owning a residential home: You own the land and the structures sitting on the land, including the house and any other buildings.
Owning a condo: You own the interior space of the condominium, along with its walls, floors, ceilings, and any private outdoor space like a patio or balcony. You also own a fraction of common areas like a lobby, parking lot, recreation center, and other amenities. You must be a member of — and pay assessments to — the condo owner’s association (COA), which is responsible for managing and maintaining all common areas.
The field of lienholders is slightly more crowded if you own fractional debt on a condo or a home in an HOA. You and your fellow fractional lienholders have the right to enforce your promissory note. The local property tax authority has a superior right to foreclose. The HOA or COA also has the right to foreclose on the property for non-payment of assessments.
Photo by Gabrielle Henderson on Unsplash
Why fractional ownership? Is it a good investment for you?
Fractional real estate ownership might appeal to investors who do not want to invest too much capital in any one asset or want a highly diversified portfolio. It can also be a good option for investors who are just starting and don’t have much capital to invest yet. The pros of fractional real estate ownership can help prospective investors decide whether it would work for them.
Pros of fractional real estate investment
Possible advantages of fractional ownership include the following:
Ease of entry: Buying shares in a fractional real estate investment can be simpler, in terms of paperwork, than closing a sale of residential property.
Low initial investment: You need less capital than if you were funding an entire loan on your own.
Access to higher-value investments: An investor can invest in high-end equities as a fractional owner.
Shared responsibility: Investors share the risks and costs of servicing the loan.
Diversification: Rather than investing a large amount in a single loan instrument, fractional ownership allows an investor to own parts of many instruments. This could include loans on a diverse range of property types, like single- and multi-family residential, commercial, and industrial.
Cons of fractional real estate investment
Like any type of investment, fractional ownership can have disadvantages. These are especially prevalent if you’re working without an experienced firm to support you.
Limited control: Investors must make decisions as a group, and majority owners might be able to outvote everyone else.
Limited liquidity: Depending on the type of business entity and its management structure, selling one’s interest in a fractional real estate venture could be difficult. The organizational agreement might limit how owners can sell their shares. Owning an entire property typically does not have these restrictions.
Reliance on co-owners: The success of the investment may depend on the investors’ ability to work well together. Conflict among fractional owners or questionable decisions by one owner can affect everyone’s interests. However, working through an experienced firm that handles everyone’s capital largely prevents issues that may arise through co-lenders (i.e. co-owners of the lien).
How can I find properties where fractional ownership investments are available?
Fractional real estate ownership can offer great opportunities for new investors and seasoned veterans alike. Finding opportunities can be difficult though.
If you’re interested in fractional investments but aren’t sure where to start, a reputable, established firm can do a lot of the research and heavy lifting for you. This is where Capstone Capital Partners comes in. Contact us today to learn more about how we can help.
