With historically high Real Estate prices, innovative companies are creating new solutions that have the potential to change how we think about home ownership and even Real Estate investing. With these emerging models, it is critically important to understand what their terms and conditions are and what it means for your rights.
In this blog, we’ll dive into fractional ownership, and dissect what it is and what you should look out for. Fractional ownership has drawn the interest of potential homeowners and investors alike. Fractional ownership typically takes form when a corporation acquires a property and sells shares of the property to investors. The fractional ownership model is not like co-ownership of a house or building, where a handful of “end-users” own property together.
The model is more geared towards investors who want to invest in Real Estate, but don’t necessarily want to go the traditional route of buying a property and becoming a landlord, or perhaps don’t have the funding needed to do so. Here’s a typical example of fractional ownership. A fractional ownership company like Addy or BuyProperly, purchases a project such as a building, shopping plaza, or a block of apartments.
Typically, fractional ownership companies will create a new corporation that owns the property. As an investor, you can buy shares (or units) in the newly created corporation, thereby giving you a “fractional share” of ownership in the property. Depending on the company you’re working with, they may have minimum investment requirements and each investment offered may have unique requirements and criteria such as a maximum number of investors. Some companies may also use other methods to administer fractional ownership.
How do I make money through fractional ownership?
The idea is that your investment will generate a return once the company “exits” the investment. What this means is selling the project to another party, or in some cases, buying out your shares and taking full ownership of the property. When an “exit” happens, investors usually reap their profits.
For example, if a building was worth $5M at purchase and subsequently sold for $10M, a year later, the investors would typically share in the $5M that is proportionate to their investment. In some instances, income collected from the property, such as rents, may be distributed to investors on a proportional basis.
There may also be ongoing costs (such as maintenance, property taxes, and repairs) that may be the investor’s responsibility during the time you own the property. Before committing to a fractional ownership investment, ask these questions:
- What is the exit strategy for this property?
- What is the timing of the exit for this property (i.e.: 6 months?, 1 year?, 10 years?)
- Will rental income be distributed to investors?
- Will an investor be responsible for covering operating costs and improvement costs?
- What has been the company’s history on exits? Have they been profitable?
- How does the Fractional Ownership company make its money?
What happens if the property depreciates?
Like anything else, Real Estate assets are not always guaranteed to appreciate in value. There may be several circumstances that can depend on the market, the condition and maintenance of the property, and a variety of other factors.While an investor’s intention is to reap a reward, it is important to understand the circumstances. Depending on the investment, this can mean a loss for the investor, or in some cases, even an additional liability, beyond the amount invested.
Here are a few questions you can ask:
- What is the plan and budget to maintain or improve the property? For example, are renovations planned? What will they cost?
- If the property is sold at a loss, what happens to my investment?
- What’s the company’s history on exists? Have any projects been sold at a loss or failed to appreciate?
How do I make sure I own the investment?
Being on the “title” of a property is the legal definition of owning a property. Most fractional ownership projects do not include all investors on the title of the property for various reasons such as administration, legal costs, etc .Not being on title, doesn’t necessarily mean you don’t have control or ownership over the property, but it does mean that it is best to ensure there is another legal mechanism that protects your investment.
Those mechanisms can vary from share certificates in the corporation that owns the property, to trust agreements, or contracts. Here are a few questions you can ask:
- How will I hold ownership in the project in exchange for my investment?
- If I own shares, what are my rights? Can I sell my shares?
Our bottom line
Fractional ownership is a new and exciting model to participate in the Real Estate market as an investor and gain access to properties that are typically reserved for larger (institutional) investors. Like any other investment, asking the right questions and doing your homework can save you headaches down the road and make you a better, more informed, investor.