Real Estate Executive magazine article
In January 2008, this nationwide publication expressed a desire to better understand fractional real estate. We gladly accomodated them and here’s the article they published:
“Get a Piece of the Action with Fractional Real Estate”
Q: I heard someone mention “fractional real estate,” but I really don’t know much about how it works. Can you explain fractional real estate and tell me how this could benefit me?
A: Real estate professionals are often asked by clients to help them chart a course and explore various options for both purchasing and selling properties. Fractional ownership is a new option that has recently emerged, which opens new doors for real estate purchasing, investing and sales opportunities. What’s interesting is how pleasantly surprised many real estate professionals are when they discover the benefits it provides to everyone involved in the equation.
Essentially, fractionals are properties where several different people share ownership and use of a second home or vacation property. Technically, a fractional-deed co-ownership interest is a tenant-in-common deal on an investment property, usually a second home. When clients ask about adding to their real estate portfolio, this is one of the hottest options going.
What it’s not
Some people may initially confuse timeshares with fractional real estate; the differences are significant. With timeshare, buyers don’t own property, they own time and access to a location. With fractional real estate, they own the property and all the gratifying benefits that come along with, including appreciation, just like a any other property investment opportunity.
You may have heard of fractional ownership as it relates to the large, “dependent” Ritz Carlton or other similar private residence clubs, which function like a luxury timeshare because they offer exclusive access to luxury resort destinations. The opportunities in this model are
Are the commissions with fractionals the same as regular properties? No, they are better because a fractional deal can be struck for more than the appraised value.
limited for real estate pros because the sales and contracts are usually handled in-house.
The exciting trend with the most opportunities for real estate pros is with the “independent” model, which is a single home, condo or cabin that is sold fractionally.
With this form of ownership, practically any home can be fractionalized. An individual owner obtains his or her own title for their fractional interest. For example, if four people fractionally owned the property, each would own a quarter interest. This is a real estate transaction; it’s not a buy in to a club. Each owner would actually own real estate, upon which they can take out a mortgage, pay for it in cash, or sell it when the property appreciates, just as they would any other appreciable property.
Many consumers are turning to fractional ownership because of the logic involved. If one owns a second home or vacation property but can’t use it more than a few weeks out of the year, they are still responsible for the upkeep and management of the place for the rest of the year. It makes sense to fractionalize the property to both recoup financially, but also to relieve the burden of whole ownership by passing the maintenance and management on to others.
Since all the owners have a common interest in the entire property, they need to know how to share the use of the property in a way that is fair and friendly. They need to know how the multitudes of operating expenses are going to be made and what the enforcements are among them. A formal fractional operating agreement answers these questions.
A Win-Win for Everyone
Fractional ownership allows they buyer to get into a much larger or higher-quality property than they could through sole-ownership. It also removes the hassles of day-to-day management from off their shoulders.
As the agent, it provides you the opportunity to expand your commission-paying property offerings.
If a client has $250,000 to spend, they can get into a $1 Million fractional. On the other hand, if a client has the means to purchase a $1 Million home, they can certainly do that, but with fractional ownership the agent can help them buy four or more separate homes and diversify their real estate portfolio. And all along the way the real estate agent collects the commissions.
Are the commissions with fractionals the same as regular properties? No, they are better because a fractional deal can be struck for more than the apprised value.
Take for instance a real example: A condominium in Colorado was being offered for $900,000. A 6% total commission for it would have been $54,000. That’s a tidy sum of well-earned commission. But the condo was sold fractionally at $1.2 million and a 6% total commission on a fractional sale totaled $72,000. That’s a 33% increase. Fractionalization is being publicized as the next logical step in the progression of “highest and best use” of real estate. And the commissions are following in that progression.
Many people are noticing already that fractional ownership may work quite well for 1031 Exchange as allowed by the IRS code. You should consult your tax advisor, but, simply put, you may defer sizeable capital gains taxes on exchanging like-kind properties. Exchanging a second home for another second home is not complicated by the fact that your new second home (or homes) are owned fractionally.
Financing the Dream
In the past, funding options have been limited for fractional deals, and anyone wanting to purchase a fractional interest in a property was stuck paying cash. Now, more and more lenders are warming up to the concept and with recently developed financing products built specifically for the fractional marketplace, buyers and sellers alike have a number of financing possibilities.
The signals for setting values for fractional ownership are beginning to emerge. Lenders making fractional loans are establishing lending policies that allow for loan amounts based on values greater than traditional appraised values. These potentially present opportunities to capture an “equity premium” as traditional properties begin to be more often bought and sold fractionally.
As with any transaction the real estate professional is at the center of the action. With resources from lenders and operating agreement providers, the fractional real estate industry has evolved to a point where everyone can walk away with a great deal.
Mark Chesney has participated in real estate investing for much of his professional life. He is the founder of GrandShare, which assists real estate professionals by providing a comprehensive, all encompassing system for buying and selling fractional real estate.
