Exploring Fractional Home Ownership

Years ago, I stayed in a vacation house with friends outside San Gimignano, a medieval Tuscan hill town.  The place was originally an estate with many outbuildings that had been converted into tourist lodgings, and the owners who had done the work lived there on-site. 

They told me the deserted mansion across the road was originally part of the estate, but they were selling it off. It wasn’t hard to understand why. From the outside, it was a stately Italian villa with the classic promenade of cypress trees and a terrace overlooking the vineyards at the back. Inside, however, was a cavernous ruin filled with partial walls and crumbling plaster. Never dissuaded by real estate hurdles and sensing a bargain, I was consumed by a desire to purchase this beautiful ruin and restore it with our friends, who are accomplished do-it-yourselfers. But sadly, neither they nor my partner at the time wanted any part of this money pit. 

I have been drawn to the idea of fractional home ownership for years. With solid boundaries and expectations, it can be your ticket to an affordable lakeside cabin with your fishing buddies or the foundation of an intentional community in the South of France. Worried about retiring solo? Fractional home ownership allows you to make plans to develop a shared space with friends or like-minded others.

Buying a property with people you know is only one type of fractional home ownership, though. In the last few years, fractional real estate investment platforms have proliferated. These are companies that purchase properties and sell them back to investors as shares, creating a new investment model you can buy into for as little as $100. 

Read on to learn how you can leverage fractional home ownership as a vehicle to earn passive income while your investment appreciates — and what the potential downside to this investment model may be.

What Is Fractional Home Ownership?

As the name implies, fractional home ownership is an agreement by which you purchase a fraction of a property along with other investors. You can do this with family or friends or like-minded strangers, as I mentioned above, with or without a third-party brokering the deal. Another option that is growing in popularity is to use a fractional real estate investment platform, which allows real estate investors with only small amounts of money to purchase fractional “shares” of a rental property held in trust. 

Co-Ownership

Should you decide to go in on a property with friends, family or like-minded strangers — technically referred to as co-ownership — all owners must appear on the title and/or mortgage and are legal owners of the property. The two most common ways to divide the property are tenancy in common and joint tenancy. 

• Tenancy in common splits ownership of the property into percentages based on how much each person contributes. Owners have an equal right to use the property while they are living there, but when it is sold, each person gets back the percentage they invested plus any proportional equity. In a tenancy in common agreement, all parties must agree to the sale. 
• Joint tenancy is when owners have split the cost of the property equally. One strange quirk of joint tenancy agreements is that when you die, your share will not go to a beneficiary but rather will be split equally among the remaining owners. On the other hand, you can sell your share at any time.

Fractional Real Estate Investment Platforms

Fractional home ownership through a third-party broker is a recent investment model that went mainstream when billionaire investor Jeff Bezos contributed over $50M in seed money to Arrived, a fractional home ownership platform. There are dozens of other platforms out there, and it makes sense that they have proliferated in a housing market so many Americans have been priced out of.

Here’s how the Arrived model works. The platform curates a list of properties based on their potential to generate rental income. Arrived claims that they deem only 0.5% out of the 100,000 properties they analyzed worthy of purchase, and of those they purchased only 0.2%. Thus, as an investor, you can rest assured that the difficult work of finding a viable property has already been taken care of according to exacting standards. 

You can browse the properties and purchase shares — or fractional pieces — of them, investing anywhere from $100 to $20,000 in a single property. Arrived manages the properties for you and pays out cash flow through monthly dividends. They pay out the appreciation on the property when the terms of the investment have been satisfied. 

Because this is a new investment model, it is morphing fast. Another platform, Ownify, allows qualified first-time homeowners to purchase their property from the platform for 2% down; fractional investors own the rest of the property, which is held in an LLC. Gradually, the homeowner gains equity.   

How Is This Different from a Timeshare or a REIT?

Although there are deeded timeshares that work much the same as co-ownership, except with a layer of management whose services you must pay for, many timeshares are non-deeded. What you purchase in the latter case is a lease that gives you the right to use a property for a set period of time over a certain number of years. 

As long as you maintain the terms of the agreement and are up-to-date on maintenance fees, you can sell a non-deeded timeshare lease — i.e., you can try to find someone who will buy the remaining years on the lease. You are also free to sell a deeded timeshare, though you may find that the price has depreciated. Timeshares tend to lose value over time, making them a poor investment.

A real estate investment trust, commonly known by its acronym, REIT, is a company that holds a portfolio of income-producing real estate properties and sells shares of them to the public as shares of stock. An easy way to think of a REIT is as a mutual fund for real estate investment. REITs and fractional real estate investment platforms share some common features. You have no physical connection to the property you’ve chosen to purchase shares in and realize the cash flow from property rentals in the form of dividend payments. Both are subject to sharp fluctuations in the housing market, both positive and negative.

REITs are unlike fractional real estate investment platforms in that they can be bought and sold through a brokerage firm and purchased as a share of stock, a fractional stock share, or an ETF. Moreover, you are buying into a large portfolio, which mitigates risk. When you invest in fractional real estate through a third-party vendor, you choose a property or properties to invest in that have already been purchased. While this gives you some ability to diversify, and the properties are vetted, fractional real estate investment may be a higher risk. 

Pros and Cons of Co-Ownership

Pros

1. Unlike a non-deeded timeshare, you own part of this property.
2. You can afford a much larger vacation house when you share the cost with others. 
3. You can use co-ownership to create an intentional community where investors share not only the property but communal living space and values.
4. You don’t have to pay a middleman for services other than standard condo and HOA fees, which can be split among owners.

Cons

1. Tenancy in common ties the interests of all the owners together, forcing them to agree on the sale of the property.
2. Joint tenancy does not allow your share in the property to be passed on to heirs. Instead, it passes to the other owners.
3. There is a risk that disagreement among the owners will lead to a hostile situation that owners may be unable to escape. 
4. Owners are responsible for their own property management.

Pros and Cons of Using a Fractional Real Estate Investment Platform

Pros

1. The properties are pre-vetted and selected for you. In fact, they have already been purchased. All you have to do is decide how much of a share you want to buy.
2. Platforms like Arrived offer a variety of investment opportunities, including the Private Credit Fund, which “invests in short-term loans that are used to finance professional real estate projects” and distributes the interest payments as dividends.
3. You can afford home ownership with the help of fractional owners, and over time, you can buy them out.
4. You don’t need a lot of money to start investing.

Cons

1. You must trust a third party to make real estate decisions for you rather than researching them yourself.
2. When you invest small sums in a fractional real estate investment platform, you lack diversity and could lose money on your individual investment even if the overall trends are positive. 
3. Because the dividends are reported as 1099 income, you will pay ordinary income tax on them, not capital gains tax.
4. The newness of this investment model, combined with its creative purchasing of loan products and use of SEC exemptions, gives this writer a little deja vu from the housing crash of 2007. 

A Final Word to the Wise: Let the Buyer Beware

Real estate investment is not for everyone. But for people who enjoy being hands on, co-ownership gives you greater potential to affect your returns based on the owners’ actions — i.e., improvements you make to the property — than you do as a shareholder in a corporation. Fractional real estate investment platforms remove that advantage, replacing it with third-party fees and management. 

As you consider your real estate invesment needs, be sure to visit DealStream.com — the #1 deal sourcing platform for dealmakers and entrepreneurs, with over 15,000 deals completed since 1995. DealStream helps people source and market deals, including residential and commercial real estate, vacation properties and more.