You have probably heard about the term “fractional ownership.” Even though it sounds simple, this term has an in-depth meaning that could be challenging to understand. If you wonder what it means and what it entails, this guide will help break it down. Read on to find out what fractional ownership means and some of its pros and cons.
What is Fractional Ownership?
Fractional ownership is a unique method in which several unrelated parties share and mitigate the risk of ownership of any high-value asset. It could be a tangible asset like a real estate property, a yacht, or a jet. Fractional ownership can be done strictly for monetary reasons, though there are cases of personal access involved. In fractional ownership, one of the main influencers for purchase is sharing the asset’s costs. This asset is not used full-time by a single owner.
With this arrangement, every endeavor needs management that administers rules and regulations. These rules must be agreed upon before purchasing the fraction. The management also maintains the asset to the standards agreed in the ownership documents. Generally, the manager oversees the daily operations of more than a single asset, although this is not mandatory. A single entity can manage a single fractional asset for better evaluation and maintenance.
Fractional ownership means each owner is guaranteed a certain percentage of access to the asset. This access is used or offered to the public as a charter or rental in most cases. In that case, the profit is split between the fractional owner and the management company. If the fractional owner finds the renter, there will be no splitting of the income. In addition, every owner pays a certain percentage of the annual agreement maintenance fee, which is equal to their percentage ownership.
Understanding Fractional Property Ownership
As mentioned, fractional ownership refers to dividing any asset into shares or portions. If the asset involved is a property, its title deed can be legally divided into shares. In some cases, this process is done by creating a mezzanine structure that guarantees easier management. For instance, fractional owners can create a company that owns the asset, allowing multiple investors or owners to buy shares in the company.
These shares can be owned or purchased by more than one person. There are several reasons why a “mezzanine structure” is vital in fractional ownership. For instance, this structure allows the transfer of shares without having to reflect changes on the deed or title of the property. In addition, the structure also contributes to tax benefits.
You are also likely to hear about Tenancy in Common, a term used in fractional ownership. However, this type of ownership is grounded in a specific state’s real estate property laws. This type of ownership is different because there is no right of survivorship to the other owners or the main sponsor. This is if one or more owners were to pass away.
However, there are also similarities with the equal sharing of rental income, operational expenses, and other benefits. What makes them appear similar is the free transferability of the owner’s interest. This could be without regard to the owners’ shares in the property.
Shared ownership of property entitles all the shareholders to various usage rights. This is mostly in the form of weeks. However, it is vital to know that fractional ownership differs from timeshare. This is because fractional ownership has much of the usage benefits and freedom found in timeshare.
The main difference between timeshare and fractional ownership is that the purchaser owns part of the title in the latter. In that case, if the property increases in value, the shares will also increase. When it comes to whole ownership, fractional owners can sell whenever they deem prudent or necessary. By doing so, they release the capital growth from their investment to a different paradigm.
Types of Fractional Ownership
Co-ownership, fractional ownership, and shared ownership are terms used to describe any arrangement where two or more people co-own a property. Without a doubt, fractional ownership is emerging as the most commonly used for time-based sharing. This commonly involves sharing of vacation real estate in the US.
However, shared ownership and co-ownership are commonly used to describe any of these arrangements in other English-speaking countries. The fact that this arrangement is described using either of these terms can be attributed to the buyer’s taste and location of the asset. This section discusses the different types of fractional ownership arrangements to enlighten you on fractional ownership. They include;
Destination Club and Vacation Club
According to how you understand them, vacation club and destination club mean different things. The definitions we will give here might not hold across the board. Mostly, vacation and destination clubs often involve multiple homes in various locations, with a unique system that allows participants to stay in any home within the club. There are also non-equity and equity variations distinguished by whether or not investors have an ownership interest.
This variation is categorized as deeded or non-deeded. Equity and non-equity clubs have a clear exit strategy after a determined number of participation years. In most non-equity clubs, the amount received by an outgoing member is generally based on the original purchase price. Alternatively, this can also be based on the money charged for new members. For equity clubs, the payout is based on the actual market value of all the properties owned by the club.
Private Residence Club
A private residence club involves equity ownership (it doesn’t necessarily have to be deeded ownership) of a specific property with around 4-13 owners per home. Private residence clubs are the most valuable and the most popular fractional ownership options. This is about amenity level, unit size, and pricing. In most private residence clubs, usage is not unit-specific. This means that when a particular investor uses any unit, it is deducted from their usage period.
You have heard of a timeshare before. This is probably the most misunderstood term in the fractional ownership lexicon. That could be because many sellers want to distance themselves from poor quality, high-pressure sales, and inadequate resale performances of timeshare projects.
Under the legal definition, timeshare refers to any arrangement where property usage is shared based on time. There is also no reliable distinction between the properties marketed as fractionals and those marketed as timeshares. However, most people think that many timeshares are deeded, while fractionals and private residence clubs are not.
Equity and Non-Equity
In inequity fractional ownership arrangements, the investors use and own the shared property. In a non-equity arrangement, they only use it without owning it. In this case, ownership could mean being named on a legal title to the shared asset. It could also mean owning a company, trust, or any other entity that owns the shared property. A fractionally owned property could be multiple homes, a single home, or a multi-unit resort.
Generally, fractional equity arrangements are not risky and offer tax advantages. It also gives the owner greater control over the involved property. Such properties tend to hold value or increase in value as time progresses. However, like all the other arrangements, there could be some setbacks. Therefore, it is vital to evaluate all the demerits of every offer before deciding.
Deeded and Titled
The participants are listed on the legal property title in titled and deeded fractional ownership arrangements. The deeded property may be multiple homes, a single home, or a multi-unit resort. However, the advantages of deeded fractional ownership are mostly exaggerated, with the disadvantages hardly acknowledged. Compared with other types of fractional ownership options, the advantage of deeded ownership is a superior tax treatment for taxpayers with American fractional properties.
However, this advantage only exists if the fractional owners use the property exclusively as a residence. Other alleged advantages like more owner control, better resale value, and lower risks are illusions. In addition, a deeded ownership has some disadvantages that could be severe compared to other types of equity fractionals. Improperly or inadequate prepared fractional ownership documents could result in costly problems that jeopardize the whole investment. Therefore, you should be very careful when dealing with this type of fractional ownership option.
Pros and Cons of Fractional Ownership
Everything has its advantages and disadvantages. Similarly, fractional ownership has its fair share of pros and cons. Here are some of the most common ones.
It is Affordable
A $4M home could be too expensive for your finance, but $1M could be manageable. You can get a highly valuable home at an ideal location through fractional ownership. All these come at a price you can afford. The same applies to home maintenance and upkeep. Through sharing the costs of home maintenance, fractional ownership makes it more realistic to own a home. You don’t have to stretch your resources trying to look for a quality home that costs way more than you can afford.
Comes with Peace of Mind
Through fractional ownership, you share the burden of homeownership. Instead of handling the whole process alone and increasing the chances of failure, you will have a group that shares schedules, accountability, home maintenance, and other chores that could be tedious. This makes it easy for you to manage as a part-owner. As a result, you will have peace of mind that normally comes with a fixed state of things. There is no pressure to handle various chores.
The Home is In Excellent Condition
A home should not sit vacant 48 weeks of the year. The home will be opened up through real estate fractional ownership at regular intervals. By running the water, opening and closing windows, turning on the heater and AC, you help keep the house in excellent condition. This prevents cases of a rusty home due to many months of emptiness. It also helps increase the home value.
Here are some of the disadvantages of fractional ownership.
Consensus Could Be Challenging
Fractional ownership means different people own one asset. As a result, you will need to decide on everything from furnishing to who is allowed to use the property at a particular time. When working with an owners group of 4-10 members, decision-making can be quite stifling and long. When some members decide to rent out their share through vocation rentals and others decide against it, it can result in severe discomfort. This could significantly affect the stability of the group.
Selling Can Be Tedious
When working with fractional ownership, the selling process is not as easy as whole ownership. Even though selling fractional ownership is not as hard as selling a timeshare, you need to research to check on how the ownership is structured and evaluate the various restrictions that apply.
This is in regard to the selling process. Selling individual shares could also be problematic. In some cases, owners could disagree on the selling criteria. This means you will spend endless hours discussing the ideal selling criteria.
There Could Be Restrictions
Fractionally owned properties could be subject to various HOA restrictions. For instance, it could be banned in certain areas or faced with extremely high tax rates. This could significantly affect the income value. When fractional ownership is banned in a certain area, it means you cannot implement it there. This will limit you to certain locations that could not be as profitable.
Another restriction could be being tied to a single location. Mostly, fractional ownership is tied to a single property. If your family likes this arrangement, it can be extremely limiting. Some of the properties are part of the exchange program, meaning that owners could trade their shares whenever they feel like it. The location problem could also force owners to trade their shares at very poor prices.
Fractional ownership has emerged as a reliable way of owning property. Through this arrangement, you get to co-own a property with a number of other investors. Depending on how you see it, fractional ownership comes with several advantages. For instance, it makes it easier to own a property. Through it, you spend less to get a highly valuable commodity.