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How does fractional ownership work in real estate investing?

Yahoo Personal Finance· Getty Images
9 min read

Fractional ownership is a real estate investing strategy involving multiple investors who own pieces of a single property. By pooling their resources, investors can get an ownership stake in properties they may not otherwise be able to afford.

Some people use fractional ownership to pool their money on an expensive piece of real estate, like a vacation home. A growing number of online platforms are also making it easier than ever to buy fractional real estate.

Is this ownership model for you? We’ll cover how fractional ownership works, the pros and cons, and how you can invest.

Fractional property ownership is a way to get into real estate investing by buying a partial stake in a property, even one that may otherwise be out of reach.

The ownership model is nothing new. For example, if you and two friends bought a vacation home using a tenancy-in-common ownership structure where you’re each co-owners with a 33.33% stake, you’d all be fractional owners.

Technically, timeshares are a form of fractional ownership. But properties that are marketed as fractional real estate are often expensive vacation homes or resorts called private residence clubs. A management company usually handles the day-to-day issues that crop up, so you avoid many of the hassles that come with property ownership.

Meanwhile, you can build equity and earn rental income without making a large up-front down payment.

Though there are several types of fractional ownership in real estate, here’s how the process of buying property and splitting it into fractional ownership interest typically works:

  1. A sponsor creates a legal entity to buy real property, like a limited liability company (LLC) or a limited partnership.

  2. The entity buys property and divides it into shares.

  3. The entity sells property shares to individual investors.

Some people buy fractional real estate solely as an investment. If you buy a rental property, you can earn monthly rental income based on your share. If the property sells, you get a portion of the profits that corresponds with your investment. You’re also responsible for paying your share for maintenance, repairs, and other ongoing expenses.

With other fractional ownership arrangements, the primary benefit is usage rights to a property. For example, if you bought into a private residence club with nine other investors and you each owned equal shares, you’d probably be able to use the home for about five weeks a year.

A growing number of startups allow you to invest small amounts in individual properties solely for the potential capital gains and rental income. These platforms are similar to crowdfunding sites that allow multiple investors to pool their money to fund real estate projects.

For example, Jeff Bezos-backed Arrived buys single-family homes and vacation properties, then splits them into fractional shares and lists them on its marketplace. With a minimum investment of $100, you can earn dividends that are paid monthly, as well as capital gains if the property sells for a profit. Investors can also choose portfolios that consist of multiple homes instead of focusing on individual properties.

Another startup, Lofty, bills itself as an online marketplace. The platform lets property owners transfer ownership to an LLC via a quitclaim deed, though they’re required to maintain a 10% stake. Lofty lists the property and allows investors to buy shares. Investors can then collect rent based on their share of ownership. Lofty requires at least a $50 investment, made through digital tokens.

There are key differences between traditional fractional ownership and timeshares.

Namely, who holds the deed. Fractional owners of a vacation property or second home get deeds and ownership for their share of the residence. With many timeshare purchases, you’re buying the right to a certain number of days’ use of the property, but the developer holds the deed. Timeshare owners typically don’t get an actual stake in the real estate.

However, some timeshares provide deeded ownership. For instance, if you’re allowed one week a year at a timeshare, you’d get a deed for 1/52nd ownership of the property under these models.

Often, the term “fractional ownership” is applied to higher-end properties and involves fewer owners than a timeshare. Because you’re sharing operating costs with fewer people, fractional ownership usually costs more than a timeshare.

With fractional ownership, an entire property is divided into shares. Buying a condominium unit gives you full ownership of the interior of your unit, whereas you and other condo owners each own an interest in common areas.

A condo is a real estate asset that comes with all the rights and responsibilities of home ownership, including taxes and homeowners insurance.

REITs, or real estate investment trusts, are another way to invest in property without paying for the full costs of ownership. REITs are companies that invest in an array of income-producing properties. Many REITs are publicly traded on the stock market.

While fractional real estate investors own pieces of individual properties, REITs generally invest in commercial real estate, rather than single-family residences and vacation homes.

Yahoo Finance tip: Fractional ownership isn’t unique to real estate investments. Some people use similar ownership agreements for assets like private jets, yachts, RVs, or fine art.

Before you toss your hard-earned money into fractional real estate, it’s important to weigh the pros and cons.

  • You can invest in real estate for less money than it would cost to buy an entire property. Some platforms allow you to buy fractional interests in properties with as little as $50 to $100 — similar to the way you can now buy fractional shares of stocks with many brokerage accounts. Even if you’re buying fractional ownership in a property that allows you usage, you can limit the amount of your investment.

  • Hassle-free real estate investing. A property management company typically handles issues like upkeep and repairs with fractional real estate. You can sit back and earn passive income through dividends or rent. You can also earn a share of the capital gains if the property sells for a profit.

  • Ownership rights plus use of the property. When you have fractional ownership of a vacation home, you may have the right to stay in the property for a few weeks each year or sell your allotted weeks to someone else.

  • You can diversify your real estate holdings. If you’re using a fractional investing platform, you can put small amounts into multiple properties to build a diversified real estate portfolio.

  • Less potential for big gains. Because you’re splitting ownership with other investors, you’ll have to split profits and rental income, as well.

  • Lack of control. Co-ownership means you won’t have full decision-making power on property management issues, including maintenance and budgets.

  • Management fees. In addition to paying property management fees, you’re on the hook for maintenance and repairs.

  • Difficult to finance. Many banks and credit unions won’t give you a mortgage for fractional ownership, so you may need to find a lender that specializes in this niche.

There are several ways to invest directly or indirectly in fractional real estate, including:

  • Buy a house with friends or family members. You and your loved ones could go in on a home purchase and split the costs. Anecdotal evidence suggests that a growing number of first-time buyers are using this type of ownership to deal with housing affordability issues.

  • Buy a property that’s already split into shares. Buying a piece of a home or vacation property allows you to get a portion of rental income and sale profits.

  • Invest in REITs. Real estate investment trusts, or REITs, invest across many different income-generating properties. Most are publicly traded on stock exchanges, so you can buy shares using your brokerage account. Since you’re essentially investing in a stock, you won’t get use of a property by investing in a REIT. But you can often invest in tiny fractions of hundreds of properties by purchasing a single share.

  • Real estate investment platforms. Fractional ownership platforms allow you to invest in small portions of individual properties. Similarly, crowdfunding platforms allow you to become part investor in real estate projects.

Investing in fractional real estate isn’t for everyone. However, you might want to consider investing if:

  • You want consistent access to a vacation home but don’t want to pay for an entire property.

  • You’re seeking passive income.

  • You want to diversify your portfolio, but you have limited funds to invest in real estate.

There’s always a risk of losing money when you invest. A real estate investment can lose value if the housing market tanks or your local market encounters tough times.

Fractional ownership can come with additional risks because selling property can be difficult. Because you’re dealing with co-owners, there may be rules about selling your property. There’s also the risk that a potential buyer could have trouble getting financed to purchase your share.

Your returns in fractional investing will depend on a number of factors, including what size share of the property you own, whether you rent out the residence, the property’s appreciation and any fees you pay to a management company.

Let’s say you and nine other investors buy equal shares in a $1 million property, meaning each person contributed $100,000. If the property was worth $1.5 million a decade later, you could sell your share for $150,000.

But that doesn’t necessarily mean you earned a 50% return. You’d need to factor in the cost of things like property management fees and upkeep that you incurred over the years. On the flip side, your returns would likely be more than 50% if you’d rented out the property.

Is fractional real estate a good investment?

Fractional real estate could be a good investment if the property’s value appreciates over time, particularly if you use it for rental income. But as with any piece of real estate, poor market conditions or unforeseen maintenance issues could cause your investment to sour. Selling shares of fractional real estate can also be more complicated than selling a regular property.

Do banks finance fractional real estate?

It depends on the financial institution. Some banks finance fractional properties, while others don’t. But even if a lender offers fractional property loans, there may be stricter requirements compared to getting a mortgage on a primary home.

What are the disadvantages of fractional ownership?

One potential drawback is that you’ll have to share decision-making about things like decor, landscaping, and upkeep with multiple co-owners. You also may need to pay fees to a management company, which can chip away at your returns. Financing and selling fractional shares can also get complicated.