What is fractional ownership?
Fractional ownership allows individuals to buy a share of a home. For instance, if a home is listed on the real estate market at $600,000, and six equal shares of the home are for sale, each share would sell at a price of $100,000.
For that price, shareholders would have exclusive access to the home for 1/6th of the year, or two months.
Generally, properties are sold through property management companies who will tend to affairs such as maintenance. However, the associated costs must be divided among the owners.
As the value of the property increases, so does the value of your individual share.
Another way to take advantage of fractional ownership is to purchase a share of a residence, then rent it out. By doing this, you can use the rental income to pay for your share. Meanwhile, any profits can be used for future investment into your own residence.
To avoid conflict, the investors should draft very clear agreements regarding the property. If, for instance, there is no clear agreement made about scheduling, owners might find themselves arguing about when they can access the property.
Further complications can arise when it comes time to sell the property, or when an individual wishes to sell their individual share. Because of these complications, it is critical to have clear agreements written up in advance of investing.
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Shared equity agreements
A variation of fractional homeownership is shared equity agreements. In these instances, you once again purchase a share of a home, but you only have purchased equity into the residence.
If, for instance, you want to purchase a home but it is just out of reach, you might consider getting a shared equity mortgage. As a borrower, you would be required to live in the residence you purchase. The lender is, effectively, hands off, but if the arrangement is such that they contribute to the mortgage interest, they could potentially claim the interest on their taxes as a deduction.
Any equity in the property would then be split amongst the owner and investor, based on the agreed upon shares.
This is a great way for first-time homeowners to get into the housing market, but there are numerous risks associated with it.
Shared equity drawbacks
With a shared equity agreement, you must pay back the shares to the investors when it’s time to sell your home. So any profit that you have made needs to be distributed proportionally to the lender. This means that you will ultimately make less profit when the house is sold, and therefore have less equity for purchasing a new residence.
This drawback can make it difficult to make gains in the real estate market, especially for people who have growing families. While the home you have might be the right size for you presently, you may outgrow it as your family expands.
In order to purchase a bigger home, you will typically require a greater down payment and higher mortgage payments. Because of shared equity in your original residence, you may discover that you’re in the same position you were when you purchased your first home.
Another drawback of a shared equity mortgage is that as the owner-occupant of the dwelling, you might be required by your state to pay the lender rent proportional to their equity.
For instance, if your co-investor has contributed 1/5th of the value of the home, you would be required to pay fair market value in rent for the same amount of the dwelling.
Paying rent on part of your home can be looked at in similar terms to having to pay condo fees. It’s important, however, that you factor in this additional cost when considering a shared equity mortgage or shared equity agreement. If you don’t, it’s possible that you’d end up paying more for your home than you anticipated.
How to invest in commercial real estate
If you are looking to get into the hot housing market, but can’t afford to invest in a house for yourself, there are various companies that allow you to become an investor without the obligation of ownership.
This “real estate crowdfunding” allows you to purchase a share in a residence from a company, and that residence is then rented out to a tenant. Any interest that is made from rental income is distributed among shareholders, and when it comes time to sell the property, shareholders split in the dividends.
There are often “membership fees” associated with this form of investment. The fees help pay the operational costs for the parent company. Additionally, you might have to lock into owning your shares for a certain time frame, so you won’t be able to sell until this time has elapsed.
While you don’t actually own a physical place you can call home in this model, it will allow you to get your foot in the door on real estate investments.
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