Family ownership of investment real estate in the United States has existed for centuries but developed further in the decades after World War II as the 30-year mortgage became the standard for investment property. Individual landlords became a means to garner extra income and secure a healthy retirement.
But real estate appreciation over the past few decades has been a double-edged sword. While it’s made many individual rental property owners wealthy, it’s also made new real estate investments far more unaffordable for Mom-and-Pop operations. One new trend that has emerged as an alternative and could be the future wave is Fractional Ownership of real estate. What is Fractional real estate investing and why is it more attractive as an investment option in 2024?
How Does Fractional Ownership Work?
Fractional Ownership of Real Estate involves asset sharing among a group of people. Each person owns a small part of a real estate asset and shares its benefits, such as rental revenue and appreciation. A sponsor company acquires the asset, divides ownership into shares or units and then sells the shares to individual investors. The money raised pays down debt and funds ongoing operations. Net income from the operations is then returned to the individual investors as dividends per share.
To get started with fractional real estate investing, choose a platform, select the investments that hold your interest and then purchase some shares in those investments. Over time you will begin to earn returns.
Benefits of Fractional Ownership
The 2008 real estate crash changed the market as institutional investors, incentivized by government discounts and long-term profit potential, bought many foreclosed homes. As home values rose and inflation drove up interest rates, the affordability of investment homes became more challenging for individuals.
At the same time, Crowdfunding websites showed that one could accomplish financial goals as part of a larger community where individuals pool small amounts of money together to fund expensive projects. Enter fractional real estate ownership with startup real estate platforms such as Arrived Homes, which had the backing of Amazon.com founder and CEO, Jeff Bezos. The benefits of Fractional Ownership are many and include:
- The ability to acquire real estate with far less capital upfront
- The ability to choose how much you want to invest, rather than a fixed down payment
- The sharing of any maintenance or management costs
- Access to acquiring assets of greater value
- The potential to generate steady income and appreciation
- Property management typically takes care of all rent collection, repairs and other day-to-day landlord operations
- Diversification of property locations to reduce risk and enhance profit potential
With programs like Arrived Homes, an individual investor receives shares of a large portfolio of single-family rental homes for as little as $100. Investors receive a monthly dividend and appreciation from potential changes in property values at the end of the investment holding period. Some other fractional ownership organizations include Mogul Club and Fundrise. You can find real estate investing apps that have different strengths.
Some investors purchase real estate investment trusts (REITs), bought and sold like any other stock. REITs allow an investor to own shares in a portfolio of commercial or residential properties.
Potential Returns For Investors
The potential returns for fractional ownership investors will vary, depending on many factors, such as location, property type and the changing of real estate market cycles. Property values can rise or fall in the short term and the rents that properties garner can also change with shifts in supply and demand or an economic cycle.
For example, during a harsh recession, rents often decline as tenants move out to return to living with their parents or share a space with a roommate. On the other hand, inflationary periods, such as the one from 2021 to 2023, often trigger large rent increases.
To understand the potential returns for investors, it’s good to study the history of the company that owns and manages the fractional ownership properties. One example is Arrived Homes, which posts its historical performance on its website. Total returns (dividends paid plus appreciation) for six properties held for 41 months ranged from 70.6% to 166.2%. Among those held for 35 months, the total returns ranged from only 1.0% to 87.1%. Several homes held for less than 27 months had negative returns and most were in single digits.
The annual rental income for homes with the best returns ranged from 6% to 8%. However, among the homes with negative total returns, the annual rental income generally ranged between 2% and 4%.
Therefore, it seems best to be selective in which markets one invests and homes may need to be held for at least three years or longer to see better returns. The average long-term return on these properties is typically between 6% and 10% annually, with about half of that return coming from rents and the other half from appreciation. Vacation rentals have a slightly higher total return than single-family homes.
With a starting investment of $10,000 and an 8% annual return rate, after 10 years of investing one would have $21,589.25. After 15 years, the return would be $31,721.69 and after 20 years it would be $46,609.57.
One of the Arrived Homes properties that has performed the best has had a 119.9% return. Since its inception in 2019, a $1,000 investment in this property would have produced a profit of $2,199.
Challenges of Fractional Ownership
Like all forms of investing, fractional real estate investing has some risks and disadvantages that an investor should understand. These include the following:
- Limited access and flexibility as decisions about your properties are made by others.
- Illiquid asset. These are long-term investments with holding periods of several years. Earlier redemption may be possible but may incur fees and isn’t guaranteed.
- Limitation on personal use of the properties
- Potential for a loss of value or smaller dividends distributed if rental prices decline
- Potential for higher fees and expenses
Fractional Ownership vs. Buying Property
There are many similarities between fractional ownership and buying property as an individual. In both cases, you will receive a deed for your share of the property. Each real estate investment should provide the investor with rental income and potential profit from long-term appreciation. Something to keep in mind- real estate is considered an illiquid asset, whether purchased as fractional ownership or bought in full by an individual, because, unlike other investments, such as stocks, it cannot be sold within just a few seconds. After the holding period, it’s easier to sell the shares in fractional ownership than to sell a home. Finally, in both types of real estate investing, there are tax benefits the individual can utilize.
However, there are just as many differences between fractional ownership versus buying property. When you buy a property, you bear 100% of the costs and ongoing expenses versus a fractional share. However, in contrast to having 100% of the expenses, you also gain 100% of the rent plus appreciation, as opposed to simply having a fractional share. Buying a property gives you complete control over all decisions, such as whether to pay cash or take a mortgage, refinance a mortgage or wait for lower interest rates and choosing or evicting your tenants.
Another large difference between buying vs fractional ownership is the time spent caring for the property. Since fractional ownership usually involves employing property management, one does not have to deal with tenants’ problems, take phone calls about repairs or collect the rent. It’s a far more passive investment than owning 100% of a property. For investors with limited time or who don’t like the occasional hassles of owning a property outright, fractional real estate investing is the better choice.
Embracing Fractional Ownership in Real Estate Investing
Fractional Ownership of real estate is a relatively new alternative to buying real estate with the advantage to the individual of being far less costly, less time-consuming and with no property management hassles. Hundreds of thousands of investors have already signed up to purchase shares and this alternative has grown stronger each year. It looks like fractional ownership could be the future wave, especially if home prices and interest rates remain high.
There are a few negative aspects, such as its illiquidity, which entails a major commitment because the required holding period is often several years to avoid a fee and realize a significant profit. So, if you cannot afford to buy a rental property, don’t despair—just contact one of the many Fractional Ownership companies that own a portfolio of properties.