What Investors Should Know About Fractional Real Estate Investing in 2023
April 14, 2022
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Fractional real estate investing can be a great way to become a real estate investor without requiring a lot of capital. If you have only a little money to invest but want to take advantage of the real estate industry, becoming a fractional investor may be the answer for you.
Fractional Real Estate
If affording an entire piece of commercial real estate seems out of reach for you, fractional real estate investing might be just what you need. With fractional ownership, you own a portion of a real estate property alongside many other investors. It's a great way to get into real estate investment without requiring a lot of capital.
Fractional ownership companies help individual investors own real estate without coming up with a large amount of capital or qualifying for commercial real estate loans, which can be hard to do. When you pool your money together, you can invest in large commercial real estate buildings that have the potential to bring in monthly income.
What Is It
Fractional ownership occurs through a sponsor, such as a REIT or private equity firm. The firm buys the real estate through its LLC, and investors purchase shares of the commercial properties to become real estate investors.
Individual investors don't have to do anything except choosing the investment they want to invest in. You aren't responsible for property management, property taxes, insurance, or anything else that comes with commercial real estate property ownership.
How Does It Work
As an owner of fractional real estate investments, you may earn rental income, cash flow, and equity when the LLC sells the property.
You have prorated access to the property's value and income as a partial owner. Of course, like any investment, there isn't a guarantee of income - renters can default, properties can become vacant, or LLCs can make poor investment decisions, so always factor that in too.
Overall, though, real estate investors may enjoy regular dividends and cash flow along with equity buildup and capital appreciation throughout the life of the investment. Of course, each sponsor does it differently, but you might earn regular monthly payments for rental income and periodic payments of equity buildup too.
You are tied into the investment until the sponsor sells the property. It helps to find fractional investments that are transparent in their fees and investment requirements, so you know the timeline required of you. Unlike alternative investments, you could be tied into real estate for quite some time, so always read the fine print.
Fractional Real Estate vs Private Equity
Fractional real estate investments and private equity can be one and the same. However, private equity is just one form of the fractional ownership model. With private equity, real estate investors buy shares of the company to invest in the properties the company invested in.
Fractional real estate means you own a fraction of the property rather than having sole ownership. You aren't entitled to 100% of the income or capital appreciation but instead share it with the other shareholders too.
Fractional Real Estate vs Co-Ownership and REITs
There are many ways to own real estate, including fractional ownership, co-ownership, and REITs or real estate investment trusts.
Co-ownership, while it sounds similar to fractional ownership, includes shared time with the property. You can own the property with multiple owners, but you each have your own time allotted to use the property if you desire. If not, like fractional ownership, you each earn a portion of the property's income from rental income and capital appreciation.
Co-ownership is more common with a vacation property. It can make more sense for many people to invest in a second home or vacation home as co-owners. This way, no one takes on 100% of the responsibility of the home, and the home sits vacant for much less time. In addition, with more people taking turns using the property throughout the year, there's a lower risk of vandalism or excessive wear and tear from no one using the property.
REITs are investments in a trust or company that buys real estate investments. REITs buy commercial real estate or income-producing real estate. REITs are required to share at least 90% of their profits with shareholders, and a majority of their business must be conducted in real estate.
You can buy publicly-traded REITs on the stock market like you would stocks or buy private REITs through a broker associated with the investment.
Fractional Real Estate Pros
There are many benefits of investing in commercial real estate as a fractional investor. Understanding the pros can help you decide if it's right for you. Since you have many investment opportunities available to you, it helps to weigh the pros and cons. The benefits of fractional investing include the following.
Access to Institutional Quality Assets
You can afford a much higher quality investment property with a fractional investment. For example, instead of investing all your capital in residential real estate, you might take that same money and invest it in a fractional investment of commercial real estate, such as a successful shopping mall.
Most single investors can't afford an investment in something so large. Therefore, institutional quality assets are usually reserved for accredited investors or investors with at least $200,000 in annual income and/or $1 million in assets.
Fractional ownership companies make it easy for the everyday investor to take advantage of larger commercial real estate investments, though.
When you invest smaller amounts of money in multiple properties, you can diversify your portfolio. When you diversify, you avoid putting all your eggs in one basket. For example, instead of investing all your money in one property, say residential real estate, you could split up your investments and invest in multiple commercial properties opening up the possibilities for more income opportunities. This also helps offset the risk of a total loss.
In the fractional ownership model, you aren't responsible for the property management of the properties. Instead, the LLC handles the ownership and management. Then, all you have to do is collect your monthly income from rent or capital appreciation when the property sells.
This is one of the simplest forms of passive income, but of course, it comes with its risks. A passive investment is nice, but you should always consider the risk of loss and ensure that it's worth what you'd give up for other investments.
Fractional Real Estate Cons
Fractional owners typically have to commit to a long-term investment with fractional investing. Unlike shares that trade on the stock market, you are locked into your investment until the sponsor sells it. Some may offer an early redemption program, but it's rare, so you must be willing and able to tie up your funds in the real estate market for the investment's duration.
There's risk with any type of investment, but investing in rental property can be even riskier. For example, you might invest in real estate properties with high vacancies, tenants who default on their rental payments, or businesses that fail without proper due diligence.
There's the risk of not filling the property fast enough or not doing enough due diligence on a tenant to make sure they have good enough credit to withstand the rent payments.
Most fractional investment sponsors charge fees to cover the cost of their administrative expenses and startup costs. Each sponsor charges different fees, and each property has its own fees too, depending on the work involved.
Not all areas allow fractional investments in real estate. You might find that you can't invest in partial real estate investments in the area you are interested in investing in. You won't know until you look at the actual property and find out the rules in the area.
How Much Should I Invest?
Fractional ownership companies each have minimum investment requirements that could vary by property as well. Decide how much you are comfortable investing before you look for opportunities to invest in fractional investments to determine how much is right for you.
Like any investment, it's best to diversify your investments so that you don't have a high risk of loss. The more properties you invest in, the more you can offset a loss, such as a non-paying tenant or a business that goes under.
Can I Make a Lot of Money on Fractional Real Estate?
No investment has a guarantee of making you a lot of money. Fractional owners often make a decent income, especially with increasing property values, but there's never a guarantee. A property's rental income, the reliability of the tenant, the property value, and the number of fractional investors in on the investment all play a role in how much money you make.
Can You Get a Mortgage for Fractional Ownership?
Getting a mortgage for fractional ownership can be difficult. You're better off investing only as much capital as you have, looking for investment platforms that accept the amount you have to invest rather than trying to find a mortgage for fractional owners.
How Are Fractional Ownership Usage Rights Divided?
Fractional owners have identical rights, but they are divided by the percentage of the property you own. If you invest as a co-owner, you may each have equal rights to use the property for a certain amount of time each year. If you own multiple properties, you have rights to the profits of each property after the other expenses are deducted from the profits.
The Bottom Line
Fractional real estate investing can be a great way to become a real estate investor without a lot of capital. You won't have to worry about property management, collecting rents, or the daily maintenance properties require. Instead, you sit back and enjoy a passive investment as a real estate investor. Learn more by signing up and visiting our blog.
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