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Fractional Ownership 101

What is Fractional Ownership?

Fractional ownership is an arrangement where a group of individuals or families co-own and share use of a vacation home or condo. Sometimes these arrangements are organized by the users themselves, but more frequently they are set up by a property owner or developer who outfits the property, creates the legal structure and documents, then offers the fractional interests for sale. Contrary to what you might think, groups of complete strangers who come together through these packaged offerings are generally much more successful at co-owning and managing the shared property than groups of friends or family members.

Why Consider Sharing a Vacation Home?

Statistics show that most people only use their vacation home 17-30 days each year. Shared ownership is appealing because it allows people to own only the share of a vacation home that they will use, rather than the entire property.

What Are The Benefits of Fractional Ownership?

The main benefits of fractional ownership are:

  • Lower Acquisition Costs: Buying a fraction of a property means the buyer pays only a fraction of the cost of the entire property. In addition, the costs of renovating, furnishing and outfitting the property are shared by the owner group. Although the per-share cost of fractionals packaged by a property owner or developer sometimes includes a “markup” (on average the total share price will be 110-250% of the cost of the home and contents), they are still a good deal for most buyers because they avoid the time, effort and difficulty of outfitting the property, creating the legal structure and assembling the owner group.
  • Lower Operating Costs: Owning real estate involves ongoing operating costs such as property tax, insurance, utilities, and maintenance, including the cost of repairing and replacing the furniture and other household goods inside. Maintaining a vacation home can be particularly complex because of intermittent usage and the distance between the owner and the property, often requiring the assistance of a local manager or management company. Sharing the cost and efforts of operating dramatically lightens all these burdens.
  • Eliminate or Diminish Need for Rental Tenants: Most vacation homeowners face the unpleasant decision between leaving the property vacant when it is not being used by the owner or renting it out. As anyone who has been involved in vacation rental knows, the rental option has significant downsides. Do it yourself, and you spend innumerable hours promoting the rentals, responding to inquiries, handling bookings, checking tenants in and out, and readying the property between tenants. Hire a manager or rental agency and you will generally give up 30-50% of the rent. Either way, the tenants extract a significant toll on the property, and the rental periods most demand are the same ones when you would prefer to use the home yourself. While some fractionals allow owners to rent out their homes when they are unable to use it, the lower cost of buying and owning a fractional means that most owners do not need to use this option.
  • Diversification of Investment and Destination: Fractional ownership allows the money that would have been needed to own and operate a single vacation home to be spread over two or three vacation homes. Spreading your dollars over several homes lowers investment risk and increases the likelihood of profit by exposing you to two or three different real estate markets. Moreover, owning vacation homes in several locations gives you more vacation options each year, while still allowing you to spend your time in your own homes where you are comfortable with the surroundings and know how everything works.

The benefits of shared ownership are so compelling that many people who could easily afford their place are opting for fraction ownership instead. Perhaps even more surprising, many people who already own a vacation home are choosing to sell some fractional interests in it to lighten their cost and management load and still use the property just as often as they ever did.

How does Fractional Ownership Work?

Fractional owners agree to a system to allocate the benefits and obligations associated with their shared vacation home. The most important benefits to be allocated are usage and, if the home will be offered for rent, income. The most important obligations to be allocated are costs and management duties. The owner agreement also describes how decisions will be made, if and how owners will be allowed to sell or gift their ownership interests, and the circumstances under which the owner group would sell the entire property.

The agreement can be set up so that only the owners and their families can use the house, or can allow unaccompanied guests or rentals either some or all of the time. Owner use can be structured as: (i) exclusive, meaning that the entire house is assigned to a particular family during that family’s usage periods; (ii) non-exclusive, meaning more than one family can use the house at the same time (perhaps with assigned bedrooms or areas of the house); or (ii) some combination of exclusive and non-exclusive.

Having a system to determine when each family gets exclusive use time is also important. Usage assignment can be fixed (meaning the Smiths get February every year), variable (meaning the Smiths different days or weeks each year), or a combination of fixed and variable. Variable use can be based upon a rotation schedule, annually-made selections using a rotating priority system, an open reservation system where families reserve the home on a space-available basis subject to a system a rules created to ensure fairness, or any combination of these approaches.

To avoid disputes and cash shortfalls that could result in credit blemishes and even loss of property, fractional ownership groups collect periodic payments based on a budget system rather than “as needed”. This means that each year the owners or a manager estimate(s) the expenses for the following year and determine the amount that will be needed from each co-owner to pay the bills. The budget should include some reserves for long-term recurring expenses such as painting, roofing, system upkeep, and furniture and houseware replacement. Each owner then makes a payment (either annually or on some other pre-determined schedule) based on the budget. The owner agreement also assigns responsibility for ongoing management duties such as bill paying, maintenance, etc.

Source: Andy Sirkin Law