For some people, the term “Fractional Ownership” may bring nightmares of late nights trying to learn the “new math” being taught to their kids in school, but my hope is that after reading this article you will understand how this strategy for purchasing Real Estate can make your vacation dreams come true.
To understand the concept of fractional ownership, we need to look back at the origin of vacation rentals first developed in France and Switzerland in the early 1960’s when Alexander Bette and his partner Dr. Guido Renggli created a company named “Hotel-und Appartementhaus Immobilien Analge AG”. Their novel idea gave travelers the rights to share “time” on a right-to-use contract at properties they purchased all over Europe. The concept of timesharing made its way to the United States in the 1970’s where over the next 30 years it later developed into a multi-billion-dollar industry as travelers began exchanging their purchased time at their resorts with other travelers from other destinations around the world.
The 2000’s introduced vacationers who were seeking more choice and less commitment to travel discounts through websites like Priceline.com and Expedia.com. These websites opened the door to travel rental portals like Airbnb and Vrbo that facilitate homeowners to share their homes with vacationers for a nightly profit. In turn, this gave rise to a new industry of vacation rentals where travelers felt more confident and accustomed to staying in strangers’ homes and homeowners looked to turn a profit. Case in point; I have a good friend who in 2014 began renting out his home during the Sundance Film Festival in Park City, Utah for $1500 per night – which in turn funded his annual family vacation to anywhere they wanted to go. Although, my friend’s example is an outlier, this began the time when I had clients looking for vacation properties where they could enjoy a second home and rent it for a profit when they were living their normal daily lives.
According to Inc.com, in 2014 alone, Airbnb owners hosted 10 million guests and their website surpassed 800,000 listings worldwide which means they offered more lodging than Hilton Worldwide or InterContinental Hotels Group or any other hotel chain in the world! Fast forward to 2021 and ipropertymanagement.com reports Airbnb owners offer over 5.6 million properties to vacation to in over 100,000 cities and over 200,000 countries!
It only makes sense that with the demand for home sharing that homeowners and investors alike have jumped on the opportunity to own a second home and have the mortgage payment supplemented through vacation rentals. Keep in mind, vacation rentals come with their own list of challenges such as property damage, poor guest reviews, property management fees, and most recently in cities in Utah such as St. George, Midway, Heber City, and Park City there are restrictions on the ability to rent residential properties on a nightly basis.
As the demand for vacation homes increased, we began seeing home sharing owners try to separate their properties from the rest of the available homes by increasing the quality of their furnishings, adding amenities, and the overall experience for the traveler. With this increase in quality, builders and home sharing owners alike began raising the sales price of their properties to the point where potential buyers were getting priced out of the market in order to be competitive. By 2018 the next evolution into luxury vacation ownership began to take hold in the United States – Fractional Ownership. Luxuryfractionalguide.com states that, “in the United States, fractional ownership started in the 1980s. It began primarily in New England and Canadian ski areas; then it spread in the 1990s to western United States ski areas. By 2000, national luxury hotel companies Ritz-Carleton and Four Seasons, as well as others, began offering properties, further augmenting the image and value of fractional ownership.
During the same period, the fractional ownership concept extended to other industries. Jet and yacht industries ran successful advertising campaigns convincing consumers of the benefits of purchasing super-luxury possessions with shared ownership. The fractional method of ownership became associated with luxury and glamor and living the lifestyles of the rich and famous.”
How is Fractional Ownership Structured?
The concept of fractional ownership becomes very appealing when you consider that the average person only uses their vacation home 4-5 weeks per year. It hardly makes sense to purchase a second home as its sole owner – especially if cities are now placing restrictions on short term rentals that can be accessed through Airbnb or Vrbo so those properties can no longer generate an income when not in use. In order to purchase a property in a fractional ownership, several unrelated individuals agree to purchase and share ownership of the home through a third party. They do this by forming a legal entity such as an LLC where each member owns a fraction of the title (most often 1/8 or 1/12) and everyone shares in an additional amount annually to cover a percentage of the fees for maintenance and upkeep. Property owners have access to the property as set forth in the Articles of Organization of the LLC. Companies such as Pacaso and Ember in Utah have simplified this process and can also coordinate the scheduling of the property, regulatory filings, and payments of insurance and property taxes. When fractional owners desire to use the home, they schedule time through their management company – which in some ownership agreements can be coordinated as far as 24 months in advance. Owners can use all of their time or allow friends, family members or in some cases even rent out their remaining time to other owners or third parties who are not owners.
Fractional Ownership vs. Timeshares
Below is a list comparing fractional ownership to timeshare ownership:
| Category | Fractional Ownership | Timeshare Ownership | Comments |
|---|---|---|---|
| Number of Owners | Typically, 2-12 shareholders with the LLC. Owners can own multiple shares/fractions. | Most commonly 52 owners – 1 owner per week owned. | Fractional owners have a higher financial commitment and are willing to pay higher costs. |
| Usage Availability | 4-8 weeks depending on the number of owners | One week per year. | Fractional Ownerships have less wear and tear with fewer occupants. |
| Equity | Owners have a share of the title, based on the number of owners. | No property equity. | Timeshare ownership is usually a vacation purchase that eliminates hotel expenses. Fractional ownership is an investment in real property. |
| Management | Owners have control over property management as dictated in the Articles of Organization of the LLC. | Project developer or hotel operator maintains management control. | Fractional owners are typically willing to pay higher annual management expenses. Check with a tax advisor to see if these fees can be tax deductible. |
| Maintenance Expenses | Owners pay maintenance expenses and taxes on the property – typically in an annual fee. | Maintenance expenses and taxes are paid in monthly fees. | Timeshare owners must expect monthly fees to increase every year. Fractional owners have a budget set aside and can decide how expenses and payments are allocated. |
| Resale Value | As property values increase, so does the potential resale value. | Resale is difficult even at reduced prices and most often must be handled by a timeshare specialist. | Intense competition for timeshare resales from other units and new developments. Fractional Ownership allows for greater access without having to join a club. |
| Property Quality and size | Higher quality and larger vacation homes. | Usually one or two-bedroom units with basic quality. | Owners of fractional shares have an incentive to maintain the property in good condition. |
| Most attractive feature | A less costly alternative to whole ownership of a vacation home. | An affordable alternative to hotels for vacation. | Buyer must decide which type is best based on objectives for the property. |
One of the most in depth and well thought out references I have found for understanding and the overall pursuit of fractional ownership was published by Andy Sirkin of Sirkin-Law. The Sirkin-Law website has various questions and answers addressed here and I would encourage you to fully investigate this site before making any decisions.
I would love the opportunity to discuss vacation rental strategies with you as an investment or for recreation - if you have any questions, please contact me at brandonrwood19@gmail.com or 801-885-2558.