Fractional real estate investing: Pros and cons

Breaking into real estate is one way to significantly increase your passive income. But it usually comes with an upfront cost: some serious capital to get started. Not everyone has the cash on hand to buy a home, renovate or remodel, and then either rent it out or flip it.

But another way to get into the market is through fractional real estate investing. If you want to start your real estate venture but don’t have the capital, fractional real estate investing might be worth considering. Here are the pros and cons and what you need to think about before you start.

What is fractional real estate investing and how does it work?

Fractional real estate investing is when many different investors split the cost of a property among them. Sometimes they may be called shareholders, depending on the exact legal arrangement. You might see the concept used for other things, such as private jets and sports cars. Partial ownership gives you a stake in the real estate and makes you a part-owner.

Fractional real estate investing can differ depending on the group of investors or organization you invest with. Fractional real estate may mean that you get a deed and equity in the property, but it may also mean that you can buy shares in a property. In this latter case, the property is typically operated by a management firm, making it more of a turnkey operation for owners.

In some cases, your fractional ownership interest entitles you to stay in the property, say, for vacation, for a portion of the year. In other cases, you can invest in the properties with no intent to actually stay in them. In either case, you can enjoy the benefits of ownership while someone else does the heavy lifting of managing the property and preparing it for the next guests.

If you’re looking to be more hands-on, you can take ownership and manage it yourself, renting it out, perhaps on Airbnb or VRBO, or using it as a retreat for yourself, when it’s unoccupied. And don’t confuse it with a timeshare, which just grants you use of a property at a certain time.

Popular sites in the space include Arrived, Ember, Fintor as well as Equity Estates. Each offers a version of fractional real estate investing that might be more in line with your needs and goals.

If a property is carved up into many shares and then securitized, the number may be based on how many shareholders are willing to put money into the home. That could be 10, 20, or more. For homes that are a purely financial investment, properties could be sliced up into any number of shares and sold to investors. So you may want to look for the set-up that meets your needs.

Of course, if you simply want to own a financial interest in real estate, then going with a real estate investment trust (REIT) is a great option, especially a publicly traded REIT.

Benefits of fractional real estate investing

If you’re looking to get into fractional real estate investing, consider the pros.

Lower barrier to entry

Rather than come up with a significant down payment yourself, you can split the cost among a few investors. If you have enough people, you could buy the property outright in cash and avoid taking out a mortgage.

Guaranteed second property

If you’re looking for a vacation home that you can visit when you’d like, fractional real estate gives you that choice. You may have to make some compromises and conditions, but if you’re on the deed and own part of the property, you have the freedom to use it almost as you wish.

Passive income

If you and your other shareholders agree to terms, you can set up the home as its own vacation rental, manage it yourself or even hire a professional management company. This set-up could get your original investment back plus become your side hustle or passive-income generator.

Lower investment burden

Sites such as Arrived, Ember, Fintor and others may let you start investing in fractional real estate with little cash, whether it’s $5 or $100 — but it could be more, depending on the company. Here you don’t have the chance to use the home as your own, but you enjoy the financial benefits of ownership.

Alternatively, other platforms may require a higher upfront cost, but still much less than a traditional purchase of real estate, and you may get to live in the property, too.

You’re not doing it alone

If you’re worried about taking on an extra property to manage, splitting that responsibility with someone else lessens the burden. You can split up the responsibilities as well. All of this gives you the chance to invest in a property without taking as much risk as you would on your own.

Drawbacks of fractional real estate investing

Like any investment, fractional real estate investing has its downsides.

Harder to finance

Financing a home with many investors isn’t the same as financing a single-family home for a couple. Mortgages are usually made for one or two people, not many. Fractional real estate is easiest when you buy the property outright in cash, but may present complications otherwise.

Potentially unknown co-owners

If you’re using a fractional real estate company to facilitate the purchase and manage the property, you’re probably getting into it with many buyers who you don’t know. That could create headaches down the road if disputes arise about who owes what and more.

Their simplicity and the hefty dividends are two reasons that some investors opt for REITs.

Costs

If you’re having a manager operate the property, you’ll want to understand how much you’re paying and what potential fees you’ll be liable for. Even if this is more of a financial transaction and you own shares, you’ll need to understand what the fee structure is. It’s not unusual for an asset manager to take a 1 percent cut on the sale or disposition of a property, and you may also be charged for ongoing management of those assets, depending on the arrangement.

It’s vital that you understand the fees and what you’ll have to pay. And while you’re at it, you’ll want to investigate how you can exit the investment and the fees associated with that.

Less control

One of the perks of buying your own property is deciding what is best for yourself. When you share that property with other people, you lose out on some of that control. The more shareholders or owners are in the mix, the less say you get in how a property is managed.

Who should invest in fractional real estate?

Fractional real estate is best for:

• Those looking to break into real estate investing. If you want to get your foot in the door with a little bit of cash and not a ton of experience, fractional real estate investing might be a good idea.
• Buyers looking for a non-primary property. Buying a home with other people means you split ownership. Only go this route if you don’t plan to live in the home.
• Investors who have done their homework. Scour different fractional real estate investing sites to see which ones have insight into the neighborhoods and locations you’re exploring. Some of these fractional real estate startups are based in specific cities or regions, which might limit where you can buy. Even if there’s a lower barrier to entry, you can still do your due diligence and find the best company to go with before you buy. In some cases, you might invest fractionally without the help of a company.

Bottom line

Fractional real estate investing is one way to boost your passive income and break into real estate investing. It’s a great option for investors with limited funds who don’t want the burden of owning and maintaining an extra property, but it does come with work. Before you fully dive in, calculate the possible returns to make sure you’re maximizing your investment potential.