Real estate is one of the top ways to build long-term wealth in America, but the high startup capital can be cost-prohibitive. Savvy investors have turned to fractional ownership as an efficient way to overcome this obstacle. This allows them to diversify risk and build large portfolios across domestic and international projects.
Fractional Investment
When it comes to fractional property investment, it is important to understand the difference between property classes such as class A and class B properties. Class A properties are typically newer, higher-quality buildings with more amenities, located in prime locations. Class B properties, on the other hand, are typically older buildings with fewer amenities, located in less desirable areas.
When investing in fractional property, it's crucial to consider the class of the property as it can greatly impact the potential return on investment. For example, class A properties may have higher rental yields, but also a higher entry price. Class B properties may offer lower rental yields but also have lower entry prices. It is important to assess your investment goals and risk tolerance before deciding on the class of property you'd like to invest in.
What Is Fractional Ownership?
This refers to the practice of buying fractions of large investments that have been divided into smaller units. This approach allows investors with limited capital to access asset classes that would not typically be available due to high minimum investment requirements.
To understand how fractional investing works, take a closer look at the process of acquiring a commercial real estate property. Every property has three components:
- Purchase price
- Down payment amount
- Monthly payments (mortgage and general expenses)
Consequently, you need money to cover all three types of expenses. Fractional ownership allows you to invest with a one-time payment while leaving the ongoing cost and maintenance to another entity.
Why Should Investors Consider Fractional Real Estate Investments?
Traditionally, investors with limited capital turned to this asset to break into the real estate market. However, there are several other benefits to choosing this over more traditional real estate investments, such as rentals or flipping. Consider the following:
- Diversified Portfolios: With fractional ownership, you can invest in a portfolio of assets and spread your risk over different markets. For example, you can use real estate to balance riskier investments in innovative technology.
- Building Equity: It is much easier to build equity with fractional shares, and investors get a portion of that equity if the managers sell the property. Even better, you can achieve this without taking on personal credit risk and while generating passive income.
- No Management Responsibilities: There are no on-site responsibilities when investing in fractional real estate, as with rental properties. Instead, you can earn passive income with no management expenses.
How Does Fractional Ownership Work?
Let us say the owner has a $500,000 budget for investing in commercial property. He or she can divide this amount into 50 smaller investments of $10,000 each. This allows you to diversify your risk by spreading the money across multiple properties and locations.
Investors use three main methods for purchasing fractional real estate assets:
- Special Purpose Vehicle: This is an LLC in which you are one of several members. The manager functions as the general partner and has discretion over using the property when vacant. This method is ideal for investors who are OK with taking on some management responsibilities.
- Purchase REITs: REITs are often used to invest in commercial real estate. They are a popular way to build a portfolio and can be purchased using your brokerage account. This is the safest way to invest in real estate, but the returns are also correspondingly low.
- Use Investment Portals: Several portals allow investors to purchase fractional shares in commercial real estate. These sites perform all of the management functions for you, making it very easy to start investing.