For individual real estate investors interested in commercial real estate investing, there is bad news and good news. The bad news is that institutional grade commercial properties are prohibitively expensive for all but the most well-funded individual investors. The good news is that there are a variety of products that allow individual investors to purchase a fractional share of institutional quality assets in sizes that match their individual resources.
In this article, we will describe what fractional real estate investing is, how it works, and the pros and cons of pursuing this investment strategy. By the end, readers will have the information needed to determine whether fractional ownership aligns with their own investment objectives.
At First National Realty Partners, we utilize a proprietary acquisition model to provide individuals with best in class fractional investment opportunities. To learn more about our current offerings, click here.
Fractional Ownership Explained
The fractional ownership model is exactly what it sounds like. With it, investors are able to purchase a fractional share of an institutional grade rental property.
To accomplish this outcome, a transaction sponsor (usually a private equity firm or REIT) creates a limited liability company (LLC) and uses it to purchase an investment property in their chosen asset class. To raise the needed equity for the transaction, they sell shares in the LLC to investors. In return for their share purchase, investors are entitled their fractional share of the property’s rental income, cash flow, and profits.
For individual real estate investors, there are both pros and cons to this approach.
Pros and Cons of Fractional Investments
Pros of Fractional Investing
There are many pros to a fractional investment, but the three biggest are highlighted in this article:
- Access to Institutional Quality Assets: By pursuing a fractional investment strategy, individual investors are able to gain access to institutional quality assets that they likely could not afford on their own. For example, suppose that an investor had $100,000 to invest. They could either purchase 100% of a single family home in a so-so part of town. Or, they could purchase a fractional share of a Class A commercial multifamily property in the best part of town.
- Diversification: Again, assume that an investor had $100,000 to invest. They could buy that same single family home, which would tie up the entirety of their investment capital. Or, they could purchase four, $25,000 interests in four different commercial properties. The second strategy provides fractional owners with portfolio diversification that isn’t available in the single family home purchase. This helps to smooth out volatility created by market conditions.
- Passive Income: In a fractional property investment, the sponsor does all of the hard work to manage the upkeep of the property on a day to day basis. Fractional owners collect passive income in an amount that is proportionate to their ownership share of the LLC. In short, fractional investors get the benefits of property ownership, but without the hassle of managing it.
While these benefits are impressive, they must be weighed against the potential downsides to fractional ownership.
Cons of Fractional Investing
Individuals considering a fractional investment should be aware of these potential downsides:
- Liquidity: While the specific terms are unique to each deal, fractional ownership does not offer the same level of liquidity as a stock or bond. In many cases, the investment sponsor will require individuals to make a five or ten year commitment, during which time they are unable to sell their interest in the deal. This amount of time is required to fully implement a property’s business plan, but may be too much for some investors.
- Property / Vacancy / Real Estate Market / Credit Risk: While not unique to fractional ownership, it is important to note that a commercial real estate investment is not without risk. Rental rates could change, tenants could default on their lease payment, or they could move out all together. Working with an experienced sponsor that has a strong track record of success helps to minimize these risks, but doesn’t eliminate it completely.
- Fees: In order to finance the substantial startup costs and administrative effort that it takes to present a property to investors, it is normal for sponsors to charge fees. The amount and type of fees can vary from one deal to another, but their presence makes a fractional investment more expensive than alternative investments.
For these reasons, it is important that each individual investor perform their own due diligence on the property and the sponsor before committing capital.
Fractional Investing vs. Private Equity
Fractional real estate investing vs. private equity is not an either or decision. Instead, a private equity investment is one type of fractional investment that is available to accredited investors. But, it isn’t the only one. There are two other options that are popular:
- Real Estate Investment Trust (REIT): REITs are real estate companies that own, operate, or finance commercial real estate assets. When an investor purchases a share of a REIT, they gain access to the income and profits produced by an underlying portfolio of commercial properties. REITs can be publicly traded or privately held and, depending on the exact structure, can be available to both accredited and non-accredited investors.
- Delaware Statutory Trust: A Delaware Statutory Trust is a company formed specifically for the purpose of commercial real estate investment. Investors purchase shares in the trust, which entitles them to a proportionate share of the income and profits produced by the underlying property.
Although private equity, REITs, and Delaware Statutory Trusts all offer fractional ownership opportunities, the specific structure of each deal type is unique and should be investigated thoroughly prior to committing capital to any one of them.
Summary of Fractional Real Estate Investing
Fractional ownership is a type of commercial real estate investment that provides individuals with a fractional share of a property rather than purchasing 100% of it.
The benefit of this approach is that it can provide investors with access to institutional quality deals that they likely could not afford on their own. In addition, fractional investments can provide investors with passive income and portfolio diversification.
However, fractional investments can also require long term commitments of five to ten years, can be more expensive than traditional approaches because of the fees involved, and still come with all of the risks associated with a commercial real estate investment.
Investing with a private equity firm is a type of fractional investment, but it isn’t the only one. Other fractional options include real estate investment trusts (REITs) and Delaware Statutory Trusts (DSTs).
As always, investors considering fractional ownership should perform their own due diligence to ensure the deal is the right fit for their individual risk tolerance and investment objectives.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.