FAQ for Realtors

Fractional Ownership FAQ for Realtors®

Fractional Interests – What are they?
Isn’t that just a Timeshare at a glorified price?
But why do some definitions and labels seem confusing – even conflicting?
How can I sort this out?
Where are fractionals located?
Why do I need to know about fractionals? What’s all the fuss about?
Who buys fractionals?
What should I tell my seller?
Why can’t the owner, or I the agent, just divide the asking price into pieces and sell the pieces?
Why do the pieces add up to more than the whole ownership price?
But how can this be beneficial to my buyer?
How should I counsel my buyers?
What do I need to be careful about?
When should I steer clear of fractionals?
What kind of legal structure is used?
What legal restrictions apply to fractionals?
What legal restrictions apply to fractionals?
What kind of risks does fractional co-ownership create?
What type of documentation is needed?
How are usage rights allocated?
What happens if a co-owner doesn’t fulfill his/her obligations?
What about management of the fractional ownership property?
What about co-ownership decision making?
What issues should I review for my buyer client in evaluating a fractional?

Fractional Interests – What are they?

Fractional ownership simply means the division of any asset into portions or shares. When the “asset” is real estate or property, the title or deed can be legally divided into shares.The purchaser owns part of the title.Assets are valuable upon purchase, get taxed, represent equity, can produce tax benefits, and can appreciate.If the property appreciates in value, then the individual fractions or shares appreciate as well.Thus a fractional share gives an owner certain rights, including among others the right to use the asset for a certain number of weeks.

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Isn’t that just a Timeshare at a glorified price?

Timeshares for the most part are not assets, but privileges – the right to use something, for a specific period of time, for a specific purpose.What’s being sold is a unit of time, or a prepaid vacation to possibly 52 owners.The major benefit of most timeshares is use, not property value or likelihood of appreciation.Timeshares lose approximately 70% of their value upon initial sale, continue to depreciate, and are very difficult to resell. Recently timeshares have gone upscale with the entry of major hotels into the mix – but most are still not deeded, only the right to use a better place.

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But why do some definitions and labels seem confusing – even conflicting?

Today’s vacation home market is evolving quickly, which means that consumers are faced with an increasingly diverse marketplace and a variety of options in leisure travel.The speed of change has resulted in no clear distinctions existing among the various models.This variety of choices plus poorly defined labels has often led to consumer confusion.

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How can I sort this out?

Vacation products can generally be classified into 2 distinct categories based on the criteria of time and equity – i.e., the right to use time at a property, vs.having an ownership stake in the underlying real estate.

Three vacation ownership concepts that are based on TIME as the key parameter include: vacation rental, timeshare, and destination clubs.

Five vacation ownership concepts that are based on EQUITY as the key parameter include: Sole ownership, private co-ownership, Fractional ownership, Private Residence Clubs, and condo-hotels. Equity based offerings hold that appreciation exists in the underlying vacation real estate and consumers should be “equity owners” to participate in that growth.

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Where are fractionals located?

The concept of fractional ownership has always existed when family and friends have grouped together to buy expensive items.Well known in the international luxury market, fractional ownership as a commercial enterprise has been known in the US only since the 1990’s. The first fractionals were in major ski areas, particularly Colorado and California where real estate was so costly that wholly-owned second homes were out of the question for most people.Eventually the idea spread to northeastern ski areas, then to golf-oriented communities like Hilton Head and beach and golf states like Florida. You’ll find them in almost every destination location around the world.

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Why do I need to know about fractionals? What’s all the fuss about?

Do you want to get in the game? Fractionals are here.Internet savvy buyers know about fractionals, as do second home buyers, international clients, and buyers who have traveled abroad.Tremendous opportunity exists here in Florida with world-class beaches and waterways for agents ready to help their clients take advantage of a growing market.

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Who buys fractionals?

Do you have a pilot in your family or among your set of friends? They’ll be familiar with the concept.Although many people dream of owning a vacation property, most either can’t afford the type they want or wouldn’t use it enough to justify the expense.Fractional ownership provides a solution by allowing the owner to pay only a fraction of the costs and ongoing expenses of vacation home ownership, and also share the risks of unforeseen maintenance problems.The market is not just baby boomers and young retirees but buyers who want benefits without the hassles.For those who can afford it, the practical appeal of a fractional could pay off both in price and peace of mind.

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What should I tell my seller?

If you make the seller aware of the opportunity to sell by both whole ownership and fractionally, you can double the market exposure for the property and increase the seller’s ability to move the property and facilitate a transaction.

The seller can also retain a fraction of the title, should they want to retain partial ownership.Some sellers need help with taxes and insurance and feel forced to sell, but retaining a portion might work with their lifestyle needs and goals.

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Why can’t the owner, or I the agent, just divide the asking price into pieces and sell the pieces?

How simple that would be! But anyone who does so becomes a private developer and then must comply with federal, state, local, and securities regulations.Documentation to protect everyone’s interests must be created to preclude future lawsuits against you or the seller.Wherever the property is located, you are responsible for the “due diligence” to ensure your client’s interests are protected.

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Why do the pieces add up to more than the whole ownership price?

The legal documentation, furniture, furnishings, equipment and marketing expenses specific to that fractional offering all need to be included in the price of the product, since the benefit to your buyer is a result of everything in the process.

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But how can this be beneficial to my buyer?

A fractional is a completely different product than whole ownership, with “value added” in the creation of a product featuring high quality, desirable usage, and lower price.For example, in a grocery store, you could buy a whole small key lime pie for $5.99 and a half pie for $3.99.That’s a markup of about 50% for some packaging.You could buy a whole large apple pie for $7.99 and a quarter slice for $2.89.Do pieces of pie sell? Does the consumer get what the consumer wants? Is the grocery store providing a service?

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How should I counsel my buyers?

If your clients want to own an impressive second home with personalized services but can’t quite justify the expense because of using it only a few weeks or months of the year, this type of real estate arrangement may appeal to them.

This is truly a “win-win” transaction, with the property being sold, the buyers getting what they see as “a deal”, and the agents helping both buyer and seller clients.

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What do I need to be careful about?

Don’t be misled by how something is named or advertised, structured or managed.Future appreciation depends on the quality of the bricks and mortar and the specifics in the documents governing the project, not on what the arrangement is called and whether or not it is deeded.

If you represent a buyer or seller of a fractional that is designed for investment purposes, (renting out the property when not in use) check your broker’s or your compliance with the securities laws (who has the series 7 and 8 SEC license?). Also make sure to advise your client to seek council with a financial professional.

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When should I steer clear of fractionals?

You need product knowledge to professionally represent either a buyer or seller in the transaction.Don’t open yourself to liability for doing something incorrectly.If there’s a seller or agent who doesn’t know what he/she is doing or a property with incomplete and/or poorly written documents, you the buyer’s agent/ broker are at risk of a future lawsuit.

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What kind of legal structure is used?

The structure can be simple or complex, with the simplest having family members or individuals who know each other then agreeing to own jointly as tenants in common.

For people being brought together through a commercial endeavor, two different approaches occur. One is to aggregate the customers, provide strong documentation for creating a self-managed entity, and sell the property and the process to the customers. Another approach is providing a two-level structure, with a company being created which owns the property, which then allows multiple owners or investors to own shares in the company. This permits the transfer of shares without the need to reflect changes on the title or deed to the property, and also facilitates sharing of tax benefits.A property affiliated with a resort company providing ongoing management and amenities gives a benefit to buyers.

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What legal restrictions apply to fractionals?

a) In the United States, four categories of rules apply: a) state real estate laws and regulations b) local real estate laws and regulations c) private deed restrictions d) federal and state securities laws

b) In Florida, regulatory approval is required if there will be more than seven co-ownership shares.That’s why most of the time you’ll see 7 or less fractions, because more than seven fractions triggers the need for full compliance with the Florida Timeshare Statute rules.

c) Local regulation can be based on number of co-owners, usage allotment, zoning, or building codes.

d) The governing documents of home owners associations may restrict or prohibit home sharing arrangements.

e) Federal & state securities law apply where rental income is pooled among owners, management is delegated, or the purpose is primarily investment.

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What kind of risks does fractional co-ownership create?

The risk/reward factor is clear…without some risk, there is usually no reward. With fractional ownership, the reward to your buyer is owning and being able to use a beautiful property in a destination location at a cost far less than whole ownership. The risks are sharing property with others and relying on them to fulfill their obligations to you. Sharing use means you can’t do what you want when you want, and that others may do things that displease you. Sharing obligations means that necessary maintenance and management tasks might not be completed as agreed upon.

These risks cannot be eliminated – but they can be reduced. Probably the single most important step to lower the risk of co-ownership is a thorough, written, signed co-ownership agreement that deals with the issues, including events you don’t expect to happen, given the reality that people change as well as their needs.Next, ensure that there is a reserve fund sufficient to handle contingencies, and that the funding for this occurs on a regular basis.

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What type of documentation is needed?

Two types of documents are needed: 1) documents detailing owner rights (usage, alteration, financing, resale, alternate exit strategy) and 2) documents outlining owner obligations (cost allocation, dues structure, repair/replacement, and rules.

The documents must be complete, clearly written, and understood by the owners.Most fractional arrangements involve a combination of recorded and unrecorded documents, with a variety of different names.On your client’s behalf, you’ll need to make sure all the important content items are present among the various documents.

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How are usage rights allocated?

This can vary, but in the most popular approach each owner is assigned the exclusive right to use the home during a specified number of days, weeks or months each year.Usage periods can be fixed, variable (rotating) or a combination of fixed and variable. There are numerous variations and hybrids of usage, and each group/owner needs to find an approach that works for them and their property, and buyers need to see a match for their lifestyle.

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What happens if a co-owner doesn’t fulfill his/her obligations?

While this occurrence is extremely rare, the possibility exists.That’s why the documentation created is so important, because a co-ownership agreement must permit the group and/or a management company the power and means to deal with a default quickly and effectively.In addition, an established default reserve fund provides security for everyone.

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What about management of the fractional ownership property?

These tasks fall into four categories: 1) usage allocation, 2) accounting, 3) cleaning and 4) repair. In higher quality properties, concierge and security services may also be included. Any of these tasks can be handled by either co-owners or outside professionals, can involve compensation or not, and can be combined for efficiency and convenience.

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What about co-ownership decision making?

Check the documents to see if there are certain mandatory duties – these should include allocating usage, paying the recurring operating expenses, and maintaining the property in good condition.Does the homeowner association hire a management company to take care of everything, or most things?

If decisions are made by a majority, this permits a majority to take usage rights away from or add cost burdens to the minority. However, requiring a consensus decision can paralyze the group if a co-owner is uninterested, unreasonable, angry, or incapacitated.

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What issues should I review for my buyer client in evaluating a fractional?

  • What is per-night cost (annual cost w.management fees & dues divided by # of days of use/year)?
  • Will I be able to control how costs, especially management fees and dues increase over time, and how property is managed?
  • Can the property be rented out? Is the rental amount charged controlled? Is this potential tax benefit or burden the primary goal of your client?
  • What restrictions apply to resale? What competition will I face within the property and in the immediate area?

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Marge Coffing   “Florida Fractional Lady”    Beach & Luxury Realty, Inc.    727-210-5905    margecoffing@gmail.com

5 thoughts on “FAQ for Realtors

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