Fractional ownership real estate originated in Old England in the 1600's when it became possible for the commoner to own land. The quality farming acreage was too expensive for the former serfs to purchase on their own so several joined together as "tenants-in-common" to purchase land.
Today this same concept allows real estate investors to purchase a fractional ownership interest in institutional grade real estate. Unlike investing in a REIT or mutual fund investors can exchange their smaller and frequently management intensive real estate for an interest in larger stable no management properties.
In 2002 the Internal Revenue Service released Revenue Procedure 2002-22. This set of 15 guidelines reduces the risk of an IRS challenge if an investor wished to do a 1031 exchange from a sole ownership property to fractional ownership. The offshoot of Rev Proc 2002-22 was the birth the Tenant in Common industry.
Benefits of Fractional Ownership Investments
- Little to no management responsibility.
- Frequently superior risk reward properties with long term leases with multiple credit tenants.
- Ease of diversification that can reduce portfolio risk.
- Each Tenant in Common owner has the same rights as an individual owner.
- Fee-simple deed at closing.
- Pre packaged real estate with debt frequently in place.
- Pre packaged due diligence to facilitate the selection process. Investors should do their own independent due diligence.
- Pro-rata share of all net monthly income, tax benefits, and appreciation.
- Potential deferred current and future capital gains taxes.
- Investment can be scaled to fit 1031 exchange requirements.
- Property and asset management reports to each owner.
- Income typically distributed monthly with periodic operating reports.
Tenant in Common owners typically exit when the entire property is sold. Owners may also sell their individual interest at any time. On sale the owner can either pay capital gains and recapture taxes or do a 1031 exchange. As with all real estate tenant in common interest are not liquid like a stock or bond. The degree or liquidity or lack of liquidity will vary with each individual investment.
Sponsors assemble the initial Tenant in Common offering. Good sponsors provide a valuable service in selecting properties, arranging financing, assembling due diligence material etc. Sponsors post closing roles can vary. It is important for investors to remember that they are investing in real estate, not the sponsor or sponsor's business.
Common Sense Approach to Fractional Ownership
Tenant in Common is real estate; there is no escaping this reality. This means that investors should be proactive in carefully looking at each property's real estate fundamentals. The list of fundamentals to consider include but are not limited to quality of tenants, leases, rent roles and expiration/option dates, price being paid for TIC interest vs. whole property, past operating statements, operating projections with assumptions, loan terms and documents, third party reports, demographics, physical characteristics and risk disclosures and assessments. The TIC Sponsor's qualifications and historical performance should also be considered.
Common Objection to Fractional Ownership
The primary objection investors have to Tenant in Common ownership is that they don't have 100% ownership. Investors do have a deeded fractional real estate ownership interest and a proportional vote on major issues.
As with all investments investors should carefully weigh the plusses and minuses of Tenant in Common ownership. They should also carefully review Tenant in Common ownership with their legal and accounting professional before making a final investment decision.
Fractional Ownership Alternative
Click Here for more information on Net Lease investments.
Net lease properties provide many of the same benefits (little to no management, potential predictable monthly income) as tenant in common with the investor maintaining 100% ownership.