Fractional Ownership vs. REITs: Which Passive Investment Strategy is Right for You?

Key Takeaways

• Fractional ownership allows you to jointly own physical properties, providing you with more direct control of your investment and a tangible investment experience. It needs more upfront capital and provides less liquidity than REITs.

• With REITs, you can easily invest in real estate by purchasing REIT shares. They provide limited control over property management, so consider this tradeoff before investing.

• Fractional ownership often involves active participation in property management, while REITs are professionally managed for a more passive investment approach.

• Both options come with risks. Fractional ownership may be affected by property depreciation, while REITs are subject to market volatility and fees.

• Having a clear idea of your financial goals, risk tolerance, and investment horizon will be key to determining whether fractional ownership or REITs are right for you.

• Balance the trade-offs of control, convenience, liquidity, and expected return to decide which passive strategy best fits your investing style.

Real Estate Investment Trusts (REITs) are another popular option for passive real estate investing. Fractional ownership allows people to buy a share of a single property. This setup gives them the benefits of direct ownership, such as rental income and appreciation in value.

REITs, or real estate investment trusts, are companies that own and/or operate income-producing real estate. They enable investors to purchase shares, offering liquidity to investors and diversification across many properties. Both strategies present an exciting way to gain access to the real estate market without purchasing a full property.

Deciding between them comes down to your financial goals, how active you want to be, and your risk tolerance. Knowing the distinctions can help you determine which method is right for you and more closely matches your investing goals and future aspirations.

What Is Fractional Ownership

Fractional ownership is one of the fastest growing investment models. It provides an opportunity for anyone to co-own a high-value property by buying a percentage share, making it an appealing option for people looking to diversify into real estate.

This intentional approach opens the door for those with a strong desire to invest in transitory, high-value properties. It greatly assists people who don’t have the full capital or are ineligible for outright ownership. By pooling costs and management, investors gain access to properties that they wouldn’t be able to afford on their own.

Definition of Fractional Ownership

Fractional ownership is the process of purchasing a specific fractional share of an asset, not the complete asset. Owners are entitled to any income produced by the property, like rental income, based on their ownership interest.

This model reduces the financial threshold to get into real estate, providing a physical asset with direct ownership. For instance, one of their investors may own 10% of a commercial property. This ownership gives them the ability to generate returns, creating a realistic investment opportunity for many investors.

How Fractional Ownership Works

This latter model directly aggregates capital from different investors. As a group, they purchase expensive properties, such as multifamily developments or commercial buildings.

Income, such as rent, is prorated according to each owner’s share. Professional management teams take care of property maintenance and leasing, so you don’t have to worry about day-to-day operations.

Platforms such as Strata and Property Share manage tenant relations and operational expenses. This allows investors to realize passive returns without having to actively participate on a daily basis.

Types of Assets for Fractional Ownership

Fractional ownership applies to many types of properties, such as residential condominiums, commercial private offices, and luxury vacation homes. Each asset class for fractional ownership fits unique investor preferences and risk appetites.

A commercial property is an attractive investment for those who seek reliable income through rent. A fractional ownership, on the other hand, attracts buyers willing to accept lower risk for high reward situations.

Niche markets such as luxury villas or one-of-a-kind homes increase these prospects, presenting additional flexibility in portfolio selections.

What Are REITs

Real Estate Investment Trusts, or REITs, represent an attractive asset class for retail investors looking to diversify their portfolios without the complexities of owning physical properties. Similar to mutual funds, they offer fractional real estate investing opportunities, allowing individuals to buy shares in a diversified property portfolio while ensuring transparency and protection through high regulatory standards.

Definition of REITs

A REIT, or Real Estate Investment Trust, is a type of real estate investment collective. It must distribute at least 90% of its taxable income in the form of dividends, providing a reliable income stream to shareholders.

These trusts are allowed tax benefits, such as the ability to avoid corporate taxes, which is not allowed through direct property ownership. REITs that specialize in multifamily apartments or data centers, for example, can help establish stable income streams.

This gives investors significant flexibility and allows them to avoid the burden of administration.

How REITs Operate

REITs raise money from the public or private investors to buy and operate income-producing real estate. Revenue REITs’ primary source of revenue is rental income, property appreciation, and gains from financing activities.

The operations of these properties are handled by professional management teams, who ensure efficiency and mitigate risks to their bottom line. As an example, a REIT that specializes in healthcare facilities would likely maximize their returns by renting their properties to well-known healthcare facilities.

Types of REITs Available

Understanding the difference between equity REITs and mortgage REITs can help potential investors align their goals with the right investment choices. Equity REITs typically attract retail investors seeking reliable dividend income, while mortgage REITs appeal to those with a higher risk appetite.

Key Differences Between Fractional Ownership and REITs

Understanding the key differences between fractional ownership and REITs is important. Understanding these differences will better equip you to match your investment strategy with your desired financial outcomes.

These key differences around ownership, liquidity, management, and cost help to shed light on how each option better serves different investor needs.

Ownership Structure Comparison

Fractional ownership provides a hands-on investment experience by giving owners direct control over specific properties. This allows investors to choose properties and determine how they are managed.

With a fractional share of a vacation rental, you actually own a portion of that property. This allows you to benefit from having an ownership stake in a hard asset.

Conversely, REITs are essentially pooled investments, where you own shares in a portfolio of properties but have no direct control of the assets. This structural difference regularly translates to better returns.

Unlike REITs, which are structured to provide diversification across a pool of commercial or residential properties, fractional ownership allows investors to hone in on specific property types.

Liquidity and Accessibility Differences

Liquidity is perhaps the most notable benefit of investing in REITs. You can purchase and trade publicly traded REITs on stock exchanges just as you would stocks.

This simplicity of trading makes them ideal for anyone who requires fast access to capital. Fractional ownership, on the other hand, usually has a set holding period, like five to ten years, which reduces liquidity.

Selling your share in a fractional property means you need to find a buyer willing to buy your stake. This process can be tedious and time-consuming.

Accessibility helps REITs a great deal. You can begin cash flow investing with as little as $15,000, while fractional ownership usually has a much higher minimum investment barrier.

Management and Control Variations

Unlike REIT investors, fractional owners have a real say in property management decisions, from ongoing maintenance to tenant selection. This offers a truly hands-on experience.

REIT investors are completely passive, as all operational aspects are managed by professional experts. This low-maintenance model is appealing to investors looking for easy, quick convenience.

It would increase investor displeasure if management choices have a strong impact on returns. Income risk, for instance, would apply to a REIT focusing on retail spaces, which could struggle during recessions and be unable to pay out dividends.

Investment Entry Costs

Fractional ownership tends to have a higher barrier to entry since you are typically buying a share of an asset that you can touch and feel.

For instance, purchasing a 10% ownership of a $500,000 property would require an initial investment of $50,000. Conversely, REITs provide a more affordable option, enabling smaller investments with the purchase of shares.

This makes REITs a more accessible option for investors seeking to diversify their portfolio without investing significant amounts of money.

Benefits of Fractional Ownership

Ultimately, fractional ownership can provide a unique, accessible, and rewarding opportunity to invest in real estate. Different from traditional real estate ownership, it offers a way for people to co-own real estate, making it more affordable and dynamic.

Here’s a closer look at the key advantages:

1. Direct Asset Ownership

Fractional ownership offers an actual seat at the table, like a stake in real estate. This tangible connection is more than just monetary profit. It delivers emotional gratification and a sense of fulfillment, most notably when your property appreciates in value.

Owning a share of a vacation home in a warm, attractive community provides a personal connection to your investment. It has the benefit of making that experience much more rewarding.

2. Potential for Higher Returns

Fractional ownership investing in premium or high-demand properties often leads to substantial returns, with many of our fractional real estate investments generating rental income exceeding 8-10% annually.

3. Customization and Flexibility

Investors can select properties for fractional real estate investing based on their goals, including diversification across vacation homes or rental units.

4. Tangible Asset Value

Fractional ownership, as a fractional investment model, provides security and inflation protection, unlike traditional paper assets.

Benefits of REITs

Real Estate Investment Trusts (REITs) offer a realistic, tangible option for investment, allowing retail investors to engage in fractional real estate investing without the headache of owning or managing properties directly. They provide a host of unique benefits, making them an attractive asset class for emerging and seasoned investors alike, appealing to anyone seeking passive income and wishing to diversify their real estate portfolio.

1. High Liquidity

One of the most unique benefits of REITs is their liquidity. Because REITs are listed on all the major stock exchanges, investors have the added benefit of a simple buy/sell liquidity that you’ll find with equities. This level of accessibility enables you to rapidly turn your investment into cash, whenever you choose.

It’s particularly useful for covering unanticipated costs or taking advantage of new opportunities. Unlike conventional real estate investments that can take months to unload, REITs provide the ability to transact in near real time. If you own shares in a publicly traded REIT, you can sell—or buy more—at a moment’s notice during market hours.

This provides you with extraordinary freedom to control your investments.

2. Diversification Opportunities

REITs are particularly strong in diversification, as they provide exposure to different real estate sectors, including residential, commercial and industrial properties. This diversified approach is a natural hedge, helping to reduce the impact of underperformance in any single property or sector.

For example, one REIT’s portfolio could consist of office buildings, shopping malls, and hospitals. This spread reduces risk, while helping to provide more stability to returns. Because REITs are required to invest primarily in income-producing, revenue-generating properties, their distributions provide a stable recurring source of income to shareholders.

By focusing, as federally mandated, on at least 80% of their portfolios on income-producing assets, REITs provide an effective risk-return tradeoff.

3. Professional Management

REITs have the added benefit of being managed by experienced pros who manage property acquisition, leasing, and maintenance. This level of professional oversight goes a long way to improve property performance and maximize returns.

For those who invest in them, this translates to not having to manage tenant relationships or property maintenance. For example, a REIT specializing in commercial properties might employ a team to negotiate leases and maintain facilities, relieving individual investors of these tasks.

This hands-off benefit is especially attractive for people who don’t have the time or knowledge to invest in real estate.

4. Lower Entry Barriers

Another key benefit of REITs is their accessibility to a broader audience thanks to their low minimum investment. Unlike purchasing individual properties, which often requires a significant upfront cost, REITs offer a more accessible way to invest in real estate.

You only need to start by buying shares worth at least $500. This affordability makes REITs an attractive choice for retail investors or individuals looking to invest in real estate for the first time.

By allowing investors to invest fractionally, people can achieve a more diversified portfolio and do so without stretching their budget.

Drawbacks of Fractional Ownership

While fractional ownership, particularly in the context of fractional real estate investing, provides an attractive alternative to traditional real estate investment, there are a few significant drawbacks.

1. Limited Liquidity

The biggest drawback with fractional ownership is the absence of liquidity. Unlike publicly traded REITs, selling a fractional share can take time given the lengthier resale process. It can be hard to find a buyer for your share of a particular property.

This can be problematic, particularly if the property has been purchased in a niche or secondary market. The newness of fractional real estate investing also contributes to its lack of liquidity. Investors should consider how much wiggle room they want financially.

They must consider the very long-term nature of these investments, as holding periods are usually in the range of 5 to 10 years.

2. Higher Management Responsibility

Fractional owners have a greater voice in property management decisions than REIT investors. High-quality professional platforms help manage the day-to-day operations smoothly. Owners will still need to weigh in on important decisions such as property improvements and leasing strategy.

This active involvement can require a greater investment of time, expertise, and energy, creating additional psychosocial burden. For instance, gaining familiarity with property markets, managing tenant agreements, or overseeing a property budget may fall under your purview.

Unlike REITs, which are completely passive and run by professionals, fractional ownership is a very active investment.

3. Risk of Asset Depreciation

Real estate markets are cyclical by nature, and fractional ownership properties are no different. Market downturns, like the real estate crash of 2007-2008, can quickly bring down property values, severely affecting your investment.

A sudden decrease in property demand or a recession can set off a chain reaction resulting in asset depreciation. This decline will eat into your returns and lower the resale value of your share.

Regular income distributions, typically monthly or quarterly, may be reduced or suspended in these situations as well. Doing market research and determining the risks up front can be crucial to minimizing these effects.

Drawbacks of REITs

Real Estate Investment Trusts (REITs) provide one of the simplest ways for retail investors to engage in fractional real estate investing through diverse, professionally-managed real estate portfolios. However, it’s crucial to consider the potential downsides, as these risks can severely impact your returns and may not align with an investor’s long-term goals.

1. Market Volatility Risks

REIT share prices tend to follow the broader stock market, moving up and down with the broader economy and investor feelings about risk. For example, in a recession, commercial properties might have higher vacancies, which affects REIT revenues immediately.

This link to broader market dynamics means that REITs can incur large losses, especially when a recession hits. Unlike direct physical property investments, REITs are more susceptible to outside financial factors, which investors should be aware of and factor into their decision-making process.

2. Lower Control Over Investments

REIT investors usually have little to no say in what properties are acquired, how they are managed, or overall strategy. Operations are run by professional managers, which keeps them more efficient but makes them less independent.

For instance, you don’t have the ability to take a building and choose to renovate it or sell it; you are wholly dependent on management teams. While this is convenient, this trade-off greatly hampers the potential for customization.

3. Fees and Expenses

REITs have high management and transaction fees, which can eat into returns. Administrative expenses, for instance, could decrease dividend payments and thus affect profitability negatively.

So having a complete understanding of all fee structures up front is imperative to determining their overall financial impact.

Assessing Your Investment Goals

Ultimately, whether you choose fractional ownership or REITs, the key is to match your investment decision with your individual financial objectives. The best fit is usually based on an individual or household’s risk tolerance, financial goals, and investment time horizon.

Here are some key questions to guide you:

• What are your long-term financial objectives?

• How much risk are you willing to take?

• What is your preferred investment horizon?

Determine Your Risk Tolerance

Your risk tolerance is an important factor in determining your investment strategy. Unlike funds which are less directly exposed to property performance, fractional ownership has the flip side of that benefit, bringing market risk and a longer effective holding period.

REITs, in contrast, provide exposure to diversified portfolios, lowering volatility but still holding risks related to broader market trends. Understanding how comfortable you are with these risks will further filter your options and begin to match them with your asset allocation strategy.

Identify Your Financial Objectives

By clarifying financial objectives, investors can better decide if generating income or growing capital is the main goal. Fractional ownership has broader appeal to investors seeking a stable, long-term income since they earn rental yields.

Conversely, REITs emphasize the liquidity and growth potential. Setting clear and measurable goals, such as earning an annual return of x percent, provides a way to measure success.

Evaluate Your Investment Horizon

Investment horizons shape decisions more than you may think. Fractional ownership is best for the long-term investor, with a typical property commitment of 5–10 years at minimum.

Or, given their liquidity, REITs can serve short- and medium-term timelines, providing an attractive return on investment in the interim. Aligning your investment choice to your timeline will allow you to set realistic expectations for both your return and access to your funds.

Factors Influencing Your Choice

With these elements, you’ll be able to find the investment path that’s right for you, whether you consider fractional real estate investing or traditional options. These factors mainly circle back to your asset preference, liquidity requirements, and active versus passive management style, allowing potential investors to match their financial priorities with the best investment choices.

Preference for Tangible vs. Paper Assets

Your preference for hard or soft assets can really drive your decision. Fractional ownership offers an extremely tangible connection to real estate assets. This value-based approach invariably appeals to people who value the emotional reward associated with the ownership of a real, physical asset.

Owning a share of a vacation home or rental property makes you feel proud. To be honest, it provides an opportunity to do something unique. Conversely, REITs are paper assets, providing real estate ownership by way of purchasing shares in real estate portfolios.

This option is ideal for investors who value ease of investment and diversification without being committed to one asset. Aligning your choice with your values and long-term goals creates a more meaningful and rewarding investment experience.

Need for Liquidity and Accessibility

Liquidity is a key factor as well. Perhaps most importantly, REITs are highly liquid, meaning investors can easily buy or sell shares in the REIT throughout the day in the stock market. That convenience is hard to beat for someone in need of fast money.

It’s most valuable when used to address unanticipated costs or take advantage of new investment opportunities. In comparison, fractional ownership usually requires a longer-term commitment, with few opportunities to quickly liquidate your investment.

For example, selling your share in a co-owned property may require finding a buyer or waiting for the property’s sale. In terms of liquidity and accessibility, REITs are hard to beat. People who don’t want to be tied down to a long-term contract are drawn to this flexibility.

Desire for Active or Passive Management

Thus, management style is another key distinguishing element. Fractional ownership usually comes with high-touch management, like working with other co-owners, managing in-house property management, or dealing with bills and maintenance directly.

This active management method can be lucrative for investors who want to be more involved in the decision-making process. On the other hand, REITs provide a much more passive investment experience, since property acquisitions, leasing, and maintenance are managed by professionals in REITs.

As a result, REIT investors are free to focus on their careers and home lives. In the meantime, they get to cash dividends from the trust’s revenue. Almost two-thirds, or 62% of American households are drawn to this model for its convenience and ease.

Knowing where you fall on the spectrum of active vs. Passive management will help in choosing the right option.

Conclusion

Ultimately, deciding between fractional ownership and REITs comes down to your individual goals, risk tolerance, and level of desired control. Fractional ownership provides a more hands-on experience with the potential for higher returns. It entails greater responsibility. REITs are a much easier, more flexible investment option, particularly for novice investors or those seeking regular income.

Consider your budget, time frame and level of risk tolerance. If you want a more active investment experience, fractional ownership provides that. If you prefer a lower-hassle approach, you may be a better fit for REITs. Both strategies come with their advantages and disadvantages, so choose the one that best matches your priorities.

Consider the pros and cons to make an informed decision. The better informed decision you can make, the better equipped you’ll be to create the strategy that meets your lifestyle and financial ambitions.

Frequently Asked Questions

What is fractional ownership in real estate?

Fractional ownership, a popular model in fractional real estate investing, occurs when several investors co-own a single property. Each fractional owner holds a share of the asset proportional to their investment, allowing retail investors to access high-value real estate without purchasing the entire property.

What are REITs?

REITs (pronounced like “reet”) are companies that own or finance income-producing real estate, allowing retail investors to engage in fractional real estate investing. Though investors don’t directly own properties through REITs, they can buy shares on public stock exchanges and earn high dividends.

How do fractional ownership and REITs differ?

Fractional ownership allows you to own real estate properties directly with other investors, contrasting with REITs, which are stock-like investments in real estate companies. This fractional ownership model provides tangible control, while REITs offer significant liquidity and diversification.

Are fractional ownership investments passive?

Sure, fractional ownership, often seen in fractional real estate investing, is mostly passive. Day-to-day property management is handled by a third-party company, allowing fractional owners to earn substantial returns without becoming landlords themselves.

Why should I consider REITs for passive income?

REITs are an attractive asset class for passive income, as they must distribute at least 90% of their taxable income in dividends. This fractional ownership model allows for easier buying and selling, providing liquidity, flexibility, and reliable income distributions.

What are the main risks of fractional ownership?

The major risks of fractional ownership, particularly in fractional real estate investing, include lack of liquidity, potential conflicts among fractional owners, and dependence on property management, making it less flexible than REITs for quick exits.

How do I decide between fractional ownership and REITs?

If you want more tangible property ownership and higher control, the fractional ownership model might be your answer. Conversely, if liquidity, diversification, and ease of entry are higher priorities, then REITs trade as the clear choice.