Private Residence Clubs and Luxury Fractional Property

Fractional or shared ownership vacation homes are a rapidly growing segment (over 30 percent in 2006) of the real estate market. Fractional real estate sales were about $1.6 Billion in 2006 and are expected to continue to grow over the next several years. Most of these fractional real estate sales may be attributed to resort and niche fractional projects rolled out by large hotel operators, such as Marriott, Four Seasons, Starwood, and Ritz Carlton (“resort fractionals”).

With purchase prices for shares generally in the $200,000 to $1 Million range, these resort fractionals are positioned for the $200,000 plus per year household income purchaser. However, a noticeable segment of fractional real estate sales other than resort fractionals is gaining significant momentum – the stand alone, single family fractional vacation home. Because of the attraction of owning a slice of the dream vacation spot near one’s home, these so-called “one-off fractionals” are being developed by fractional developers, spec home builders, realtors and even the homeowners themselves at many resort markets across the country with shared ownership pricing in the sub-$200,000 range.

A fractional offering of 1/6th, 1/8th or 1/10th can dramatically increase the number of affordable buyers (an attractive feature in today’s market). Fractional, when done properly, will even create value because, like any subdivision of land, the sum of the independently marketable fractions will generally sell for a price that is greater than the whole ownership value.

Great! How hard can it be to simply sell your property to a few folks who want to go in together on a vacation home? Not hard at all. In fact, informal, for-sale-by-owner or “FSBO” fractional ownership is common and has been done for many years through a form of ownership known as “tenancy in common.” Tenancy in common has been around since the 16th century and permits two or more parties to own undivided fractional interests of a property with unequal percentages and, unlike joint tenancy, without right of survivorship. For example, a tenant in common would take title to their property via vesting on the grant deed with language something like this:

Usually, in the vacation home fractional context, the fractional interest percentages are equal in order to facilitate fair and pro-rata sharing of the usage of the property, in this case 10.0% fractional ownership interest. If FSBO fractional is as simple as language on the grant deed, then why not be a do-it-yourselfer?

Great question. The answer is that it’s not simply the vesting of a tenancy in common interest on the grant deed that creates a fractional vacation home, it’s the addition of everything else. Be careful! Absent a thorough understanding of all the potential securities compliance, state law compliance, income tax, capital gains tax, property tax, financing, and disclosure issues created by selling off parts of the vacation home, you are setting yourself up for future disaster. Also, without a knowledgeable fractional developer involved, you will either spend countless hours setting up property management, bookkeeping and scheduling systems to keep track of cleanliness, usage, operating expenses and maintenance or you will enjoy constant dissatisfaction and frustration with the inevitable burden of the one or two owners that never seem to hold up their end of the deal. Just ask any vacation home owner who has owned with family and friends – these arrangements are, at best, difficult and, at worst, nightmarish. You could easily end up with a situation where: any owner may force the sale of the entire property if they happen to be in a financial jam, any owner could borrow against the property and put a lien against everyone else’s ownership interest, any owner could sell their interest to someone financially unable to share in the expenses of the property, any owner could trash the place and everyone would have to pay for the repairs, any owner could die and the other owners would have to wade through the probate proceedings, or worse, any owner could become insolvent and the other owners would have to wade through the bankruptcy proceedings. Ouch.

The difference and value a fractional developer brings is the legal, accounting and management structures put in place that consider each and every one of these undesirable circumstances and protect the fractional buyers from them to the maximum extent possible. For example, a fractional developer will investigate federal securities laws to ensure that the seller of fractional interests does not unwittingly create the equivalent of a sale of an unregistered security due to inappropriate management and rental income treatment. A fractional developer will investigate state laws concerning subdivision of property to ensure that the sale of fractional interests in combination with a rotating usage of the property does not create the equivalent of a subdivision and if it does, comply with any associated bodies of law related to subdividing land. A fractional developer will also ensure that each fractional owner may independently sell their interest at any time while eliminating their ability to force the sale of the entire property at an inopportune moment. To protect against an owner from selling at below market value, a fractional developer will create a right of first refusal for the non-selling co-owners in the event of a voluntary sale of one’s share. In the event a co-owner dies, divorces or becomes insolvent, a fractional developer will create a buy-out right in the non-selling co-owners to protect the property from probate, divorce or bankruptcy proceedings. I could go on and on but you get the picture. Admittedly, some of the measures employed, especially where bankruptcy of a co-owner occurs, are not legally bullet-proof, however, it eliminates the most obvious problems and minimizes the risk of others. Check my upcoming articles to learn more about the risk of bankruptcy of a co-owner.

If you are evaluating a fractional developer or purchase of a fractional property, ask to see their legal, accounting and management structure. Legitimate fractional developers will have a series of documents that provide the protections discussed above as well as a comprehensible property operating budget (with reserve funds for replacement of life-limited furnishings and personalty), and a management agreement with a third-party property manager to handle maintenance, scheduling, cleaning, rental, etc. If you are a spec home builder, realtor or homeowner considering offering a FSBO fractional, and you do not have the expertise and understanding to prepare and implement such structures, you should consider bringing a fractional developer onto your team.

Gary L. Winter, Esq. is a member of the California Bar and practices real estate, corporate and trust law with the firm of Powell & Pool, PC, in Fresno, California. Mr. Winter is also a founding member of Lloyd Lanson Fractional Ownership, a fractional development company specializing in one-off fractional vacation homes in California.