With so many emerging ways of investing options, the real-estate sector has never been more lucrative. The new investment opportunities provided by Real-estate Investment Trusts (REITs) and Fractional Ownership (FO) in commercial properties have made it possible for smaller investors to experience high returns on commercial grade A properties that were previously out of reach.
In this article, we discuss fractional property ownership and REITs as two such alternatives. Through this, readers will learn what each option is and their pros and cons.
What is Fractional Property Ownership?
In its most literal sense, fractional property ownership refers to a stake in any asset. Just like owning a percentage of a company's equity shares makes you a part-owner, fractional ownership in real estate lets you invest in shares of real estate properties, where you own the share of the property based on the amount you have invested.
What is a Real Estate Investment Trust?
REITs are a great way to diversify any investment portfolio. These firms offer higher returns to investors by owning and managing large real estate projects that generate income from rental or development activities. Besides, REITs allow mutual funds to distribute profits to their shareholders; under taxation rules, 90% of all taxable gains must be returned in accordance with investor’s ROI expectations.
Fractional Property Ownership vs REITs: Pros and Cons
To fully consider the pros and cons of fractional ownership and REITs, it's best to compare the two on their major offering points.
1. Property Type
The fractional investment model allows investors to purchase both existing and under-construction properties.
According to REIT operational rules, at least 80% of a REIT's investment portfolio should be invested in income-generating properties. This means investors need to purchase existing assets.
2. Capital Requirement
The first thing to consider is your investment capacity or capital requirement. Fractional ownership requires a minimum investment of between 10 to 25 lakhs. However, the figure may differ depending on the property type and value.
The initial capital to be invested in REITs depends on your ability. You can make even smaller investments on REITs.
2. Lock-in Period
Fractional property ownership doesn't have a defined lock-in period, meaning that investors can sell their shares anytime they wish. Investors are free to sell their stake in the property at any time. However, some work may be required to determine the valuation of the investor's stake.
Publicly traded REITs don't have a defined lock-in period either. This gives a REIT investment a fair amount of liquidity. However, investors may be constrained by changes in the market value of their asset and can only profit if the shares are sold at a price higher than what was paid. Lock in period for sponsors and sponsor group members of REIT have a lock in period of minimum three years.
3. Hidden Charges
Regulations mandate that REITs must distribute at least 90% of the net distributable cash flows to their investors to avoid scams. With fractional property, there is a complete distribution of the net distributable cash flows (post taxes, etc.) This is because the fractional company doesn't impose any hidden charges. However, it charges a small fee for its property management services.
Investors in a fractional property ownership model are free to transfer their fractional ownership stake.
REIT investors don't directly own property. Thus, they cannot transfer property ownership. However, they may sell their shares at any time.
Investors can control the diversification process with the fractional investment option. They have complete control over which properties and asset classes they invest in.
REIT investors achieve diversification through share purchases. Since REIT portfolios are diversified by the real estate market and real estate sector, investors are not actively involved in portfolio construction.
In a fractional property ownership investment, the property is valued at regular intervals so that investors know the value of their investment. This is especially helpful when unit holders need to sell their holdings.
REITs require property valuations at least twice per year. Also, the stock price of publicly traded REITs fluctuates constantly and can be found by looking up the ticker symbol for the REIT.
In a fractional ownership model, the property is valued on a monthly or quarterly basis. Therefore, values tend to be less volatile.
During periods of economic distress, the share price of publicly traded REITs can experience significant fluctuations even if there are no substantial changes in the fundamentals of the underlying properties.
9. Time Horizon
It's very important to understand the time horizon for the investment. Neither investment option has a lock-in period; however, the time horizon should be longer to earn decent returns. You may not reap the full benefits if you exit a REIT investment in the short term. Similarly, it takes some time for the returns on a commercial fractional ownership property to stabilise.
Which Is The Better Investment?
With so many differences between the two real estate investment options, it's normal to wonder which is the better investment. The truth is neither is objectively better than the other. They are both capable of producing healthy returns.
However, each commercial real estate investor has unique preferences, risk tolerance, and time horizon. Therefore, one of the two alternatives may be a better fit for a person's needs. Also, each investor must conduct due diligence and select the best option suited to their specific situation.
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