Investment funds: the right product at the right time?
1st November 2011
David Disick looks at the relative merits of shared ownership real estate funds and fractional property ownership
“Build a better mousetrap, and the world will beat a path to your door.”
Ralph Waldo Emerson
Even as fractional vacation home ownership continues growing world-wide, some forward-thinking developers have invented what they believe is an improved ownership model: Investment Funds.
This product aims to satisfy the desire of today’s increasingly demanding buyers for a property that offers both leisure enjoyment and investment value.
Developers exploring ownership alternatives may wish to consider the benefits of an investment fund offering vs. those of a fractional ownership offering.
The Essential Difference
Investment Fund. Investors own shares of stock secured by real estate.
Fractional Ownership. Fractional owners own deeded real estate.
Investment Fund. An investment fund is an offering to qualified investors of an ownership interest in a portfolio of luxury resort and/or city properties in a variety of locations.
Ownership entitles investors to enjoy a specified amount of vacation use in the properties and to benefit from the high level of personalized vacation services offered by the local concierge.
Ownership is for a pre-determined, finite number of years. By the end of this term, the properties are sold and proceeds are distributed to the investors.
Evidence of ownership is a property-backed stock certificate in the company that owns all the properties in the portfolio.
Fractional Ownership. Fractional ownership is an offering to the public of an undivided fee simple deeded interest in a particular residence. This entitles owners to use their property for a specified number of weeks each year—usually about three or more—depending on the size of their fraction. Luxury properties offer concierge services and onsite amenities.
Owners may exchange their use rights with other properties in the developer’s network or may join the network of an outside exchange company.
Evidence of ownership is a real estate deed. Owner usage of their vacation weeks is determined by the reservation system described in the ownership documents
Investment Fund. Investment fund purchasers prefer the perceived greater liquidity of stocks in comparison to the relative illiquidity of real estate. They want professional portfolio management services for their investment and a clearly defined exit strategy from it.
They also seek to spread their risk by owning property in several markets and enjoy a variety of vacation use rights in different locations.
Fractional Ownership. Fractional ownership buyers prefer the security and assurance of a real estate deed to their property. Real estate is something tangible and familiar that they like and understand. It can help diversify an investment portfolio and can serve as a hedge against inflation.
Fractional owners are willing to take responsibility for deciding how to manage the eventual sale of their property.
Management of the Asset
Investment Fund. A portfolio manager is a full-time professional team responsible for the successful acquisition of vacation properties and their cost-effective operation and maintenance on behalf of the owners.
Fractional Ownership. Once developers sell out, they usually move on to other ventures. The homeowners association contracts with an outside management company to maintain the property.
Investment Fund. Subscription agreements provide for a future date certain by which the portfolio manager offers the assets for sale at what is anticipated to be their appreciated value. Proceeds/profits are distributed to the investors.
Fractional Ownership. When owners choose to sell their fractional interest, they may list their property with general real estate brokers or may sell it themselves. The time on the market of their property and re-sale value depend on local market conditions.
Compensation to the Portfolio Manager or Developer
Investment Fund. Compensation to the portfolio manager is based on fees for acquiring properties “favorably,” i.e., at market—or preferably below; operating the vacation use program efficiently; managing the properties cost-effectively; and maximizing profit at re-sale.
A meaningful portion of the manager’s compensation is deferred to the sale at the “back end”. In this way, the manager’s interests are closely aligned with those of the investors throughout the life cycle of the investment.
Fractional ownership. In fractional offerings, prices are based on the developer’s costs plus a profit mark-up. Purchasers pay the developer’s profit “up front.”
After the developer sells out and moves on, the homeowner association contracts for property management through competitive bids and negotiated agreements with an outside company working to maximize its own profit.
Flexibility of Usage Rights
Investment fund. Since investors own an interest in a portfolio of properties, usage rights can be based on the number of points for nightly use allotted to them according to their membership level.
Nightly use points also allow for weekend or week night occupancy and more flexible arrival and departure days. This helps maximize the ability to optimize occupancy and fulfill investor requests for accommodations.
Fractional Ownership. Use of the fractional property is determined by the number of guaranteed weeks their fraction size specifies. Owners usually have priority access to their deeded property and may choose not to exchange it at peak use periods.
Arrival and departure days at fixed weekly intervals may result in loss of potential occupancy space when vacationers stay for less than a week.
Reservation systems are either by rotation or first-come, first-served. When demand for holiday and peak usage times exceeds available accommodations, a computerized rotation system may distribute use equitably among owners over the years.
The "Elephant in the Room"
Clearly, if investment funds can indeed deliver an extremely satisfying leisure experience plus a foreseeable and hopefully profitable exit strategy, why aren’t there more of these funds?
What often discourages developers from offering an investment fund is what we call “the elephant in the room," i.e. the securities issue.
In most places, if you sell real estate to earn a profit for others, you are selling a security. This can require registrations and licenses and can entail compliance with complex regulations, prohibitive legal fees and glacial bureaucratic approvals.
This common perception of insurmountable difficulty, however, is not necessarily so. There are ways to discuss investment value legally, if presented to qualified investors in appropriate ways. Also, legal documentation can be created both expeditiously and cost-effectively.
To be sure, providing lifestyle value and a chance for an owner to sell his/her property for profit through real estate brokers at some time in the future can be appealing. But in today's challenging market, buyers are especially cautious. They understand that family needs change. If/when they decide they want or need to sell their vacation home, they want to “cash out” as soon as possible. They don’t want to wait years for a sale.
Offering today’s hesitant buyers an agreed upon, professionally managed and potentially profitable future exit from their investment could well persuade them to invest. This could provide developers of investment funds a competitive edge in a crowded market place.
Or, think of it this way:
The service of a professional concierge to help plan and arrange a vacation experience has become a necessity in today’s luxury market. Doesn’t it make sense to proceed to the next logical step?
Why not offer the service of an experienced professional concierge/portfolio management team to handle all the pesky details of marketing and re-selling a leisure home profitably at a specified future time?
Another consideration: In today’s tight credit markets, new construction loans are difficult or impossible to find. In stark contrast, numerous favorable buying opportunities exist in already built whole ownership homes that can become part of an investment fund portfolio.
If your vacation property offering can satisfy both lifestyle and investment motivations, wouldn’t it be nice to have the world beat a path to your door, rather than having to beat the bushes, along with many other competitors, trying to find scarce and elusive buyers?
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David Disick chaired the panel on Fractional and Shared Ownership at the 2011 OPP Investor Conference in London. This article is an outgrowth of panel discussions and further thought afterwards.
What is your opinion of investment funds? Could this be something saleable in your market? We look forward to hearing from you. Please comment in the space below.
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David M. Disick, Esq. is president of The Fractional Consultant. His company helps developers in the United States and abroad secure financing. A former Wall Street securities attorney, he is recognized as among the pioneers in the fractional industry. He is the author of Fractional Vacation Homes: Marketing and Sales in Challenging Times. It may be ordered from: http://www.TheFractionalConsultant.com.