The Pros and Cons of Fractional Real Estate Investing

Investing in real estate is one of the tried and true methods of building wealth. A study from Coldwell Banker revealed the average millennial millionaire owns three properties. 

Historically, breaking into real estate has never been easy for the average person. Today, crowdfunded or fractional real estate investing has made it possible for everyday investors like you to participate. And, you can do it with as little as a dollar.

But this style of investing doesn’t come without risk or disadvantages. Just like any other investment, it’s important to understand the benefits and potential pitfalls of fractional real estate before diving in

What Is Fractional Real Estate Investing?

Fractional real estate refers to any type of investment that is owned by multiple parties. Timeshares are a classic example of a fractional real estate model. 

With timeshares, individuals own a specific week of the year on a vacation property. However, timeshare ownership can hardly be considered an investment. With the ongoing maintenance fees and the low resale values, some may view timeshare ownership as a liability rather than an asset.

It's More Accessible Than Traditional Real Estate Investments

In the past, real estate investments have had a massive barrier to entry because investors needed good credit and a substantial down payment to buy a property. Plus, investors needed to be able to navigate the confusing property buying and financing process. By comparison, fractional real estate investing can be much more accessible. 

There are investment websites that allow all legal U.S. residents and citizens to invest in real estate if they have money. In some cases, investors can get started with $500 or less. For example, Concreit has no minimum investment amount to get started.

Ability to Diversify Within an Asset Class

Many people who own real estate may own a single property outside of their primary residence. If the property has poor cash flow or falls in value, they have no other outperforming property to compensate for an underperformer. After all, even a 5% down payment may be out of reach for most college students and young professionals. If you’re lucky, you can partner with your parents, to help you buy property.

Investors who opt for fractional real estate may be able to achieve a diverse real estate portfolio with a modest first investment. Prudent investors can even ensure that their portfolio is diversified across geographies and investment types. 

Use ‘Leverage’ Without Huge Personal Credit Risks

Most of the real estate crowdfunding sites reviewed on The College Investor use leverage (or debt) as part of the investment strategy. A typical investment on any of these sites may be financed between 50-75% through debt. This is far less leverage than a typical primary residence which requires 5% down or less.

Typical real estate investors must take on the risk associated with that debt by themselves. However, fractional investors don't take on personal credit risks. If an investment fails, an investor may lose some of the money they invested. But they won’t be personally liable for unpaid debts, and their credit will not take a hit.

No Real Estate Management Headaches

Sometimes, people may shy away from real estate investing because they don’t want to handle the proverbial “clogged-toilet-at-midnight” issues. With fractional real estate, professionals handle property maintenance and management and investments are completely passive.

Diversify Away From Financial Markets

Real estate has long been an asset class that has allowed investors to preserve and grow wealth over time. In many cases, investors hold real estate as a sort of “counterbalance” to the volatility in the stock market. 

Often Has Low Liquidity

Crowdfunded real estate investments are often very illiquid. Investors cannot readily receive a return of capital, especially when an investment is performing poorly. 

Liquidity tends to vary from company to company and even from project to project. Today, many companies will offer to buy out investors as long as an asset is performing well. However, investors should not invest in fractional real estate if they think they need to cash out in the near future. The companies are under no obligation to buy back shares from investors.

You May Lose Out On Certain Competitive Advantages

It’s true that fractional real estate opens up a new way to invest for people who have typically been locked out of large-scale real estate projects. But investors who choose fractional real estate may lose out on certain competitive advantages—case in point, some real estate newbie investors use house hacking as a way to get their foot in the door. House hackers can take advantage of traditional home mortgages to buy their first property. The “hack” is that their investment offers a subsidized place to live, even if it isn’t as profitable as the investor hopes.

Likewise, investors can boost their real estate returns through sweat equity. Knowledgeable investors may be able to spot a deal on a rental property by buying an investment in an up-and-coming area. Even those aforementioned landlord headaches are worth it if there are opportunities to boost returns. 

Fractional real estate investing requires paying fees to professional management companies. Landlords can decide whether to pay that fee or take on the management themselves.

Lack of Control

Investors who opt into a fractional real estate investment have little or no say in the direction of a project. When an investment faces trouble—and they all do at some point—shareholders are unlikely to be consulted about what to do. 

As an investor, you have to trust the investment management company to do what is right. That can be tough, especially when an investment underperforms expectations.

You Have to Do Your Own Research

Over the past half a century, stock market investing has been massively simplified. These days, anyone who can buy and hold an index fund can exactly match the performance of the broader market. 

Even investors who opt to invest in real estate funds need to understand the following questions.

Information about individual stocks is broadly available. Investors who opt for individual stocks typically know whether they are investing for growth (appreciation in the stock price) or income (dividends being paid out).

Understanding fractional real estate investments isn't as straightforward.

Dig into the documents to figure out important details like:

You May Need to Be a Accredited Investor to Qualify

Some fractional real estate companies such as Concreit are open to all investors. 

Final Thoughts: Should you Invest in Fractional Real Estate?

Fractional real estate investing can be a great way to gain exposure to real estate without all the hassle and risk of conventional real estate investing. However, you should know what role fractional real estate will play in your portfolio before buying it. 

In some cases, fractional real estate may not make sense. For example, if you don’t have a solid emergency fund in place. Because fractional investments are typically locked up, you won’t be able to tap into the fund in the case of an emergency.

In other cases, fractional real estate can be a wonderful opportunity. To illustrate, let’s say you live on the coast and you want exposure to real estate in America’s heartland—you may be able to find the right investments without finding deals or managing a property yourself.

Before jumping into fractional real estate investing, consider your goals and overall current financial situation.