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
“Ninety percent of millionaires become so through owning real estate.”
Andrew Carnegie—industrialist, philanthropist, and one of America’s richest men
Get Started With Fractional Real Estate Investing
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.But today, fractional real estate isn’t limited to just timeshares. Many online crowdfunding platforms are using the fractional model to open up high-cost investments to more people. A typical earner may not ever be able to afford investing in a retirement community or 50-unit luxury condo building.
In a nutshell, here’s how fractional investing works:
Fractional real estate investors own a small portion of an expensive real estate project, like a retirement community or a high-rise condo. They get to enjoy cash flow or growth from the investment if it performs well. If it doesn't, the investor may lose money.
Pros of Fractional Real Estate Investing
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.In some cases, investors can even invest in real estate “funds” with geographic diversity. For example, when you invest with Concreit, you’re investing in their real estate fund which holds a variety of real estate assets.
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 “counter-balance” to the volatility in the stock market.Real estate often continues to generate cash flow, even when the stock market falls into a bear market. Holding real estate, along with stocks and bonds are smart ways to diversify your passive income portfolio.
Cons of Fractional Real Estate Investing
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.
Companies like Concreit are working to change that. With Concreit, you get weekly dividend payments on your investments. However, this could change due to market conditions, but it’s a differentiator right now.
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.However, other companies, for example, RealtyMogul require investors to be accredited. Accredited investors must earn more than $200,000 annually or have a net worth of $1 million or more, excluding their primary residence.
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.
Excited About Fractional Investing?
If you’re ready for this opportunity and want to take action, check out Concreit. You can open an account in minutes with no minimum investment requirement.
Hannah is a wife, mom, and described personal finance geek. She excels with spreadsheets (and puns)! She regularly explores in-depth financial topics and enjoys looking at the latest tools and trends with money.
Editor: Claire Tak