Fractional Ownership vs REITs- Which one is better?

The debate on fractional ownership vs. reits is heating up as the Indian commercial real estate sector witnesses massive growth. This surge in demand for commercial real estate is expected to be driven by the ambitious aim of achieving a stable economy and reaching a five-trillion-dollar economy by 2024-25.

Although Fractional ownership and REITs do share a few similarities, it’s crucial that you understand these investment ventures work differently. Due to its distinct processes, there will always be the debate on “fractional ownership vs REITs” continuing to persist in the real estate industry.

In this blog, let's delve deeper into these concepts and their benefits and potential drawbacks through which you will have a clear understanding of fractional ownership and REITs, to make a better decision.

Concept Of Fractional Ownership

In its literal sense, Fractional ownership means owning a part of ownership in any asset. Fractional ownership in real estate allows you to invest in fractions of properties asserting you to be a co-owner of the property to which you have invested, just like owning a percentage of equity shares in a company grants you a partial owner.

With the advancements of fintech, fractional real estate companies are gaining momentum by which companies can now fractionalize assets. This method allows real estate projects to raise funds from a broader pool of potential investors, not limited to just friends and family.

It is a revolutionary investment approach in commercial real estate that eliminates the substantial-high amount of money required to purchase a property. Fractional ownership enables investors with limited capital to partake in commercial real estate. In this method, individuals pool their money into a Special Purpose Vehicle (SPV), which then allocates shares in small ticket-sized shares. And with this pooled capital they purchase large ticket-sized commercial properties that are worth significant value.

The investors are distributed rental income from the property and benefit value appreciation when it is sold. Moreover, some fractional ownership properties provide access to property usage rights, adding a further layer of value to the investment.

Advantages and Disadvantages of Fractional Ownership

The reasons behind its gaining momentum in the field of investment, are its advantages, which prove to be convenient to the investors for a perfect investment with great returns:

Advantages:

• Diversification:

Investing in multiple properties decreases the chances of risk because diversifying your investment helps spread your risk across various properties. This reduces the impact of potential losses and increases success.

• No interference of Management:

Being an investor in fractional ownership, one doesn't need to concern with marketing the property. Properties under fractional ownership typically have a dedicated manager responsible for overseeing the property management, streamlining the investors’s role.

• Profuse Investment Options:

You will find abundant of options to invest under fractional ownership. You can invest in residential properties, office spaces, and warehousing in other commercial properties that provide flexibility to suit our preferences.

Disadvantages:

Certain disadvantages you need to take care of before investing:

• Co-owners conflicts:

Differing opinions among co-owners regarding property matters can not only drain financial resources but also consume valuable time and energy. Resolving such conflicts promptly through proper communication is necessary to prevent these issues.

• liquidity:

Fractional investments generally lack the same amount of liquidity compared to other investment options. Therefore, selling your share in fractional ownership might build challenges, plus it might even be unattainable.

• Limited control power:

Fractional owners might face restrictions on decision-making authority over property-related choices. Reaching a consensus among co-owners might be necessary for implementing any alterations or decisions.

• Property management costs:

Fractional real estate investing includes the crucial task of ensuring the property's proper upkeep, which involves regular maintenance and management. This responsibility becomes burdensome if one of the co-owners fails to fulfil their share of these duties.

• In examining fractional ownership, it's necessary to weigh these advantages and disadvantages against your investment goals and risk tolerance.

Concept of REITs

Real Estate Investment Trusts, commonly known as REITs are companies or financial vehicles that own and manage a good range of commercial properties. It pools capital from various investors to invest in income-generating properties for maximum returns. Investing in such REITs is like investing in Mutual Funds, which invest in such Real Estate Companies or Direct Investing on Stock Exchange.

This offers investors a unique opportunity to tap into the world of real estate without facing the complexities of direct property ownership. Thus, the substantial profits made by the company are distributed to the shareholders through dividends. In addition, the market price appreciation reflecting the worth of the company can profit from substantial returns over time.

Recently, with the entry of the three REITs in the Indian Financial Market Embassy Office Parks, Mindspace Business Parks, and the Brookfield India Real Estate Trust on the stock exchange, the REITs space has garnered a lot of attention from retail investors too. This is because of the increase in the number of advantages REITs carry.

When you invest in Real estate investment Trusts and REITs, the hassles of actually owning a property are eradicated, such as the cost of the maintenance fees of the property.

Now, let's take a look at the advantages and disadvantages of REITs:

Advantages and Disadvantages of REITs

Advantages:

REITs are a pivotal aspect of an investment portfolio as they provide a potential yearly income and at the same time have the possibility of long-term capital gain.

For Instance, it has come to notice that during the previous 20 years, REIT’s performance of total return has crossed the S&P 500 Index. In 2022, the three REITs, Embassy Office Parks, Mindspace Business Parks, and Brookfield India, have transcended the BSE Realty Index.

As per the research of professionals, it seems the post-tax returns on REITs are two times higher than those of fixed-income products. Furthermore, the market regulator has decreased the minimum registration value of investments in a REIT IPO from Rs 50,000 to Rs 15,000 - 500, making it a more realistic alternative option for people.

REITs are highly liquid stock markets enabling investors to vend their stakes in their assets easily. REITs typically earn significant cash flow through the renting of their real estate. This frequently results in dividends paid to investors as well as capital appreciation.

In REITs, you don’t need to physically own a home to diversify your portfolio and have exposure to the real estate market; instead, you may gain exposure to corporations that hold properties in the world’s most desirable locations, offering sufficient potential.

Disadvantages:

Similar to the equities market even REITs are market-linked and also volatile. This means their performance can be influenced by various factors just as stocks are.

Commercial real estate might encounter weak periods of subdued capital appreciation, and there could be periods where property values don't rise significantly, and this can be linked to conditions like economic trends, market sentiment, or changes in demand, that are coupled with political and regulatory risks.

Try to avoid trusts who heavily focus on a single industry, like the IT sector, which may face long-term tenancy impacts due to the transition to hybrid work styles, potentially affecting demand for office spaces and impacting long-term rental income.

Make sure the assets of REITs are actually coming from credible real estate developers and keep track of the fund manager of generating consistent returns. The quality of the properties greatly affects the potential returns and stability of the investment.

Comparison of Fractional Ownership and REITs

Now that we have a clear perspective on Fractional Ownership and REITs, it’s time to dive deeper into the difference between fractional ownership and REITs that will help determine which investment aligns better with your objectives.

Fractional Ownership Vs REITs:

Both Fractional Ownership and Real Estate Investment Trusts (REITs) are the newest emerging ways to invest in the real estate sector. These tech-enabled investing strategies attract people who seek a successful commercial real estate investment. To make an informed decision, it's necessary to be clear with the basics of Fractional Ownership and REITs and be aware of their differences and suitability for your investing goals.

FAQs:

Q1. What is the difference between REITs and fractional ownership?

Ans: Fractional Ownership means owning a part of any asset. whereas, REITs is an investment in which Real Estate Investment Trusts companies own and manage commercial properties and sometimes even offer financing options at the initial stages of the project.

Q2. What gives higher returns REITs or private real estate investments?

Ans: Recently, REITs, have been known to be providing higher returns than any other private real estate investments. Having said that the returns on REITs rely on various aspects of private real estate investments. In addition, as REITs are listed on the stock exchange it involves the risk of market price fluctuation.

Q3. Is fractional ownership a security?

Ans No, because fractional ownership cannot be traded in the secondary market.

Q4. What is better than REITs?

Ans: Every investment option has its advantages and disadvantages. Its popularity and profits depend upon various factors like market risk fluctuation, the type of asset you invest in, etc.

Q5. Which is better REIT or mutual fund?

Ans: REITs distribute dividends and are compulsory to share 90% of taxable income with shareholders, however, REITs have lower real estate tax exemptions when compared to mutual funds. However, Mutual funds offer solid returns through compounding. Choosing which is better totally depends on individual goals, risk tolerance, and preferences.

Q6. Why should I invest in fractional ownership?

Ans: One should invest in fractional ownership because it allows one to invest or own a fraction of property. Especially, in fractional ownership one is able to invest in Grade-A commercial properties with very minimum cost compared to other buying processes of commercial real estate.

Q7. Do REITs perform better than stocks?

Ans: Yes, REITs often perform better than individual stocks as they have higher dividends when compared to stock markets.