Ruth Saldanha: In its latest statement in October, the Bank of Canada held rates. This is a small bit of relief for many Canadians who have mortgages and have been eyeing rising rates with some amounts of alarm. For those who may or may not own their homes but still want some exposure to real estate in their investment portfolios, fractional ownership of real estate may seem attractive. Is it though? Madeline Hume is a NEXT Senior Research Analyst with Morningstar Research Services, and she has been tracking fractional ownership. She is here today to talk about what she has found. Madeline, thanks so much for being here today.
Madeline Hume: Thanks for having me, Ruth.
How Does Buying Just a Part of a Home, Work?
Saldanha: So, let’s start by talking about what exactly is fractional ownership of real estate. How does it work?
Hume: Yeah. So, it means different things to different people. There’s no one definition that applies to all fractional real estate. It can mean even slightly different things in Canada versus the U.S., for example. Typically, what everybody agrees upon is that it is an ownership stake in a real estate investment that confers some sort of access or rights to the property, but there’s no standard definition for what those rights or access actually are. So, some businesses that build themselves as fractional real estate platforms are giving you a certain amount of time or unit of time spent on the property in a given year, like a time share. But what I’d like to talk with you about today is fractional real estate platforms that offer access to real estate properties as an investment vehicle.
So, what does that mean in practice? That means that investors are putting down a certain amount of money. It could be as low as $50 in some cases, quite a bit lower than a down payment. And in return, they’re expecting some distribution of income from rents of the property and the potential for capital gains when the property is ultimately sold.
Fractional Ownership of Homes Vs Single Stock ETFs
Saldanha: So, this sounds a little bit like a single stock ETF, but instead just for a single home or maybe for a building. Is that it?
Hume: It’s maybe the closest comparison that I could draw for investors that may not be able to get a handle on it, but I would say that there’s one crucial difference. Practically, all shares of Microsoft, for example, for a stock are created equal. If you sell one share, you know exactly what on the other end as an investor you’re buying. And you can exchange those like-for-like. But with real estate, no two properties are the same. They’re much more difficult to buy and sell because you need to find a buyer that’s interested in the unique property that there’s exposure to.
The Risks of Fractional Home Ownership
Saldanha: So, you touched a little bit upon some of this, but what are some of the risks of fractional ownership?
Hume: Yeah. So, the biggest one is liquidity. So, when you have the challenge of not having an asset that’s like-for-like with another investment, it means that when investors commit their money to a particular project, it can’t easily be withdrawn like a stock or an ETF can be sold. Either investors have to pay a penalty to liquidate their shares or sell it to another potential investor, which means they have to sell it for whatever the other investor thinks those shares are worth and that’s certainly up for debate.
What to Do For Exposure to Real Estate – Without Fractional Ownership?
Saldanha: So, assuming I’m an investor who wants some exposure to real estate but doesn’t have enough for a down payment or for an entire house, what are my options here?
Hume: Yes. So, there is one long outstanding option that many investors have successfully used since time immemorial, and that’s a real estate investment trust. It’s commonly known as a REIT. Essentially what it is, is it’s a share that invests in a basket of diversified properties. And because those shares are traded daily on exchanges and there is a certain amount of liquidity that’s expected for those vehicles, the properties that they’re invested in are not just diversified, so you’re getting exposure to multiple properties at once, but they also oftentimes are held to higher quality standards, lower leverage standards, things that protect investors when the markets start to get hit.
Saldanha: Great. Thank you so much for joining us today with your perspectives, Madeline.
Hume: Ruth, it’s been a pleasure talking with you.
Saldanha: For Morningstar, I’m Ruth Saldanha.