Complete Real Estate Investing vs. Fractional Ownership via a Legal Entity

Real estate investing is a popular way to build wealth and diversify an investment portfolio.

Two primary methods of investing in real estate are complete, outright ownership and fractional investing via an LLC or similar vehicle.

But is it better to acquire complete title ownership or are you better diversifying by fractional ownership through an investment vehicle (e.g. an LLC)?

Each method has its own set of advantages and disadvantages, which can influence an investor's decision based on their financial goals, risk tolerance, and investment strategy.

Here we explore the differences between complete real estate investing and fractional ownership and weigh the pros and cons of each.

Complete Ownership Real Estate Investing

Complete real estate investing involves purchasing an entire property outright.

The investor owns 100% of the property and is responsible for all aspects of its management, maintenance, and financial obligations.

But there are also benefits to complete and outright property ownership of your own real estate.

Benefits of Outright Real Estate Investing

1. Complete Control: The investor has complete control over the property, including decisions related to renovations, tenant selection, and rental rates.
2. Potential for Higher Returns: With full ownership, the investor can potentially earn higher returns, as they receive all rental income and benefit entirely from property appreciation.
3. Tax Benefits: Full owners can take advantage of various tax deductions, including mortgage interest, property taxes, and depreciation, with depreciation through cost segregation analysis being the most helpful.
4. Equity Build-Up: As the mortgage is paid down (preferably with the rental income tenants), the investor slowly builds equity in the property, which can be leveraged for future real estate investments.
5. Property Appreciation: Over a long horizon, most real estate properties tend to appreciate. While this benefits both outright and fractional owners of real estate, full owners have greater options on what to do with their properties.
6. Leverage: Once equity is built-up, the property can be used to leverage into other assets without losing ownership of the property. Financing tools like cash-out refinancing or second mortgages can help to provide needed cash for other opportunistic investment opportunities in the future.

The Downsides of Outright Real Estate Investing

1. High Capital Requirement: Purchasing a property outright requires a significant amount of capital, which may not be feasible for all investors. This is particularly acute when real estate financing is not used to acquire the property. But, even on a $200K property, a 20% down payment of $40K can be prohibitive for many would-be retail investors.
2. Concentration Risk: Owning a single property or a small number of properties can expose the investor to higher risk if the local real estate market declines. True diversification among various real estate markets takes longer to achieve, particularly when individual properties can be expensive.
3. Management Burden: Full ownership comes with the responsibility of property management, including dealing with tenants, repairs, and maintenance. This often equates to owning a completely separate business where you, the investor, acts as the business manager. This is not the passive investment scenario that every owner would prefer.
4. Liquidity Issues: Real estate is not a liquid asset, meaning it can take time to sell a property and convert it into cash. Fractional shares, on the other hand, are typically easier to sell and hypothecate.

Fractional Real Estate Investment & Ownership via an LLC

Fractional real estate ownership involves multiple investors pooling their resources to purchase a property through an LLC or similar vehicle.

Each investor owns a percentage of the property or assets based on their peri-passu investment amount and shares in the profits and expenses.

Benefits of Fractional Real Estate Investing

1. Lower Capital Requirement: Investors can participate in real estate investing with a smaller capital outlay, making it more accessible to a broader range of investors, often with less capital.
2. Diversification: Fractional ownership arrangements allow investors to diversify their real estate holdings across multiple properties and locations, reducing risk. Instead of putting five-figures into a single property, an investor might buy shares in a performing REIT or among fractional ownership in dozens of properties for the same price, reducing the overall risk of a single real estate investment.
3. Professional Management: Properties are often managed by professional firms, relieving individual investors of the day-to-day management responsibilities. Investors are 100% passive in the ownership of their real estate.
4. Shared Risk: Financial risks are distributed among all investors, minimizing the impact of any single property’s performance on an individual investor's portfolio.

Cons of Fractional Real Estate Investing

1. Limited Control: Investors have limited control over property decisions, as management is typically handled by a third party or determined by a majority vote among investors.
2. Potential for Lower Returns: Returns are divided among all pooled investors, which may result in lower individual returns compared to full ownership.
3. Fees: There may be higher management and administrative fees associated with the LLC, which can eat into profits. In the case where professional management is in place for larger properties, fees can often eat into cash flow even further. General Partner fees and "carry" can also eat into expected returns on a piece of fractionalized real estate. Finally, the administrative burden of compliance, particularly when securities laws are involved, can absolutely eat into what could have been a more lucrative real estate investment.
4. Liquidity Concerns: While the fractional ownership model can be more liquid than full ownership, selling a fractional interest can still be challenging and may not be as straightforward as selling stocks or bonds. If a given investor in single family homes, comes into a personal cash crunch at the same time their property loses a tenant, they may not be able to sell as quickly as they want.

Conclusion

Both complete real estate investing and fractional ownership via an LLC offer unique benefits and challenges.

Complete ownership provides full control and the potential for higher returns but requires significant capital and management responsibility.

Fractional ownership lowers the capital barrier, diversifies risk, and offers professional management but comes with limited control and potentially lower returns.

Investors should carefully consider their financial goals, risk tolerance, and real estate investment horizon before deciding which method aligns best with their real estate investment strategy.

Consulting with financial advisors or real estate professionals can also provide valuable insights and help in making an informed decision.

Here at Invest.net, we offer complete ownership options for savvy investors looking for turnkey real estate opportunities.

Contact us today!

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