My Experiment with Fractional Real Estate Investing

Hi!

I mentioned this before - I never thought I’d buy a house before I was close to retirement. Yet I did. Another tenet I had was that I’d never invest in real estate. And yet, here we are.

I bought a fractional real estate.

How I got myself into it

My wife and I had initially gone to a property expo to “window shop model houses” as she put it. Although we didn’t find one we liked in the show, we eventually found another house that we loved and booked. In that property show, we came across a start-up which dealt in fractional real estate investing.

Their pitch was fairly straightforward. Their company has curated a few properties in prime locations of touristy places. They list them on rental platforms like AirBnB, manage the property and get rental income. These properties are expected to provide good rental yields along with an appreciation in property value. The company is providing folks with the opportunity to buy a fraction of the property and get a cut in the rental income and property appreciation.

On returns, they promise an interest of 6% annually on properties which are under construction till the company can list it for rent. Once they rent it out, they promise a minimum of 10% return or the rental yield, whichever is higher. That sounded like a decent return on capital compared to dismal 3-4% on residential properties. And they also gave you a week of stay free in the property, but during the off season.

I was still skeptical, but my wife was all into it (throwing you under the bus Momo if it goes south 😘). She even wanted to become a privileged member by investing Rs 50L in 5 properties. But (thankfully) we didn’t have enough money - coz house - so we compromised and invested Rs 10L into one property.

What I’m concerned about

Getting into fractional real estate investing is fairly simple, but what I’m not comfortable with is what comes after.

Now let’s be clear - the real return from any property is its appreciation in value. Rental return is great, but that’s not where the money is at. Coming back to fractional real estate, I’m beholden to the company to determine what the current value is. That’s a lot of information asymmetry between the company and me. Yes the company also holds a fraction so they are incentivised to value it as high as possible. But I’ll only benefit from it if I too hold on to my fraction as long as the company does. If I want to exit early, it’s in the company’s interest to benefit from the arbitrage by quoting me a lower price, and then a higher price to the next buyer.

There’s also the black money component. There are too many folks who won’t buy or sell without putting in a significant fraction as cash, often unaccounted money. I don’t know how the company will navigate this and still comply with tax authorities. Another concern with this is what if they’re already handling a lot of cash? Their incentive will be to provide a lower value to us investors and the government, and pocket the unaccounted money as profit. I could, in theory, turn my head the other way. But what if the company is caught?

This brings up a big problem - what if the company goes bust? They manage the property, so if they fold up I’m now stuck with a property that requires all fractional owners to make any decision. Do we find another company to manage the property? Do we sell it immediately to recuperate some value out of it? What if there’s this one fractional owner who decides to be contrarian for the sake of it? There are too many questions which rely on good intentions and cooperation of all parties to make it work.

One issue which I think the company has mitigated is the exit problem. In some other fractional investment companies, I would need to myself find another buyer and sell it at a potential loss if I need money urgently. Here the company has promised to find a buyer themselves within 60 days and take a 2% cut as brokerage. If they don’t find one, they will buy the fraction back at the “current market price”, whatever that might be.

Let’s see what the future holds

I don’t want to imply the company invested in is nefarious, and wants to run away with my money. My concern mainly is in the fact that I’m flirting with investment opportunities which are unregulated, so I’m relying on good intentions of the company to get anything out of it. I don’t want to be stuck fighting court battles or running from pillar to post to get my money back. So let’s see, maybe I am too naive to see the potential of a untapped opportunity, or I’m too foolish to see the problems and still get my hands burned. I’ll keep you posted on how this turns out.

Until next time!