© 2007 Bankrate.com

 

 

NORTH PALM BEACH, Fla. – Aug. 9, 2007 – If the cost were the same, which would you rather own: a vacation home in the hills of Tuscany or holiday digs in London, Aspen, South Beach and Rio de Janeiro?

If you prefer the latter, you’re not alone. A growing number of Americans are following the lead of well-heeled Europeans and investing in fractional ownership of vacation property. For the price of that Tuscan villa, you might own quarter shares in the four other destinations.

“That’s exploding,” says Andy Sirkin, attorney and partner in Sirkin Paul Associates of San Francisco and Paris, which specializes in fractional ownership. “Every week, we see a 10 to 20 percent increase in the number of calls.”

As a fractional owner, you actually become a co-owner of a vacation property; you split the purchase price, maintenance and taxes with your co-owners, as well as the property’s appreciation down the road.

 

 

The advantages of fractional ownership are numerous:

 

The disadvantages are few but can be significant. Though their number is growing with demand, there are still relatively few lenders willing to finance the purchase of a fractional. All kinds of financial foibles can arise if you fail to carve the terms of your fractional in stone with the help of an attorney familiar with the nuances of this emerging field. The pro rata shares may add up to more than what the property would have cost a single buyer. Be as careful in selecting a vacation fractional as you would your own home, since there is no guarantee it will hold its value, even in a resort location.

 

 

Baby boomers lead the way

Sirkin says fractionals reflect the changing lifestyles of baby boomers who want to either recoup some of the outlay on their little-used vacation home or diversify their vacation destinations without having to sell the place or, worse, rent it.

“This way, they have use of the house when they want it, the house is not beaten up by being rented out, and they’re not bearing the entire cost of acquiring or maintaining the house. Plus, they don’t have the management headaches of renting it out. That is what is causing people to turn to this in increasing numbers.”

 

 

Ownership and control

If this all sounds a little familiar, it should. In fact, perhaps the biggest hurdle facing the emerging fractional industry is that it is frequently confused with your parent’s version: the timeshare.

Two things separate the fractional from the timeshare: ownership and control. With a timeshare, you typically bought the use of a property for two or three weeks a year; there was no ownership in the property itself and you had little, if any, control over when or where you stayed. With a fractional, you are actually a co-owner of the property, either by deed or, as is often the case with foreign fractionals, as a shareholder in a nonprofit business entity such as a partnership or limited liability company. Although deeded ownership does not guarantee you any particular level of control per se, it does provide the opportunity to incorporate that into your governing documents.

As your parents may attest, the problem with timeshares is that their investment value tended to decline rather than appreciate, especially when the developer moved on.

“What gave older timeshare concepts a bad name was that people didn’t really have any control at all, so what happened was, either the property became run down over time or costs went up exorbitantly, or both,” says Sirkin. “So it got to the point where you were paying more than you would for a much nicer hotel room down the street. They were too big, the developers had no incentive to keep it up once they sold out the project and there was no one to actually take care of it.”

Neil McAllister, co-founder of YourFraction.net, a fractional advisory service based in Florida and Edinburgh, Scotland, says fractionals have learned from the mistakes of timeshares.

“I think with the average timeshare, something like 50 percent of it goes to commissions and fees, whereas the true brick-and-mortar value is really quite low,” he says. “The finance people we’re using have said they would prefer that the total of all the fractions does not exceed 130 percent of the value of the property.”

Fractionals are all the rage just now, with megadevelopers such as Ritz-Carlton, Four Seasons, Marriott and Interwest busily marketing private residence clubs, or PRCs, in their luxury resort properties, hoping their four-star pedigrees will lure boomers away from do-it-yourself options.

Would you rather be a direct owner in a small fractional or a luxury PRC member? Sirkin says the choice once again comes down to equity and control. “If you buy a nice house in a desirable resort area, that is going to hold its value, period. Even if the group doesn’t do such a good job of being a group, the basic real estate value is there,” he says.

 

 

The fractional solution

There is little doubt that America is on a tear for vacation real estate. According to the National Association of Realtors’ most recent “Vacation Home Buyers Survey,” vacation-home sales rose 4.7 percent to a record 1.07 million in 2006, up from 1.02 million the previous year. Vacation homes accounted for 14 percent of all homes purchased last year, up from 12 percent in 2005. Four out of five owners surveyed said they purchased the home primarily for vacation use.

But Christine Karpinski, author of “How to Rent Vacation Properties by Owner,” says those dream getaways often come with some unrealistic expectations.

“Very few people buy a vacation home with the intention of renting it out; they always think they will be able to use it, but people just aren’t realistic,” she says.

Karpinski is now affiliated with HomeAway.com, which lists some 85,000 paid rental listings for homeowners looking to recoup some of their vacation home investments. HomeAway charges between $140 and $400 for a one-year rental listing, depending on features. She finds fractionals a more realistic alternative to vacation-home ownership – if you think ahead.

“It’s a great way to build equity,” she says. “A lot of times people don’t get into partnerships because they have this idealistic view of the future; they want to retire to Florida or Hawaii. But a lot of times, those decisions are made between the ages of 45 and 55, when you don’t necessarily know your future. Ten years later, you may have aging parents and new grandchildren to where you don’t really want to move to Hawaii.”

 

 

How to draft the agreement

Hammering out the details of a fractional falls somewhere between drafting a partnership agreement and writing up governing documents for a condo association. Sirkin estimates the average cost at $2,000 to $4,000, with an additional $400 to run it by a real estate attorney in the county or country where the property is located – definitely a good idea. But remember, those costs are shared by your co-owners.

Most of the fractions Sirkin has worked with number four to eight co-owners; the number is often driven by the desirable number of weeks each year and the proximity of the property. Among domestic destinations, Colorado ranks first, followed by Florida, Hawaii, California, Nevada, Texas and the Carolinas. A quick online search for “fractionals + (your desired location)” will put you in touch with local Realtors, developers and others in the know.

McAllister, who is currently working on fractioning a 55-apartment Tuscan villa and a golf estate at St. Andrews, says fractionals allow even average Joes to have their vacation home and afford it, too.

“If you buy at a sensible price, there is a very good chance that it will appreciate in value, whereas timeshares do nothing but depreciate. And whichever way you look at it, either as an investment or free holidays for X number of years, there’s very little risk.”