Updated 9.16.24

What is Fractional Ownership Real Estate?

There are numerous reasons for investing in commercial real estate, including recurring cash flow streams, growth in property value through appreciation, and tax savings.

Almost all income-producing real estate provide these benefits. However, locating and acquiring high-quality real estate investments directly can be time consuming and expensive, with the best properties oftentimes out of reach.

That is why many sophisticated investors today are bypassing the older model of direct ownership and investing in fractional interest real estate instead.  But just what is fractional interest real estate?

Fractional interest is an ownership interest in a percentage of a given asset.

In real estate investing, fractional interest ownership occurs when individual investors act as a group to purchase shares of commercial real estate such as multifamily apartments, industrial, warehouse, office and shopping center properties.

Benefits of Fractional Interest Real Estate Investing

Traditionally, real estate investors have focused on owning 100% of a single property. This strategy may be useful for smaller, potentially riskier “mom-and-pop” types of investments but is not practical for larger properties. It is the bigger is (potentially) better concept.

Until recently, owning high-quality property leased to regional and national credit tenants was simply out of the reach of most investors due to the large capital requirements and expertise required.

Fractional Ownership Real Estate Investing enables those with different investment strategies to own the same commercial real estate that may not otherwise be unattainable for the average investor.

Today, a growing number of commercial real estate investors are realizing the benefits that fractional interest real estate investments have to offer:

Tranquility Grove Townhomes
Tranquility Grove Townhomes, a gated community consisting of ninety-two townhomes, in a prime North Houston, TX location is an example of a property available for fractional ownership investing.

Lower Barrier to Entry

The capital required to invest in a fractional interest of real estate is much less than purchasing an entire property. In addition to requiring less funds, the transaction costs of a fractional investment are much lower, without the need to conduct property due diligence or obtaining financing. These costs are shared with all the other investors.

Turnkey Pre-Packaged Investments

Institutional-grade real estate used for fractional investing is pre-vetted by the Sponsor or Trustee, with financing opportunities either in place or committed to with lenders. In most cases, property is pre-leased to a regional or national credit tenant on a net lease, which reduces investment risk and allows for a more predictable return of investment. In the case of multifamily or student housing asset classes, the sponsor has completed due diligence to ascertain the economic metrics are aligned with the sub-market and how to grow the value of the asset during the hold period.

Diversify Investment Portfolios

Investing in fractional interest real estate makes it much easier to diversify investment portfolios and mitigate risk for the investor. Investors wishing to add income-producing commercial real estate to their portfolios have the option of placing capital in multiple investments, creating a more systematic diversification of capital compared to owning an entire property on their own.

Options for Investing in Fractional Interest Real Estate

The two most common options for investing in fractional interest real estate are with Tenant-In-Common (TIC) ownership and/or by owning a beneficial interest in a Delaware Statutory Trust (DST).  See article DST Vs TIC Property Investing

Tenants-In-Common

A tenants-in-common investment is real estate that is directly co-owned with other investors. Unlike a DST, TIC investors must take an active part in making decisions about the property, although daily operations are often delegated to third-party asset and property managers:

  • TIC agreements require that major property decisions such as financing or selling require the unanimous agreement of all owners.
  • While TIC interests can be bought and sold, one of the biggest risks is that a new co-investor may become uncooperative by not agreeing to a major property improvement or by refusing to sell, even if all other owners agree to do so.
  • TICs are generally structured to accept a lower number of investors, making it more difficult to diversify risk and invest in larger, more expensive Class A real estate.

Delaware Statutory Trust (DST)

NAS Investment Solutions specializes in DST structured properties.  A DST is a legal entity that directly owns the real property, while investors own a fractional or “beneficial interest” in the DST:

  • Because DSTs have no limit to the number of investors, NAS Investment Solutions’ DST properties allow investors to own part of a larger, investment-grade property with a minimal amount of capital.
  • DSTs are completely passive investments, with all major property decisions made by the trustee of the DST.
  • Beneficial interest structure of a DST shields investors from potential liability because the DST owns the real property, not the investor.
  • Individual investors do not have to qualify for financing, because loans are made to the DST directly.
  • A variety of properties may be held within the same DST, each with a different debt structure, providing investors with a deeper level of diversification from a single DST investment.

Since 2004, DSTs have been steadily increasing in popularity compared to TICs, in part because of the truly passive, hands-off nature of fractional interest DST real estate investments along with the ease of using a DST on the replacement side of a 1031 tax deferred exchange.

Factors to Consider Before Investing

Although fractional interest real estate investments offer a wide range of benefits, they may not be the best choice for every real estate investor. Some of the key factors to consider before investing in fractional interest real estate include:

7279 Syracuse - Example of Fractional Interest Investing sponsored by NAS
7279 Syracuse is an example of a NAS sponsored property for fractional interest investing. The property is 100% leased to a NASDAQ publicly listed company and occupied by the corporate headquarters of a technology company that serves as a major supplier to the healthcare market.

Liquidity

Because of their relative illiquidity, fractional investments are best suited for real estate investors with a targeted holding period of at least 7 – 10 years.

Risk-Adjusted Returns

Fractional real estate ownership allows an investor to own part of a property that they otherwise may not be able to attain on their own.

In exchange for the relatively lower risk of owning part of a high-quality property leased to a national or regional credit tenant, in a NNN lease, with predictable cash flows, overall returns may be lower than higher-risk Class B or more speculative investments.

Capital Diversification with Passive DST Fractional Ownership

Fractional ownership investments, in a NAS Investment Solutions’ commercial real estate property makes fractional ownership an attractive option for the replacement property in a 1031 exchange. Fractional ownership also allows investors to diversify an investment portfolio away from more volatile stocks and bonds, and the potentially higher risk of direct property ownership.

Sponsorship

Fractional interest real estate is a passive investment. Rather than requiring the investor to actively participate in property management and operations, the Sponsor is responsible for identifying and structuring pre-packaged investment opportunities, then overseeing the daily operations and achieving the targeted investment returns.  See article: The Importance of a Credible Property Investment Sponsor

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Tranquility Grove Townhomes

Multifamily Investment with Value-Add Upside
Prime North Houston Location
* 1031 Exchange Eligible *

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Frequently Asked Questions

  • What are the advantages of a DST-Structured investment in commercial property?

    There are numerous advantages to investing in a DST structured property offering.

    • The purchase of DST interests is simpler, faster and does not require as many documents as buying sole ownership of a property.
    • Capital Gains are deferred, if investment is for a 1031 Exchange
    • No daily property management obligations that come with sole ownership
    • Ability to create a diversified real estate investment portfolio
    • Cash flow distributions
    • Annual depreciation/tax deductions
    • Appreciation upon sale of the property
    • Upon the sale of a DST property, the investor may engage in a 1031 exchange, even if the DST interest was purchased without 1031 exchange proceeds.
    • A DST is a pass-through tax entity, which is not subject to federal income tax, nor to the Delaware franchise or income tax.
    • Because the DST is the mortgage borrower, the lender does not require individual DST investor guarantees, nor does the lender require investors to submit personal financial information to qualify for the mortgage loan.
    • Investors with interest in a DST property are protected from property liabilities held by the DST. As a result, the maximum pre-tax loss (excluding income tax considerations) is equal to the amount invested in the DST.
  • Are there a minimum and maximum investment amounts to participate in a DST property offering?
    • Yes; $50,000 to $100,000 are typical minimum investment amounts but this may vary from sponsor to sponsor.
    • The maximum amount is contingent on the overall size of the DST offering and the discretion of the DST Sponsor.
  • Are DST-Structured properties commonly used for a 1031 Exchange?

    Interests in Delaware Statutory Trusts are the primary investment method for fractional 1031 exchange investments at this time.

  • Are there any restrictions on a DST-Structured Investment?
    • The IRS places several prohibitions on the power of DST trustees if the Delaware Statutory Trust is to be used with a 1031 tax deferred exchange. There are seven restrictions, sometimes referred to as the ‘Seven deadly sins of a DST’:
      • Once a DST offering is closed there can be no further contributions by current owners, new owners, or beneficiaries.
      • Existing loan terms cannot be renegotiated, nor can new funds be borrowed, by the DST trustee.
      • Sales proceeds from the investment real estate cannot be reinvested by the DST trustee.
      • Capital expenditures can only be made by the DST trustee for normal repair and maintenance, minor non-structural capital improvements, or those required by law (such as items related to zoning codes).
      • Liquid cash held by the DST between distribution dates can only be invested in short-term debt obligations.
      • All cash in excess of necessary reserves must be distributed to investors.
      • New leases or re-negotiations of current leases may not be entered into by the DST trustee.
  • How does an investment in a DST-Structured property differ from an investment in a TIC-Structured property?
    • Like TICs, DSTs have multiple investors that purchase fractional interests and the investors share in the total financial performance of the underlying investment property. However, the primary differences between the two investment structures are:
      • A DST is not limited to a maximum of 35 investors required by Revenue Procedure 2002-22.
      • DST investors (Beneficiaries) are purchasing a beneficial interest in a trust and do not receive deeded property.
      • Beneficiaries in a DST are not necessarily required to form single-member Limited Liability Companies (LLCs).
      • Beneficiaries do not have voting rights or operational control of the property.
      • In a DST structure, there can be no cash calls or additional money invested into the property beyond typical maintenance and certain capital expenditure needs, unlike in TICs.
  • What is a 1031 Exchange?

    A 1031 exchange is a swap of one real estate investment property for another in a specific way that allows for capital gains taxes to be deferred.

  • How a 1031 Exchange is Accomplished?

    There are seven recommended steps common to most Section 1031 tax deferred exchange:

    BEFORE YOU CLOSE ON THE SALE OF THE RELINQUISHED PROPERTY:

    Step 1: Consider retaining the services of a certified public accountant or an attorney with tax deferred exchange experience to assist in planning for an exchange.

    Step 2: Engage a Qualified Intermediary, or “QI,” (also called an Accommodator), being sure to name the QI as the principal in the sale of the relinquished property and in the purchase of the replacement property.

    Step 3: Sell the relinquished property, making sure to include a cooperation clause requiring the buyer to cooperate with the seller’s 1031 exchange, and instruct the escrow officer or closing agent to order exchange documents from the QI.

    AFTER CLOSING THE SALE OF THE RELINQUISHED PROPERTY

    Step 4: Escrow closes on the relinquished property, with the closing statement showing the QI as the seller, and sales proceeds from the relinquished property are sent to the QI and placed in a separate segregated trust account.

    FAILURE TO SEND SALES PROCEEDS DIRECTLY TO QUALIFIED INTERMEDIARY FROM ESCROW WILL RESULT IN INABILITY TO EXCHANGE.

    Step 5: Within 45 calendar days of the close of escrow of the relinquished property the exchanger identifies one or more replacement properties and sends written notice of this to the QI.

    Step 6: The exchanger executes a purchase contract with the seller of the replacement property, making sure the cooperation clause is included in the purchase contract, and naming the QI as the buyer of the replacement property.

    Step 7: Within 180 calendar days of the close of escrow of the relinquished property, the exchanger instructs the QI to transfer funds to close escrow and sends 1031 exchange-related documents to the escrow company, and the sale closes with the closing statement showing the QI as the buyer on behalf of the exchanger.

    • After the replacement property has closed escrow, the QI will send a final accounting statement to the exchanger. The statement will show that funds have come from one escrow directly into another, all without the taxpayer having constructive receipt of the funds.
    • Real estate investors should note that although the qualified intermediary is indicated as the seller and buyer on the purchase contracts, the deed and title are always from the taxpayer to the buyer, and from the seller to the taxpayer.
  • What qualifies as a “like-kind” replacement property?
    • The definition of a qualifying like-kind property is very broad, for both the sold property and the replacement property: real estate used for investment or business purposes. Personal use property is not eligible.
    • Investment real estate (held for either appreciation or for rental) can be exchanged for real property used in a trade or business. Partial interests such as TICs or DSTs, are exchangeable with other types of real property.
  • How is a replacement property identified?

    A like-kind replacement property is identified if it is designated as replacement property in a written document signed by the exchanging party and received by the QI before the end of the 45-day identification period. Every QI uses their own form of documentation. Please consult with your QI to determine the exact procedure they require.