TelferYoung Limited
The Concept & Valuation of Fractional Interest in Property
17 April 2007
Over recent years the concept of fractional interests in real estate, particularly holiday or resort accommodation, has materialised in New Zealand
A fractional interest is simply a divided ownership right in property that represents less than the whole. It can however have many forms, include freehold and leasehold interests and be subject to many different ownership and management structures.
The concept is well known and accepted internationally.
A fractional interest in this respect is not 'time share'. The purchaser owns a divided interest in the real estate not an allotment of time to use or occupy the real estate. Naturally the ownership of an interest comes with full rights of use and enjoyment, subject to the underlying freehold or leasehold tenure.
With fractional ownership the person owns a 'fraction' of the property and has his or her name on the title. This interest can be mortgaged, sold, transferred or exchanged. This ownership interest is exposed to market movement, both positive (as has been the case recently) and negative.
Why do people purchase a fractional interest in real estate?
One of the main attractions to fractional ownership is that it allows people to have ownership and enjoy the use of a property in a sector of the market which ordinarily they may not be able to afford. At a lesser entry level price it provides to the owner the full bundle of rights available under the parent tenure for a pre-determined portion of the year. It allows for efficient use of an asset and a superior 'true' lifestyle return on capital invested. Fixed annual ownership costs are reduced and subject to the ownership structure maintenance and management costs are pre-determined.
An example of a fractional ownership would be a $1,000,000 'villa' in a new resort development. The villa would have a freehold fee simple title sub-divided into say four unit or strata estate titles by way of a fractional title document. The four quarter fractions would then be sold to separate owners for $250,000 each. The four owners would be entitled to apportioned exclusive use of the million dollar asset and would benefit from future value growth.
An essential and critical part of the fractional interest is an accompanying management or property sharing agreement. This is a legal document that formalises all legal concerns regarding rights and responsibilities of each co owner.
Typically the document would detail:
- Rights of Occupation - on a quarter share situation this would typically provide for 13 weeks per year per owner on a rotating basis so that each owner has the ability to experience all seasons and peak holiday periods.
- Rights to Mortgage - detail on assurances on default - sale issues.
- Liquidity - entry and exit strategies, generally providing for other interests to have a first right of purchase
- Annual Management - maintenance, furniture packages, cleaning, payment of activities and annual standing charges.
- Sinking Funds - for replacements, upgrading and refurbishment.
- Conduct of Co-ownership Relationships - dispute resolution, termination of interests.
Valuation Issues
The market approach is the most appropriate methodology to adopt when assessing the value of fractional interests. Analysis of sales of 'like' interests in similar property types in the same or comparable locations with appropriate judgement applied to both national and international market forces allows the valuer to determine the appropriate level of market value. When valuing the factional interest it is essential to have knowledge of the management or property sharing agreements of the 'comparable' evidence. The nature of the agreement can and will influence the value of the fractional interest. Issues such as ability to mortgage; liquidity; ability to sublease must be considered.
The value of the 'whole' interest is relevant as is the number of 'fractions'. It is possible that the value of the fractional interest in a co-ownership structure may be greater or less than the value of the 'whole' asset.
New Zealand provides excellent lifestyle and holiday opportunities with global demand. As the price of holiday home ownership increases particularly those in preferred locations, fractional ownership will increase. The concept is logical, has merit and will become more common. The legal structures and operational documents associated with ownership will however remain complex and do significantly influence value levels. Valuation advice should therefore be sought prior to entering into a fractional ownership agreement.
Mark Dunbar
This monthly paper reflects the views of the writer and may not represent the views of all TelferYoung staff.