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HOW ARE FRACTIONAL OWNERSHIP EXPENSES DIVIDED?

In shared ownership arrangements involving a single home, operating expenses such as insurance, maintenance, repairs, improvements, utilities and management are usually divided in proportion to ownership, so that a 20% owner will pay 20% of each of these expenses. When using the Pay-To-Use Approach, owner usage fees and rental income would be offset against expenses, and the 20% owner (after paying the usage fees for any days or weeks he/she spent in the home) would get 20% of any surplus if income exceeds expenses, or pay 20% of any deficit if expenses exceed income. In jurisdictions where property tax is increased as the result of the resale of a fractional share, the buyer should pay the entirety of the increase. A resale by one co-owner should never increase a non-selling co-owner's property tax burden. In states where resale does not trigger reassessment, property tax can be allocated like other operating expenses.

In fractional ownership arrangements involving multiple units, the developer must first determine whether usage of each co-owner will be restricted to a particular unit or units, or whether all co-owners will share use of all units. In the former case, the developer may opt to have each co-owner contribute only to the costs of operating the unit or units to which he/she has usage rights.

HOW ARE FRACTIONAL OWNERSHIP TRANSACTIONS FINANCED?

Industry surveys have shown that only 30-35% of fractional ownership purchases involve financing, and 65-70% of fractional interest purchasers pay all cash for their fractional ownership interest. Historically, when fractional ownership arrangements involving a single house or apartment were financed, the only available option was to obtain a group mortgage secured by the entire home. Larger projects could obtain fractional financing, where each fractional owner could get his/her own loan secured only by his/her ownership interest. More recently, individual fractional financing became available for fractional ownership arrangements involving a single house or apartment, but events in the lending industry have slowed this trend.

If there will be a group mortgage, the fractional owners will need to calculate how to divide the mortgage payments. If the down payment is shared in the same proportion as the price, the mortgage will also be divided in proportion to price. On the other hand, if some co-owners contribute more down payment than others (relative to their price), the mortgage division will be different than the ownership division. To illustrate, imagine five families want to equally share a $500,000 vacation home, and plan to buy it with a $100,000 down payment and a $400,000 shared mortgage. Now suppose Family #1 has only $10,000 for down payment, Family #2 has $30,000 for down payment, and the other families each have $20,000. Family #1 will be buying a $100,000 share with $10,000 down, meaning they will need to borrow $90,000 of the $400,000 group mortgage or 22.5% (90/400). Family #2 will be buying a $100,000 share with a $30,000 down, meaning they will need to borrow $70,000 of the $400,000 mortgage or 17.5% (70/400). Each of the other families will be buying a $100,000 share with $20,000 down, meaning they will each need to borrow $80,000 or 20% (80/400). In this situation, all mortgage payments will be divided according to amount borrowed, meaning Family #1 will pay 22.5%, Family #2 will pay 17.5%, and each of the other families will pay 20%.

HOW ARE FRACTIONAL VACATION HOMES MANAGED?

It is useful to divide fractional ownership management tasks into four categories: usage allocation, accounting, cleaning, and repair. Any of these jobs can be handled by either co-owners or outside professionals, can involve compensation or not, and can be combined as needed for efficiency or convenience.

Usage allocation management is necessary only in relatively complex usage systems, such as those that are based upon reservations or involve a pay-to-use element. Simple usage systems, such as fixed assignments or fixed rotations, do not require any management and are therefore less expensive and more reliable. Keep in mind that systems that are supposedly automated or web-based still require monitoring, upkeep and backup (when (not if) the system fails), so someone must be in charge of managing even the most automated usage system.

Accounting management involves collecting payments from co-owners, paying bills, and keeping records. To avoid shared ownership disputes and cash shortfalls which could result in credit blemishes and even loss of the shared property, it is absolutely essential to collect co-owner payments based on a budget and regular assessment system rather than "as needed". This means that at the end of each year, an owner or manager estimates all of the expenses for the following year, including group mortgage (if any), property tax, insurance, maintenance, repairs, improvements, utilities and management, and determines the amount, if any, that will be needed from each co-owner to pay the bills. The anticipated expenses should include some reserves for long-term recurring expenses such as painting, roofing, system upkeep, and furniture and appliance replacement. Each owner should be required to contribute his/her payment on schedule. In this way, each co-owner knows with a fairly high degree of precision what will be expected of him/her in the coming year, and it is easy to track whether a co-owner is meeting his/her obligations before a significant problem develops.

Cleaning is a management task with a surprisingly high potential to cause displeasure and discord among fractional owners, particularly in small co-ownership groups sharing one home or apartment. Most co-owners enjoy using their vacation home much more when they arrive to find it clean and orderly, and cleanliness is essential for successful rental to non-owners. Unless an unusually consistent and high standard of cleanliness and order prevails among all of the co-owners in the group (and their families and friends), it is likely that resentment and even anger will develop over the condition of the home when certain users leave. It is also true that one is supposed to be on vacation when using the home, and may not want to have to spend the last day of vacation cleaning. For all of these reasons, I strongly advise even the smallest and least formal vacation home co-owner groups to employ a cleaner or cleaning service to clean the property on a regular basis. The cleaning person can also monitor the condition of the property, and inform the co-owners when a particular co-owner or guest has damaged, broken or stolen something. One of the best things about shared ownership is that the cost of this type of service can be spread over the entire group.

Repair management is important because without it, no one person is responsible for keeping the fractional property in good repair, and small inexpensive problems can develop into large expensive ones. The repair manager should be responsible for periodically inspecting the property, fielding comments and complaints from co-owners, and arranging for and supervising repairs. If the repair manager will be doing any major repairs him/herself, it is important to establish, before beginning work, whether the repair manager will be compensated and, if so, how much. "Time and materials" compensation should be avoided because it often leads to disputes, particularly where the repair manager is not a professional contractor and may not use his/her time and/or the materials efficiently. A much better approach is to establish a scope of work, time for completion, and payment amount in advance. This avoids most potential disputes and allows the group to compare the repair manager's proposal to bids from outside contractors.

HOW DO VACATION HOME FRACTIONAL OWNERS MAKE DECISIONS?

In fractional ownership projects organized by a developer or property seller, the developer/seller must determine how much power to give the owners, how various types of owner decisions will be made (managing board versus owner vote, majority vote versus super majority versus unanimous), and how the transition between developer control and owner control will be handled. Where the fractional project involves multiple units, the seller/developer whether certain decisions should be made by subgroups of owners (or governing board elected by subgroups) based on divisions of usage rights and/or maintenance obligations. In other words, should decisions about a particular unit or units be made by all owners, or only those owners whose usage and/or payment obligations will be affected?

Regardless of how many owners and homes will be in the fractional ownership group, and whether the shared ownership arrangement has been created by a seller/developer or by the fractional owners themselves, it is useful to establish certain mandatory duties, things the group will be required to do unless all owners otherwise agree. These mandatory duties should include paying the recurring operating expenses and maintaining the building in good condition. Establishing mandatory duties prevents an individual owner (in a group of only two owners), or a majority of owners (in a group of three or more owners), from taking actions that endanger the group investment.

Groups of three or more co-owners typically have tiered voting systems where certain decisions are made by a majority or a subgroup such as a board of directors, and certain decisions require unanimity (or alternatively, a larger majority). Decisions requiring a higher level of approval are typically those involving major physical changes to the property, large expenditures, changing usage rights allocations, selling the entire property, and borrowing money against the property, and could also include anything else the group thinks is particularly important. When analyzing how decisions should be made, keep in mind that allowing a decision to be made by a majority allows the majority to take usage rights away from, or add cost burdens to, the minority. On the other hand, requiring a decision to be made by consensus can paralyze the group if there is a co-owner who is uninterested, unreasonable or angry. The personalities and relationships of the original co-owners may change over time, and new people may come into the group through resale or death, so don't assume that the level of cooperation, ease of consensus-building, and rationality you experience now will continue into the future.

In groups of only two co-owners, voting is obviously problematic. If the co-owners do not agree, the outcome depends on how the co-ownership agreement treats the item under consideration. If the agreement states that the action under consideration requires the consent of both owners, no action will be taken since the owners did not consent. If the agreement is silent on the issue, the co-owners will need dispute resolution assistance, typically mediation and/or binding arbitration.

One particularly important but often overlooked area of decision making and potential dispute is the layout and furnishing of the shared vacation home. The property can become an overly cluttered repository for all of the co-owner's unwanted furnishings, or an unpleasant maze of clashing tastes. I suggest that the co-owners initially agree on a furniture layout and, if items must be purchased, a budget and plan for how purchasing decisions will be made. Once the initial furnishing and decorating is completed, any additions or changes should require group approval.

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