Fractional investing an increasing practical solution shaping investment landscape
With the increasing trends seen in first home buyers receiving financial help from their parents, the notion of fractional investment has become an emerging practical strategy to consider for investors and related SMSFs.
In a recent update, Warren Gibson, head of marketing at DomaCom, said that recent Digital Finance Analytics had revealed that 60 per cent of first-time home buyers get financial help from their parents. This is most often in the form of cash (gifted or loaned) or as guarantor on a home loan.
“Going guarantor means the parent/s use the equity in their home as security for part or all the deposit, enabling the child to get into a home with little or no deposit of their own and eliminating Lenders Mortgage Insurance,” he said.
“For those without the benefit of a bank of mum and dad (BOMAD) to call on, it is still possible to achieve home ownership by engaging a broader base than just mum and dad. Family members, friends and even random strangers can participate in funding residential property as an investment.”
The idea of sharing a property for the benefit of several parties is not new, going back centuries, such as share farming or share cropping, according to Mr Gibson.
“Today, shared ownership may be the only way some people can afford to get into the housing market. But instead of having a bank loan, which may be difficult to get, they can have a stake in a property in proportion to their contribution,” he said.
“You can call this idea fractional investing, syndication or crowdfunding, but it all amounts to the same thing, with the occupant paying rent instead of interest on that part of the property, which is fractionalised into units, they do not own.
“For example, if you buy 5 per cent of the equity, you are paying rent on the 95 per cent you don’t have. As and when you can afford to purchase units from the other investors, you increase your equity and reduce your rent accordingly.
“Apart from the rent, the investors also share in any capital appreciation until they sell. The ‘tenant’ can buy out the investors over time as and when they have the cash to do so or can arrange finance. That may be after their equity has increased or their income is sufficient to service a loan.
“Although shared ownership has always been an option, the lack of a robust legal structure and independent management has meant that a dispute is just around the corner when things don’t pan out as planned for all parties involved. Let’s face it, life can throw a curve ball that results in one party being unexpectedly disadvantaged.”
Mr Gibson noted these joint arrangements need an umpire in the form of a legal structure that ensures everyone can be accommodated when circumstances change.
“We’ve all heard the stories. Dad tips in $100,000 for his son to buy a house with his bride. The marriage breaks up, the house is sold, and the bride takes 50 per cent of the assets, including $50,000 of dad’s money, which he has no claim on because it was gifted,” he explained.
“Had a legal structure been in place, dad would get his $100,000 from the sale proceeds of the house.
“A legal agreement could save this situation but may still be argued in court. A financial product sitting over the asset is less likely to be challenged.
“Where a unit trust legal structure is in place, everybody wins fairly from the outset.”
Mr Gibson said there are several advantages to this fractional model for potential home owners and investors.
“Investors will have a liquidity solution and a long-term committed tenant with skin in the game who will look after the property because they own part of it. They are also investing with a social goal in mind. Investors can be family members too and retain the right to the funds they are contributing, so no loan is needed,” he explained.
“The tenant has investors to whom they pay rent and can buy out over time, with the option to borrow when they can afford to do so.
“In the fractional model, mum and dad do not have to provide a guarantee, and the tenant/home owner does not need Lenders Mortgage Insurance to start their journey.
“Although fractional investing has been deployed across several different property and asset types, such as renewable energy, rural farmland, and commercial and residential property, it works just as well in assisting first home buyers who may be short on the requisite deposit.”
Tony Zhang is a journalist at Accountants Daily, which is the leading source of news, strategy and educational content for professionals working in the accounting sector.
Since joining the Momentum Media team in 2020, Tony has written for a range of its publications including Lawyers Weekly, Adviser Innovation, ifa and SMSF Adviser. He has been full-time on Accountants Daily since September 2021.