Fractional property investing rings true to its name; a means of making a profit by purchasing a fraction of a property that belongs to a greater complex or asset.
It all starts off with signing into a unit trust or fund, which is commonly managed by a licensed fund manager whose responsibility is to purchase properties and split them into separate units or bricks. An interested investor steps in, purchases one, or a few of these units, and reaps a financial return once they are sold on.
It’s an alternative to pooling saved assets into a single property, which often entails having to sign into a substantial loan with the bank. But how does investing through building bricks ultimately work?
Whilst it won’t necessarily generate a high return, it can provide an investor with a secondary income and some room to move, without them having to be ripe in both experience and savings.
Director of OpenCorp and industry leading expert in fractional property investing, Matthew Lewison, explains how fractional investing fits into the property climb.
“If the property is purchased by the fund for $500k then the manager will issue 10,000 units – sometimes called financial bricks – at $50 per unit. Each unit therefore entitles the owner to 1/10,000th of the underlying asset. If the asset value goes up by, say $10k, the value of each unit relating to that asset will increase by $1, equal to a 2% increase for the investor,” Lewison says.
However, if an investor is to get a complete understanding of the gains or losses they’ve collected from the units they’ve bought into, they will need to sell their units on the open market.
Otherwise, they will need to sit tight and wait for the moment the underlying asset, the property in which the investor has invested in, is sold; wherein the sold price of the entire asset is split up and the owner of each unit pockets a share of the cash return.
But whilst a large head-count of investors are involved in this means of property investing, the average investment is very small, Lewison points out.
“For instance, BrickX has over 13,000 members after operating for a couple of years and currently holds $19.7m of property. This is equivalent to around 35 properties at Australia's median dwelling price. It suggests that the average investment with BrickX is around $1,500.”
Having said this, what’s the allure behind fractional property investing?
Put candidly, you don’t need to have much capital to start. The investor also has power of choice over which properties their money is tied into.
But Lewison reveals how the options fluctuate: “It does depend on what properties are available at the time, either as newly acquired assets of the fund they’re signed with or through the resale of another investor’s units.”
What’s the minimum amount needed to start to invest?
Catching a first break as an investor, especially for those on a lower income, can be challenging. In an economic climate where house prices are rising faster than incomes and competition is heated in major-city areas, it can be years before an investor is ready to take their first confident stride into the market with hopes riding high on pocketing a return.
It’s also nerve-wracking for first-timers, to be testing the waters when the economy sits on a cusp, everyone’s eyes intently focused on which way the Reserve Bank and housing prices will tilt to next.
Furthermore, saving for a deposit costs time and means sacrifice. Although more viable now with Lenders Mortgage Insurance diminishing mandatory cash deposits to as little as $10k, or 5% of a property’s value, such an amount can still take months if not years to accumulate.
But fractional property investing can in some ways present a short cut.
“Theoretically, investors looking to get started in fractional investment can kick off with just $50,” Lewison reveals.
“The fractional investment platforms offer a range of properties, from houses in regional areas to apartments in inner or beachside suburbs.”
With a lower barrier to entry – a slither of a single pay check – fractional property investing takes some of the buying pressure away and opens the participation pool up to a wider range of demographics and income types.
The benefits of fractional property investing
The small amount needed to begin means that the time it can take for an entry level or lower income investor to start capitalising in residential property is significantly reduced.
“Investors can also save time, as a lot of the work is done for them in securing and managing the properties,” Lewison says.
For those new to investing, this can take some of the pressure off making high-risk investment decisions, although it’s expected that even newbies will employ the advice of a qualified financial professional to help them call the right shots.
This relief stems from the fact that investors are able to divide their limited capital across a broader range of properties, rather than having all their money attached to the one property, Lewison explains.
“Self-managed superannuation funds can invest without needing a huge balance or being completely exposed to a single asset,” he says.
Fractional property investing also takes the investor out of the property manager or landlord role because they don’t need to be physically available at the property nor ensure it is up to scratch come sale day.
However, offering a small investment amount into a brick or unit won’t necessarily breed a single high return, and certainly not one substantial enough to act as a deposit for an investor’s next move. But it will mean a more controlled return, in increments, that can build-up over the long-term.
And that sense of control, in what can often be an unpredictable playfield, is considered of value to any investor – especially to those who happen to be vigilantly engaging with the market for the first time, juggling household finances, or not being able to save for a large deposit.
A first-timer can dip their toe in the water and see how the investment and the manager performs, Lewison says.
“If the performance is positive, then you can increase your investment. Most of these platforms offer regular savings plans and distribution reinvestment plans, which allows you to add to your balance on a monthly basis similar to a bank savings account.”
What are the ins and outs of ‘liquid investments’?
Since fractional property investing operates through a functional secondary market, it is termed as a ‘liquid investment’. But what does this mean? And why is it important to understand how such a platform operates?
According to Lewison, at this stage, the true depth of the fractional property investment market is unable to be accurately measured, predominately because it is not as transparent as an open market, such as the ASX.
This means it becomes more vulnerable to being open to manipulation by either the fund manager or an independent third party.
“The secondary markets are hosted and controlled by the fund manager. They do not share the volume of bids, to buy, versus offers, to sell,” Lewison explains.
“The fund manager has a vested interest in demonstrating that there is a secondary market as this is one of the key selling features of their offer. As such, there exists a strong potential for the manager to arrange related parties to buy-up offered units to give the appearance of a functional secondary market.”
Lewison believes that it’s not until the fractional investment market reaches over the $100m range that such instances of moulding will be a thing of the past.
“If [the market] does get artificially propped up, then [investors] may find themselves in an illiquid investment once the artificial demand is withdrawn,” he says.
Building a fractional property investment portfolio
Rather than buying into full ownership of a house, or even signing into as much as 50% of its gains and losses through the means of a property joint venture, an investor can spread the same amount of their invested cash across multiple properties.
For instance, their assets can be split-up across 20 properties, which means the investor acquires a 5% hold in each.
Lewison sheds light on what can happen if any units or bricks suffer losses: There is better chance that the profits of the other remaining properties or bricks will make-up for these losses, and altogether, a profit will stand, regardless if there were a few bricks that chipped away.
However, whilst this blanket of security stretches, fractional property investing can be limiting in some regards.
Most fractional property investors will be far from experts, Lewison says, and although a portfolio can efficiently be tapped into, “leaving it to novices to choose their own properties to build a high performing portfolio is not likely to produce the greatest results”.
“And because every investors portfolio is different, fractional property investment platforms won't ever be able to publish their performance results. In other words, they are designed for the investors ‘user experience’ and not for a high performing, long-term investment outcome,” he says.
Whilst an investor will most likely have to borrow money from a lender to fund and control a house with the power of their cash deposit, this varies with fractional property investing.
“In the case of fractional property investment, banks do not have recourse against any of the owners of the underlying property, and as each property within the trust has separate ownership they cannot be used to cross-collateralise a mortgage. Therefore, gearing on fractional property investment assets is often 0%,” Lewison explains.
When an investor purchases a single property through a 20% deposit and bank loan arrangement, they can benefit from 100% of the capital growth and income the property turns over after expenses and interest. If the property value goes up by 20%, they have effectively doubled their initial equity.
On the other hand, if the deposit was invested across a number of fractional property investments, Lewison says: “They would only own 5% of 4 individual properties, which would entitle them to 5% of the capital growth and income from the properties after expenses, but give them no control over decisions made about that asset.”
If the property’s value increased by 20%, the investor would gain a 20% increase in their own equity, Lewison explains.
“You are potentially trading off higher returns, which you could achieve when buying direct property in your own name, with getting early access to the market and easier diversification.”
Tips for first-timers
To those new to investing and interested in exploring fractional property investing, Lewison advises: “Don’t get caught up with the fancy packaging.”
“At the end of the day, investors should invariably be looking for an investment that achieves their medium to long term financial goals while balancing the risks that they are prepared to expose themselves to,” he says.
The director also points to the double-edged nature of diversification. Whilst it can be a great risk minimiser, to jump into a varying range of multiple properties, it could also mean money being spread across many bad investments if done without diligent thought and reason.
Keeping that in mind, it’s important for investors to make well-informed decisions no matter how much money they choose to invest. A game-plan can best be instrumented alongside the advice and guidance of a qualified financial professional who is well-versed on both the perks and risks of fractional property investing.
Know your risks
As with all other property investment avenues, the chance that the property value could decrease poses a risk. And if this does occur, any units or bricks an investor has bought into will also throw a loss.
There are a number of ways this can happen.
“It might be difficult to find tenants, and the property may not receive the rental income that was forecast,” Lewison says.
“The secondary market for selling units might diminish and investors could be stuck holding on to the investment, unable to exit until the manager or trustee decides to sell the asset.”
Managed funds are also subject to strict compliance laws, Lewison explains, so if the manager or trustee doesn’t feel as though their business model can measure up to the set-out regulatory standards, they may decide to close the business down.
“This would create uncertainty for investors who then co-own a property with a dozen or so other unrelated investors,” Lewison says.
Furthermore, it’s important to note that properties will only be sold following a holding period that can last anywhere from 5 to 7 years.
“If you are stuck holding units in a property that is underperforming, you may have to hold it for 5 years and then still not be able to sell it because all individual unit holders are limited to a minority stake in each property, for stamp duty and land tax purposes,” Lewison says.
“Therefore, your real liquidity hangs 100% on the secondary market for the resale of financial bricks.”
What’s the likelihood of a substantial return?
For those aspiring to ‘get rich fast’, Lewison does not think that fractional property investing will sound too exciting.
Firstly, income returns can be minimal. The investor is mostly relying on market capital growth, meaning that if the market happens to pick-up by 10%, a unit or brick will also increase by about 10%.
Investors might choose to actively trade their bricks, buying and selling regularly in the hopes of picking up a quick profit. But with transaction costs applying to most trades, Lewison says this could also be a very quick way to erode capital.
As with regular property investment, he believes that the buy and hold strategy still makes the most sense.
“There is something to be said for a strategy that’s not purporting to make you wealthy beyond your wildest dreams overnight,” Lewison says.
“To give some context, the Australian property market has been the best performing asset class over the last 30 years with only 4 short periods of negative growth.
“If an investor could have contributed $100 per week in a portfolio of Australian property market, starting in 1988 without any gearing, and assuming the portfolio at least matched the average rental yield of 3% and annual capital growth of 8.7% seen across the Australian market, that investor would today have $1.2m in net assets with their total contributions being just $166,400.”
Not a bad profit, considering that the investor would have taken on no debt to achieve such an outcome. But that’s not to forget that the future is unclear; the returns and hazards for investors starting in fractional property investing today may throw different results.
“The industry is still quite new, with various players like BrickX and Domacom leading the way but perhaps still finding their own feet. Their offerings will most likely continue to evolve, to provide more choice to investors, encouraging more participants to enter the market,” Lewison says.
“With Australia’s property market valued at well over $5 trillion, almost triple the size of the ASX, fractional investment platforms mark the first wave of disruption to Australia’s residential property investment market.”