NY Times "House Divided" and shared mortgage thoughts...

April 2, 2009 New York Times Article "House Divided" has some info on how fractional vacation home sellers are structuring shared mortgages. Whether you can do so depends on the lender and, ultimately how much equity you have.

Buyers of fractional interests should take care to ensure that sellers will utilize down payment funds to pay down the shared mortgage and not pocket it unless the seller had that equity in the first place! This can be done through provisions in the co-ownership documents.

Remember that shared mortgages still have joint and several liability (all for one, one for all). Co-ownership documents are a must to ensure precautions are taken to prevent one non-paying co-owner from dragging the rest down with him.

Finally, think EXIT STRATEGY. When you resell your fractional under a shared mortgage, you will want to get your name OFF the shared mortgage and the new buyer ON without the hassle and expense (unnecessary) of refinancing. Most second home loans do not have this flexibility. We can work with lenders to add it to the loan documents.

SEC opinion is fodder for more securities speak

Just a few days ago the SEC rejected the notion asserted by certain tenant in common (TIC) real estate developers that a master lease and property management TIC structure did not involve securities within the meaning of Section 2(a)(1) of the Securities Act of 1933. See http://www.sec.gov/divisions/corpfin/cf-noaction/2009/omni011409.htm

At the same link is a copy of the request, prepared by Darryl Steinhouse, partner with Luce, Forward, Hamilton & Scripps, LLP of San Diego, California. Mr. Steinhouse's letter contains a solid overview of the different TIC structures and a thorough explanation of law that transactional real estate lawyers and sophisticated real estate investors will appreciate.

Does the SEC opinion letter mean that fractional vacation homes (typically structured as tenant in common transactions) are securities too? Not in my opinion. While the SEC provided no rationale for their decision in the letter, by stating this opinion the SEC must feel that each element of the test created by the US Supreme Court in SEC v. W.J. Howey (1946) 328 U.S. 293, could be met: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profits; and (4) solely from the efforts of the promoter or a third party. Later clarified in United Housing Foundation v. Forman (1975) 421 U.S. 837, 852 where the court found the "touchstone is the presence of an investment contract (security) in a common venture premised on a reasonable expectation of the profits to be derived from the entrepreneurial or managerial efforts of others."

While its true that certain flavors of fractional vacation home product (some condo hotels and others) have been structured by developers as investments where purchasers are sold on ROI rather than amenities they intend to use, most are not. Fractional vacation homes are a lifestyle purchase for most people and are generally structure by developers as such. This means that there is no expectation of profits on the part of the purchaser, only an expectation to use the property themselves.

In light of this new SEC opinion letter, developers and home owners interested in offering their property(ies) in fractional interests would nonetheless be well advised to retain counsel familiar with this area of the law in order to provide a legal structure that steers clear of the Howey elements. Buyers of fractional interests would be well advised to have counsel review the thick stack of documents necessary to effectively offer fractions and confirm that the seller has properly structured the arrangement to avoid securities implications. Beware of attorneys and real estate agents that offer to fraction a vacation property by simply forming an LLC or corporation! Read my previous post below for more detail on this.

I'm fractioning my vacation home - Do I need a securities license??

I bet you're thinking "What? You're kidding, right? This must be wrong. How can a vacation home (real estate) be a "security" that requires licensing??" But it's true. Real estate of many kinds, even an orange orchard, if offered and sold without taking securities law into consideration can get lumped into the legal definition of a "security".

If you are a vacation home seller considering offering your property as a fractional or a realtor listing or bringing buyers to fractionals or a vacation home buyer considering purchasing a fractional interest in a vacation home or resort property, THIS POST IS FOR YOU!

Read on for the 3 Telltale Warning Signs My Fractional Vacation Home Is A Security that should make you STOP in your tracks, ASK more questions about your project or deal, and RUN to a fractional expert.

A host of issues can arise when offering and selling a vacation home in fractional interests. The question of whether offering and selling fractions is offering or selling a "security" or creating an "investment contract" comes up from time to time and I recently compiled some of my research on this.

The short answer is.... it might(!) depending on how you structure the deal. I know, everyone hates the now-patented lawyer answer "hmmmm. maybe!" but the truth is real estate co-ownership deals actually can be structured in such a way as to implicate securities laws. Why do I care about implicating securities laws? Securities laws require application, qualification, registration and approval or approval of exemption before the thing being sold may even be offered. If you are offering a security or investment contract you must be a licensed financial advisor, registered representative and have appropriate state and federal licenses. Offerings to non-accredited investors may require registration and offerings to accredited investors may require private placement memorandums. Failure to comply can result in a shutdown of your project, fines and lovely third party liability. Real estate brokers take note: your agents representing buyers and sellers of fractional vacation homes better know the difference because you are not licensed to sell securities.

Warning Sign #1: Not for personal use

As a general rule, people primarily purchase their vacation home for their own use. They may have a secondary purpose of having a high-quality investment property poised for future appreciation in a resort market. Finally, they may even intend to derive some income from the property to offset expenses by renting to vacationers. The first warning sign that securities concerns could arise is when these priorities reverse and the primary or sole buyers’ goal or sellers’ offering of the property is for investment or income purposes.

Warning Sign #2: Rent pooling

“Rent pooling” involves the creation of a common or pooled fund of money that is derived through rental of the property. As a testament to the necessity and efficiency of the fractional product, even fractional owners don’t use all of their time in the property. Fractional owners may choose to avoid renting their unused time altogether, however, it is often highly desirable to retain a property manager and hold the property out for rent in order to offset the costs of ownership.

Warning Sign #3: Not deeded ownership

I often hear the remark “ we don’t need any help fractioning our property, we’re just going to have our attorney form a limited liability company (LLC) and fraction it that way.” What?? Wrong. Structuring a fractional as an LLC opens up a laundry list of potential problems that are beyond the scope of this article. But let’s get one very fundamental thing straight: Vesting ownership in the name of an LLC is not “fractional ownership.” Fractional ownership means multiple owners hold title and are vested in undivided fractional interests. If an LLC is the vested owner, there are no undivided fractional interests, the LLC owns 100%! This also means that the “owners” are not really owners of the real estate at all, they are owners of the LLC. If the MLS listing says “1/6 ownership of this beautiful property…” and the structure is through an LLC, the listing is misrepresenting the thing being offered for sale. Real estate agents and sellers beware. You heard it here first. To avoid possible claims of fraud or negligent misrepresentation and securities laws, fractional owners should be vested on title as tenant in common undivided interests before you consider taking that listing or showing that property. Each owner should receive a deed to their respective interest, not shares of a corporation or membership in an LLC. By the way, the LLC may have separate capital accounts for each member but will have a common operating account which would look a lot like rent pooling discussed above.

Fractional vacation homes are a great way to expand your lifestyle, diversify your risk and make efficient use of our earth’s resources. Make certain to have competent counsel before you, buy, sell, lend or otherwise participate in a fractional ownership arrangement.

The author offers a complete menu of services for fractional sellers, buyers, realtors, institutional and private lenders, title and escrow companies in affordable, flat fee, percentage or hourly structures. Setup a phone consult by calling Jan at (559)228-8034 ext. 25, email at jberman@powellandpool.com , or fax at (559)354-5278.

If you'd simply like a complete copy of my article "3 Tell Tale Warning Signs My Fractional Vacation Home is a Security", Email jberman@powellandpool.com and we will be glad to send you one.

Where to Retire magazine article

A prospective client recently told me they were going to try to determine whether there was interest among potential buyers for a fractional interest in their California beach home. My response was that fractional industry insiders will tell you that even though sales may have dropped off somewhat at the moment, interest in fractional ownership is at an all time high. Now, more than ever, sophisticated families seek to diversify their real estate portfolios and hedge their risk by only buying as much cabin or beach house as they can realistically use. My google alerts for news on fractional ownership have been active for years and I certainly see more news today on existing and new fractional homes than a year or two ago.


In fact, Alan Macher has written an informative article on fractional ownership in this month's Where to Retire magazine. Alan interviewed me a couple of months back and he was kind enough to include a few quotes on page 49.

Check out the article here: http://www.elcorazondesantafe.com/images/news/elc_article.pdf

FSBO Fractional: Do It Yourselfers Beware

Do you own a vacation home that has substantial untapped appreciation?
Are you a custom home builder with projects in resort areas?
Are you part of a group of family or friends that has considered "partnering" on a vacation property?

Solution: a Fractional Offering on your vacation property.

Currently Own
By selling 5/6 or 7/8 or 9/10 of your current vacation property, you can cash out of the majority of the appreciation on your property and diversify your portfolio. 1 out of 4 fractional owners purchase fractional vacation homes in other geographic locales. Wouldn't you like to have a property on the beach AND in the mountains?

Custom Home Builder
By putting a fractional offering on your custom home project, you can expand your target market and potentially increase demand. In a 180 mile radius around our project in Shaver Lake, California, the market that can afford whole ownership of our property is only 1.9% but the market that can afford a 1/10th interest of our property is over 10%! More buyers that can afford means more traffic at your site, more people talking about your beautiful property. Speaking of talking, fractional will create "buzz", especially if you are one of the first movers in a previously un-fractioned market. We have received free press in the form of newspaper articles, TV interviews and other notoriety, simply because we were offering fractions for sale. In the past three weeks our Shaver Lake property has been shown 13 times. A little buzz in this market doesn't hurt.

Go In With Friends/Family
You say "well, I'd just rather go in with my buddies and my uncle Ben than go to all that trouble." A fractional offering is even MORE relevant in this scenario than any other. If I could list all the disastrous stories I've heard of family and friends informally purchasing a vacation home together, it would be volumes. My family thought about going in together for a mountain cabin in 2000. We didn't do it because we were afraid that one person wouldn't clean, wouldn't pay bills on time, would want to sell at an inopportune moment, etc. etc. Bottom line: we missed out on a tremendous investment opportunity. The little cabins we were considering purchasing went from $150,000 to $500,000 and then we were priced out. A fractional offering can be private (just for you and your family / friends). Among other things, an appropriately structured offering sets up accounting and management structures to deal with cleanliness, monthly bills, reserve funds for replacement of life-limited assets, allows one co-owner to voluntarily sell their fraction (yes, without everyone having to sell), and has provisions to protect each other in the event a co-owner dies, divorces, declares bankruptcy.

Who can put a fractional offering on my property?
There lies the niche for fractional development and consulting at the individual home and small development level. At www.lloydlanson.com, we supply the expertise necessary to put a fractional offering in place on your property. Email me at garywinter@lloydlanson.com with some basics about your property and we'll set up a call to discuss.

Also, check out my latest article on fractioning one-off vacation homes at Nick Copley's site http://www.sherpareport.com/prc/fsbo-fractional.html

Can HOAs Regulate Fractional Ownership?

Here's an interesting article where a Tahoe HOA makes remarks about regulating or eliminating fractional ownership in their development to preserve the status of the community. For some time now, HOAs in certain resort areas have put in place conditions, covenants and restrictions (CC&Rs) that prohibit the sale of timeshares within a development. However, the difference between timeshare and fractional is vast. In my opinion, HOA or municipality attempts to regulate fractional are erroneously rooted: (1) in a misunderstanding of the definition of fractional ownership (they think it's timeshare); and (2) in fear that the "caliber of the neighborhood" will degrade due to the influx of fractional buyers perceived as being lower class.



Of course, fractional ownership is NOT timeshare. See my post on March 12, 2008 and the article by fractional owner / attorney John Gosselin. I'm still formulating my reasons why I believe an HOA or municipality probably can not legally eliminate fractional ownership from a development. My initial thoughts are: (1) CC&Rs and zoning ordinances restrict the use of property, not the form of holding title; (2) If such a CC&R or zoning ordinance was passed, it would be overbroad and effect all co-owned property in the development; and (3) attempts to distinguish those fractional owners who have a formal co-ownership system for use from those who don't will be patently discriminatory. If your HOA is considering such amendments to its governing documents please contact me, as I'd be very curious to learn what their justification is. More on this in future posts as I predict that this will be a very hot topic when fractional projects continue to sprout in exclusive gated communities across the nation in resort areas.

As for the fear that here come the fractional buyers and "there goes the neighborhood" - I find this personally distasteful and factually baseless. What evidence is there that fractional ownership would in any way degrade a community? None. In fact, there is ample evidence to the contrary. Many fractional owners actually can afford a whole property in such developments but choose not to put all their eggs in one basket and instead buy multiple fractions in various geographic locales. In addition, fractional ownership has been shown to actually assist the local economy by keeping a second home occupied a higher percentage of the year and thereby keeping local merchants busier in the slow seasons. Remember, that the fractional owners are "owners" not renters or visitors. Owners, even of fractions, take pride of ownership because they have a significant investment at stake.

Fractional Ownership: Getting A Piece of the Pie

Attorney John Gosselin is the Managing Partner of Gosselin & Associates, PC in the Boston area. John recently purchased a fractional vacation home and wrote a brief article about what to consider on purchase. I find John's article to be generally well-written and recommend it to you. My thoughts on the article are below:

"They're Not Timeshares"
What's a Timeshare? The term "timeshare" has become somewhat a term of art in the nation's vernacular, it conjures up images of hard-selling elderly people on a $20,000 purchase at a crowded resort with a long buffet line and buyer's remorse when arriving back home and thinking "why did I just spend all that money to go back to a resort once a year when I could just pay at time of service?" Timeshares in the legal sense are merely pre-paid vacations at the resort. They give the timeshare owner the right to stay at the resort for a week or two per year for a fixed term such as 10 years. Once the ten years is over, the timeshare ceases to exist. Timeshares are legal "licenses" where the resort owner has merely given permission to the timeshare owner to stay. There is no ownership of real estate and therefore no hope of appreciation or significant resale value. This is not a slam on the timeshare industry because, by pre-paying, the timeshare has provided a significant savings for the timeshare owner over paying at time of stay.

How is the Fractional Vacation Home (FVH) Different? Night and Day. While there are many fractional resorts that now offer a very small share of ownership in the resort as an ownership alternative to timeshares, the following are key differences of a FVH:
1. FVH is a stand alone property;
2. FVH is owned with a few other people (generally less than 11 in California);
3. FVH is usually within 3 hr drive from your primary residence;
4. Owners receive a grant deed to a undivided fractional interest of the property;
5. Owners may resell their fraction (yes, as with every other piece of real estate there is a resale market);
6. Owners fraction value will track with the surrounding real estate market;
7. Owners may treat their fraction as an investment for tax purposes and utilize their expenses as deductions and even take advantage of Internal Revenue Code Section 1031 in certain situations (see your tax advisor obviously because situations differ);
8. Owners may borrow against their fraction without being on the same loan as other owners;
9. Owners have a voice in the management of the property;
10. Owners have responsibility for ongoing maintenance costs in proportion to their ownership interest;
11. Owners generally get a lot more usage of the property (at least 5 weeks per year and up to 12 weeks).

More on this soon...