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.
Friday, April 17, 2009
Wednesday, January 21, 2009
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.
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.
Thursday, January 15, 2009
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.
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.
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