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.
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1 comment:
This is an excellent abstract on the intricacies of security regulation and fractional real estate. It is very hard to come by concise knowledge on this topic. Thanks for your contribution.
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