Benefits and Risks of Fractional 1031 Investments

Benefits and Risks of Fractional 1031 Investments
Posted by on Nov 9, 2016

Headquarter Building Example

Fractional 1031 investments are subject to the same benefits and risks as other real estate investments. However, the structure of fractional 1031 investments have their own unique characteristics.

Benefits

  1. 1031 Eligible: Fractional 1031 investments are considered direct ownership of real estate thus qualifying for a 1031 exchange.
  2. Timing: Funds may be exchanged for a stake in an already acquired property, allowing investors to easily identify viable replacement properties within the 45-day identification period and ensure effectuating the exchange within the 180-day closing period.      
  3. Pre-Packaged: Investment review is simplified via expedited due diligence as evaluation materials are typically already gathered and made easily available to potential investors. Additionally, debt and property management have already been secured, creating a true “plug and play” investment.
  4. Institutional-Grade Assets: Investors are able to own a share of a property that is notably larger than they could achieve on their own. These properties may exhibit less risk and provide greater liquidity.
  5. Flexibility & Diversity: Investments may be in the exact amount necessary to meet exchange requirements. Proceeds may be reinvested into multiple investments, which combined with the pre-packed feature, allows for more efficient diversification than an investor could otherwise achieve.

Risks

  1. Illiquid: Investors have little control over timing of property sales. Exit through a sale of an investor’s interest is difficult as there is currently no secondary market for fractional 1031 investments.
  2. Passive: Investors have little control in property operations and may have minimal input in major decisions. Thus, investors are largely reliant on the operating ability of the Sponsor for investment success.
  3. Investment Period: Target holding periods are often five years or greater, and are not suited for investors looking for a temporary investment.
  4. Returns: Fractional 1031 investments provide passive, consistent cash flow from lower-risk, high-quality properties. In exchange for these benefits, investors may yield lower returns than they may have become accustomed to if self-managing their investment properties.
  5. New Capital: Raising new debt or equity in a fractional 1031 investment structure can be difficulta and has its drawbacks including potentially restructuring the ownership or jeopardizing the ability for future 1031 exchanges.

If you haven’t done so already, I strongly encourage you to read our eBook “Fractional 1031 investments”. Fractional investments are an attractive option for many 1031 investors due to ease and access to high-quality assets.  However, these investments are generally best suited for long-term passive investors and may not meet the objectives of all investors. If you’re considering any fractional investment, talk to your advisors and then contact us.

At Realized, we’ve structured and managed dozens of fractional investment s. We know how to underwrite not just the real estate assets themselves, but how to evaluate the strength and expertise of the sponsor entities. Realized can dramatically reduce the complexity of completing your 1031 exchange.

 


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Topics: 1031 Exchange, 1031 Replacement Properties, 1031 Advanced Topics, Replacement Property Interests