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Legal - Fractional Ownership Solutions

The Director of Legal Services at FNTC Ltd Philip Broomhead gives us an insight on fractional legal structure.

Fractional ownership is an alternative to whole ownership, usually of second homes. Many real estate developers and leading hotel brands are now including it as part of their product offering to provide more choice, balance their portfolios and improve their overall business performance by

  • Increasing customer loyalty
  • Attracting new customers
  • Maximizing profitability
  • Increasing year round occupancy levels

 

A property is normally divided into fractions ranging from two weeks to ¼ shares (13 weeks). Owners of larger fractions usually have the benefit of occupying part of their fraction as fixed weeks each year and the remainder subject to a rotating period of annual use. Fractional schemes can exist in perpetuity or for a shorter term, for example 115, 25 or 50 years. This will depend on the commercial objectives of the developer of the scheme.

A one off purchase price is normally paid for the fraction and then the owners will share the annual costs of maintenance of the properties and common areas and facilities by paying an annual fee.

Fractions can be sold for stand alone real estate developments or where the accommodation is part of a holiday complex which may include a hotel and leisure facilities.

It is often complicated and expensive to divide a property into fractions and a country’s law may not often provide for this to happen. In this instance, FNTC can provide different structures in order that this process can be easier to administer in the long term, cheaper to run and when an owner wishes to sell his fraction, there are minimum costs and taxes.

Normally the legal title to the whole property to be fractioned will be granted to a company, which can be owned and controlled by FNTC as trustee for the benefit of the fractional owners, who in some schemes form themselves into a club of owners. By this method, owners derive their fractional title through the trustee subject to a set of rules and a deed of trust. This offers the same level of protection and security to each owner that he would have had if he had an individual registered leasehold title. Depending on the country where the property is situated will depend on the type of title being granted to the company. In the UK, this would be either a freehold or long leasehold title if the fraction was being bought in perpetuity, or a shorter leasehold title if the fraction is to exist for a shorter period, for example 25 or 50 years. In the case of fixed term schemes, there can be a mechanism whereby the trustee, on behalf of the fractional owners, sells the property on termination of the fixed scheme and distributes any net proceeds of sale to all the fractional owners registered at termination.

In any fractional scheme, the rules to which each fractional owner must adhere are very important and by having common rules this ensures that the fractional properties are preserved in the same quality state throughout the life of the fractional scheme or in perpetuity. These rules will provide for how the property and common areas are to be maintained and the mechanism for charging and increasing the annual fee, normally to include a reserve fund, to ensure the long term quality and ultimate saleability of the fractional property should it be a fixed term scheme or should the fractional owners resolve to terminate it early and sell.

Alternatively, the fractional developer may wish to transfer title to the property to a company and then sell shares (or membership of the company if it is a guarantee company without a shareholding) in that company which would equate to fractional occupation rights in the different forms described above. Care has to be taken to ensure that the sale of shares is not classed as an investment product or collective investment scheme, both of which are strictly regulated under financial services legislation. In this case, FNTC can administer the share scheme and where shares are subsequently sold within the life of the scheme, FNTC can deal with this. In these circumstances, it is often advantageous for a “golden” or controlling share to be held by FNTC in the event of shareholder disputes amongst the fractional shareholders.

Depending on the country of operation, it may be possible for individual fractional owners to have a title deed or leasehold interest, which can be registered in their own name. However, this method of fractional ownership is cumbersome and expensive as often notaries have to be employed and taxes paid. If the fractional scheme is set up in this manner, without any independent administrator controlling matters on behalf of the owners, then where a fractional owner dies or disappears, it can be a long expensive process to deal with the sale of his fraction if it is in the form of a registered title deed, and in the meantime, his annual fees remain unpaid which means that the remaining fractional owners will have to subsidise this shortfall in the annual fees by paying higher fees themselves, until such time as the fraction is resold or transferred. If there were many fractional owners in this position, this could effectively paralyse and ultimately bankrupt the fractional development.

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