Benefits of Fractionalizing Vacation Home You Already Own
The first thing that comes to mind is going in with friends or family, because vacation homes are very expensive
Host, Christine Karpinski: Today our guest is Andy Sirkin . Andy is an attorney specializing in co-ownership of properties. Andy, thank you so much for joining us.
Guest, Andy Sirkin: Thank you for having me.
Christine: Andy joins us from France. He is in Paris. How nice to be in Paris, huh?
Andy: It is. It’s great. It’s just becoming spring here and the weather is starting to improve a little bit, trees are blooming and so on, so it’s a great time to be here.
Christine: Thank you so much for joining us. OK, we’re just going to go right in. Can you tell me a little bit about yourself and about your practice, and what exactly you do?
Andy: Sure. I graduated from law school in 1984 and pretty much started immediately getting involved in various types of co-ownership; but when I say co-ownership I just mean real estate with more than one owner. My job in these transactions is to deal with the relationship among the owners, to make sure that their relationship is well thought out and organized, and that they have an agreement that they can rely upon to solve any problems that might come up in the future. I originally got involved in co-ownership mostly because of my own interests. It was a way that I could afford to buy my first home, by joining up with other people. And it was a time, at least in San Francisco, when many, many people were in the same position I was. They needed to join up with other people in order to buy their first home, or to buy a second home or what have you, so there was a lot of interest in the topic. And as I learned about the topic for my own benefit, I started to share that information with others and my law practice grew in that way. So for the last 22 years or so that has been my world. Over those years I have put together roughly 6,000 co-ownership relationships of various types for people and property all over the world.
Christine: That is very interesting, and I imagine a lot of what you are doing today is primary residences, but I bet you are doing a fair amount of vacation homes as well. It seems to be very popular with vacation homes going in. The first thing that comes to mind is going in with friends or family, because vacation homes are very expensive. They are in areas where it is sometimes double, triple or quadruple what the average per-square-foot is, compared to a primary residence, say, in your hometown. So can you just briefly kind of go through… The benefit of co-owning is, it is for affordability, is that correct?
Andy: Yes, certainly affordability is a big factor. A good way to sort of introduce the topic in general is to talk a little bit about just how much, or really, how little, most people use their vacation homes or their second residences. I have read statistics that the average person only uses their second home about 17 days a year, so that second home is soaking up a lot of resources in relation to the amount of use that people are actually getting out of it. So from a buyer’s perspective, this is a way to bring the costs more in line with the benefits that they are actually getting from the house. Now of course, as you know, many people who have second homes and don’t use it that often turn to vacation rentals as a way to sort of help with the economic burden of the home, but vacation rentals is a business, and it’s a tough business. It involves a lot of back-and-forth with people who might want to rent it, a lot of upkeep, a lot of management; or if you delegate some or all of those tasks to a management company it cuts pretty deeply into your income stream. It’s just a very tough way to make a vacation property work, whereas owning a property with other people is a much easier and more elegant way to bring those costs and benefits in line with each other. I think that is why more and more people are turning to this as a way of buying; and also, I should mention that many people are turning to it who already have a vacation home. In other words, people who have owned a vacation home for some time and are realizing that it is not worth the economic and management burdens that they are having to confront to keep the home up, so they are selling fractional interest in it and just keeping a fractional share that is commensurate with the amount they use the property.
Christine: That’s a very interesting perspective, selling off a portion of your existing home. What I’m seeing is, especially in markets where it is very, very expensive to purchase or to sell; I am seeing some sellers actually selling the properties as fractionals. Can you talk a little bit about how you would go about doing that?
Andy: Sure, but before I do let me just echo what you are saying. A huge amount of our business is actually generated from the sales side of the transaction rather than from the buy side, so what you are seeing is definitely representative of the way the market is moving. More and more people are just realizing, first of all, the economic benefits of fractionalizing homes they already own, as we just mentioned, but also the diversification benefits. In other words, what they can do is they can spread that investment that is all tied up in their second home, they can spread it out so that they are invested in a number of different resort communities rather than just one, which lowers their risk and increases their potential for appreciation-based profit. And perhaps more importantly, it allows them to vacation in multiple places. If you own a second home, say, in Lake Tahoe or in Mexico or what have you, from an economic standpoint you really have to go there for most of your vacations. The beauty of fractionalizing is that by divesting yourself of some of that vacation home, you can then take the proceeds from your fractional sales and perhaps by fractional interest in homes in other places in the world. So now you can vacation all over the place and still be in your own home, where you know how things work, and you have your stuff there and so on. So there is a lot of benefit. So turning now to answer the question you actually asked me: how do people go about doing it? The way we approach it is we start with, essentially, a consultation with the client where we talk about the specifics of the property, we talk about how the seller–if we’re dealing with the seller–or the buyer if we’re dealing with the buyers, are going to use that property: how far away do they live, what kinds of time periods do they go there more typically, and so on. We take them through a whole series of questions that are designed to get us the information we need to recommend some alternative structures for how the co-ownership might be structured. Then we’ll go through the pros and cons of those various structures, and eventually, through the course of maybe an hour to two-hour conversation, we will develop the structure for the co-ownership. Then based on that we will prepare the co-ownership documents, and then send them to the client to review and perhaps go through a little bit of a revision process, and eventually we will have a set of documents that puts the property in a position to be fractionalized.
Christine: Is this something that you need to do, like, say I wanted to sell a portion of one of my homes? I also think that this is probably a good way for long-time owners–people that bought, say, ten years ago, who see massive amounts of appreciation to their property but they don’t necessarily want to sell their property–this is probably a decent way to get some cash out of your home as well. But with regards to doing this, do I have to come to you and settle this up prior to even putting it on the market? It’s something that I need to cross all the T’s and dot all the I’s before I can even market it as a co-ownership?
Andy: We strongly recommend that you do the structure and the documents first. The reason that we like that approach is really two-fold. First of all, if you go on the market without the structure in play, it becomes very difficult to describe to prospective buyers exactly what it is you’re offering to sell them, what you’re going to get, how much it’s going to cost, what they’re ongoing obligations are going to be, and so on. Your inability to present a package to people ends up making it very, very hard to get anybody to agree to anything. You can’t get people to commit to buy something when they don’t really understand what it is they’re buying and how much it’s going to cost. So that’s the first reason. The second reason is you want to put yourself in a position where you can enter into a binding contract with a prospective purchaser and you want that contract to be specific and clear enough to avoid any potential disputes between you and the purchaser down the road.
Christine: That’s exactly what I was just thinking when you said that, because I think of buying with family and things getting ugly and everybody ends up not talking to each other after the fact. So I think, probably, that’s pretty important to do; make sure all that stuff is figured out, right?
Andy: Yes. Well, I think you’re making two points and both are important enough to be mentioned separately. One point is the ongoing operation of the property and relationship of the co-owners. In other words, the relationship that exists after the buyer buys and the seller sells and the people are all just using the property and managing it together. So that’s the relationship that’s got to be managed by your co-ownership document. There’s also the purchase and sale transaction. In other words, when you’re out there selling your fractional interest and people are buying them, you need a contract related to the purchase. What am I going to buy, how much does it cost, how is it going to be financed, and so on. One of the reasons why we think it’s so important to do the documents for the long-term relationship is to set you up to do a short and clear document for the short-term relationship. That is the purchase and sale. If you didn’t have your co-ownership documents set up in the beginning and you just agreed with somebody, ‘Well, I’ll just sell you half my property or one-twelfth of my property or one quarter of my property’ without having all the things about the future spelled out, it would be a large potential for a dispute in the context of the purchase and sale. In other words, when it comes time to close the sale and all of a sudden the buyer starts saying, ‘Well, I thought I was going to be able to use the property during the summer months when it’s beautiful there and you were just going to have the rest of the time.’ And you say, ‘Wait a minute, that isn’t what I thought. That’s why it’s so important to have all the details developed before you go on the market.
Christine: Face it, buying a home can always get a little disputed and there are always a lot of things that can happen in just a regular purchase. So I imagine when you’re buying as a co-ownership, it could get that much more confusing. Now I think, probably one of the points we need to make here is can you tell me the difference between this and a time share? I think that probably a lot of listeners are going, ‘Well, wait a minute, I have no interest in timeshares whatsoever.’ Can you tell us a little bit about how this would be different than what we know in the United States as timeshares?
Andy: Yes. I think that there’s sort of a distinction between what I might characterize as the legal definition of a timeshare and the actual meaning of the timeshare that most people have in their minds. From a legal definition standpoint, a timeshare is simply any arrangement, regardless of type, under which there is multiple owners and they agree to divide up the use of the property according to time. In other words, some people use it sometimes and some people use it at the other times. Now you can see how that legal definition would be broad enough to encompass all types of different arrangements, both the old-fashioned timeshares and what now becomes the new fashion fractional. Which brings us to the practical difference. When you and most people think about timeshares, they think about the way timeshares used to be organized. The way they used to be organized was you’d have a property that was owned by some organization and then you’d have people essentially buy usage right to the property for some period of time without actually acquiring any ownership in that property, and without having any control at all of how that property was managed, how it was maintained, how decisions were made, and so on. You were essentially joining a club and the only sense in which you were a member of the club was that you got to use the property. You weren’t a member in any sort of management or control sense. The difference between that and what I’m calling modern timeshare, or a fractional, is that in today’s fractionals, people have both ownership and control, typically. Meaning that they own the property and also that they have decision-making power over how the property is managed, what their costs are, what the maintenance standards are, and all of the various operational decisions that go into that property. And even in cases where there isn’t direct ownership. Because there are some modern fractionals where the people don’t actually own the title to the property. They may, for example, own a company that owns the property. Those are still distinct from the old fashioned timeshares because there is no other organization involved in ownership. In other words, the people who are using it own the entirety of the company that owns the property. And they have control completely over how that property is managed and maintained, what their costs are, and so on.
Andy: Everything I just said is really a generalization. It applies most of the time, but not all the time and it’s still important for people to examine the particular fractional arrangement they are considering from the standpoint of ownership, and particularly from the standpoint of control. I think that a lot of people who are looking at fractional ownership, particularly fractional ownership in a big complex, as opposed to kind of standalone home or apartments that we’ve been talking about so far. Let’s say you’re looking at fractional ownership in a property operated by Ritz, or Marriott, or Four Seasons, or something like that. You may be getting ownership, you may be getting a title to something, but you may not be getting that critical element of control. And it was the lack of control that ultimately was the problem in sort of the first generation of timeshares. I mean, yes, people didn’t have ownership, but more importantly, they didn’t have control. And what worries me about some of these current large timeshare developments is that even though people do have ownership, they’ve essentially given up all their control to these large operating companies. And it worries me about what that’s going to mean to these people going forward, in terms of, ‘What is the quality going to be like in the future, what are the costs going to be like in the future,’ and so on. I have a strong preference for the kind of smaller standalone single homes, single condominiums, fractional ownership arrangements where the people do maintain that control.
Christine: It’s funny, that’s exactly what I was going to interject with. That it’s more so, talking about the difference with regards to owning a whole building, such as Marriott, or one of those kind of fractional ownerships. I think they sort of changed the name from timeshare to fractional. They changed a little bit of the structure, but the overall idea is still the same that you’re just buying into one week, you have no control, and all of those sorts of things. But what you’re talking about is maybe just buying one property in a building. Like, if I were to go and I wanted to buy a second home, say in Cape Cod, we’re talking about saying, ‘OK, that property might be a million dollars, but I can’t afford a million dollars, so I can either buy that property with friends or even strangers.’ Or maybe even the seller, because they know that there are very few buyers that can afford a million dollars, or they might split it up into quarter ownership and each person would only have to pay $250,000 and have use of it a quarter of the time. So, I think that it’s definitely a really interesting concept of selling your home or buying just a portion of it.
Christine: I think probably one of the things that people are thinking right now is, what happens with rentals? Could I still indeed use that property as a vacation rental?
Andy: Well, it depends. It depends on what the group documents say. I would say that the majority of the documents we prepare do permit rentals. Now, when I’m talking about rentals in a context, I am, in general, not talking about the group renting out the house when the owners aren’t there. I’m talking about individual owners renting out their time separately. They may be going through a shared rental agency, but the money from the rental is just going to the one owner who had that time assigned to them, it’s not going into a pool system where the group pools the rent. Again, there are some exceptions to what I’m saying, but that’s the general way most people set it up, is the individuals can rent their own time. But there are some groups that simply don’t want tenants in the house at all, they just decide as a policy decision that they feel tenants have too much wear and tear on the property, or they are concerned that there will be too many people there or what have you, and they just decide that they don’t allow rentals at all. Before we go on, can I go back to something you mentioned in your last question?
Andy: There are, actually, two things that I wanted to comment on that I think you touched on briefly. The first is this issue of entering into a co-ownership arrangement with family or friends, versus entering into it with strangers. I just wanted to mention, after all these years of experience, one of the things that I have concluded is that groups of strangers actually work better. They have less problems, the relationship is smoother, and there is less risk compared with groups of family or friends.
Christine: It goes back to that old saying: “Don’t do business with family. Keep family and business separate.”
Andy: Yeah. There are, of course, exceptions to every generalization, but I think that if you have a prejudice, let’s say, in favor of doing a fractional or co-ownership arrangement with family and friends, if you’re the kind of person who’s saying, “God, I would never do this with strangers, ” you might want to re-examine the assumptions that are driving that, because actually, if you look at it statistically, much less risk if you do it with strangers. The other thing I wanted to touch on was, you mentioned a little bit about the costs, you know, the million dollars and dividing it four ways. A really important change in the last few years that is driving what I will call sort of the stand-alone fractional market, you know, fractionals involving a single home or a single condo, is the advent of individual financing. It used to be that if you were going to do a co-ownership arrangement like this, and you needed to do financing, the only way to do it was in a group loan. In other words, you get a loan on the house or a loan on the condo and everyone would share in the loan. But today that model is being supplanted by individual fractional loans, so that now if you had four owners buying that house on Cape Cod separately, four fractional owners, they could each have their own loan, secured by their own one-quarter of the property. That obviously takes quite a lot of the risk associated with fractional ownership–specifically the risks of defaulting on a group loan–out of the equation, and that makes it more attractive to a lot of people.
Christine: And it probably–this is just an assumption, you can correct me if I’m wrong–but when you’re talking about a single loan as opposed to a group loan, I would imagine that the rates would probably be better, because the risks are less.
Andy: Well, so far it’s largely a matter of just competition. In the case of a group loan, you’re talking about just your garden-variety home or condo loan, and there are a lot of lenders providing that, so they are all competing with each other, which pushes rates down. Whereas the fractional loan is a relatively new product, you don’t have a lot of sources for that, so the costs of those are somewhat higher than the cost of just a house or a condo loan; but the benefits are also there to justify those increased costs. So, my sense is that most people in this market, given the choice of having a slightly riskier but less expensive group loan versus having a more expensive but less risky set of individual loans will go with the second option.
Christine: Very interesting, because I would have thought it was the opposite. Now, can you just probably, in 30-second-or-less, give me some of the points that people need to consider, either in selling their property as a fractional or buying a fractional portion of a property?
Andy: Well, I mean, I think there is of course the cost-benefit question that we have already touched on: why do this? How does it compare to, say, renting? How does it compare to, say, owning the whole property yourself? I think we have covered those issues pretty well. Then, having gone beyond the question of should I do this or not, you then get into the question of, what type of fractional arrangement am I looking for? The main thing that distinguishes one type of fractional or one fractional arrangement from another is the way the usage is structured. There are a large variety of different ways that the usage can be structured, and let’s face it, ultimately, how you use the property, when you get to use it, how usage decisions are made, is probably the most important issue. So, let me just sort of lay out some of the common usage models.
Andy: At one extreme there is fixed usage, which means that every year, you as a particular fractional owner have use of the property during a particular time. So, for example, you might have, let’s say, two months, January and February, or March and April, and every year you get to use the property during January and February. That never changes. At the other extreme is floating usage, under which you have the right to use the property for a particular amount of time each year, but when your time is varies from year to year. Then, of course, you have a combination. You have arrangements under which each owner has some fixed time and some floating time, or where some owners have only fixed time, some owners have only floating time, and some owners have a combination of fixed and floating time. If you are not confused yet, you will be as I keep going.
Andy: Another question related to the floating time is: OK, if we are going to have a floating arrangement of usage assignments from year to year, how exactly does the floating work? How do we determine from one year to the next when an owner is going to be able to use the property? There also, there are sort of two extremes and then mixtures of the two extremes. At one extreme you have a fixed system of rotation. So, in other words, let’s say that each owner gets to use the property eight weeks a year, and maybe there are six owners. You have six eight-week packages that are sort of pre-constructed. One package might consist of Week 1, Week 9, Week 17 and so on. The next package might be Week 2, Week 10, or whatever, they could be in two-week blocks. The group members rotate through the packages. So, in the first year you may get eight-week Package Number One, and then the next year you get eight-week Package Number Two, and so forth until you have completed all eight packages, and then you start at (Package) One again. One of the reasons people like this approach is that there is no chance in it at all. You know exactly when your weeks are going to be, every year until the end of time. If you want to figure out when you are going to get to use the property in 2038, you could sit down and actually figure that out.
Christine: I would imagine that the first thing that comes to mind is Spring Break or Christmas or Fourth of July Week–you know, the popular weeks that everybody wants. I guess this would be a way to make it fair so that one year one person might have Christmas week, and then next year the next person, and so on and so forth.
Andy: Right. Well you know under this system that you are always going to have every week at one time or another. You can’t possibly miss out, so that’s nice. Now the disadvantage of this approach is its rigidity. In other words, it doesn’t allow you, from year to year, to sort of have any say in when your weeks will be. But I should interject here that you can always trade with other owners; and in fact, these groups trade all the time. It’s very common for owners to trade days or weeks in this arrangement. This brings me sort of to the second extreme of floating systems, and that is the system wherein there is a rotating system of priority. So, in other words, you might have first priority this year, last priority next year, second priority the year after that, or what have you. So, you do rotate through the full priority, so you will have the same number of first priorities as everybody else, but then in any particular year, owners select their weeks or months or days based on their priority. If you happen to have first priority in a particular year, you are going to be able to pick exactly the weeks you want, or at least some of the weeks you want. The next year you may have last priority, which makes it less likely. Now, within that sort of priority system you can inject all sorts of protections to make sure that everyone has at least a reasonably good year every year. For example, you can break the year up by seasons, or according to holidays, or so on, so that the person, for example, with first priority, they have first choice in a particular season but last choice in another season. So, I guess, my point is that there are all sorts of different ways that these arrangements can be set up, and that’s why we spend the time up front discussing with the client…
Christine: To figure it out, right.
Andy: … how is the property going to be used? What do you value as far as advance notice? Some properties really only have a few good months a year in terms of quality usage, whereas other properties are really year-round properties.
Christine: Like that Cape Cod, for instance. I mean, if you end up with your months being December, January, February, it might not be the best arrangement for you.
Andy: Exactly, yeah. Exactly. And another type of fractional that we haven’t really talked about too much is where people live full-time in a resort community–Laguna Beach comes to mind because I have had several like this in Laguna Beach–but they always go away during the best months. So, you live in Laguna Beach, but you always go somewhere else in the summer; and yet there are all sorts of other people who really want to go to Laguna Beach for the summer. So, people will sell just, maybe, two months, and keep the property the rest of the year. I recently did one of these in Bainbridge Island, Washington, somebody who lived there all year round but doesn’t want to be there during the tourist season, and wanted to sell just the right to use the property during those months, and was able to generate almost the full value of their house just by selling the two months.
Christine: Wow! That’s pretty good.
Andy: Well, when you think about it, you can see how that might happen. If you have got a market that is basically being driven by the resort industry, where people, by and large, are buying whole houses knowing they are only going to use them for two months, it is not particularly surprising that somebody might pay almost the full value of a house just for those two months’ usage, because they don’t have to worry about the house the rest of the year. They are dramatically cutting their carrying costs and maintenance costs of the house by sharing it, and it is a great deal for them even though they are only getting those two months of usage.
Christine: Very interesting. Well, we are running out of time here, but what this all comes down to is, first of all, buying or selling as a fractional is very complex. It sounds like there are no generalizations you can make, as with most transactions there are always going to be idiosyncrasies and specific things that happen within the transaction that need to be addressed, and I think probably the bottom line is, you need to hire a professional that could assist you in either purchasing or selling. And of course, Andy, you are probably one of the top attorneys that does the fractionals. Can you tell us how people would contact you or your firm?
Andy: Sure. We have a web site, which I think you are already aware of, which is www.AndySirkin.com, and people can read up on a lot of the things that we’ve talked about on this call, on our site. They can contact us by email or by phone if they would like to speak with us. We don’t do free consultations.
Andy: But we are happy to answer one or two questions on the phone, if people just have a couple of questions. I think most of the common questions that people have are actually answered on our web site.
Andy: We sort of do the web site in a very thorough and detailed manner in order to avoid doing the free consultations; but as I say, we start the process by setting up a one-to-two-hour telephone or personal consultation to discuss the pros and cons, and then hopefully the structure of a particular transaction, and then we sort of go from there.
Christine: OK, and just to reiterate, it’s www.AndySirkin.com, and we’ll also have a link to it on our web site, the Owner Community. Thank you so much for joining, there’s just so much, and I think the other thing that needs to be said is, Andy, you wrote a chapter for my second edition of ‘How to Rent Vacation Properties by Owner.’ There is a lot of information about buying fractionals and selling as fractionals, and all the things that you need to think about, a lot of cursory information that you could read about in the book as well. But, thank you so much for joining, and enjoy Paris.
Andy: Thank you very much. Thanks for having me, and I’ve enjoyed the conversation, and if you feel like I can come back on and give your listeners any more information I would be happy to do that.
Christine: Oh, we’ll definitely do that. Thanks so much.
To explore some of the issues raised by these arrangements, read on. Are today’s fractional vacation ownership offerings just timeshares with a new name? In the world of pre-developed “fractionals”, “condo hotels”, “condotels”, “private residence clubs”, and “destination clubs”, how can you tell a good deal from a bad one? If you’re organizing your own fractional, how do you develop an arrangement that is fair and will withstand the test of time? Most important, do the risks and headaches of sharing with others outweigh the economic benefits?
For more information about the various types of fractional vacation property, and how to compare a timeshare to a private residence club, destination club, vacation club and other types of fractional, shared and co-ownership of vacation residences, see Analyzing, Comparing and Choosing Among Fractional Vacation Ownership Options. For answers to the most frequently asked questions about fractional vacation home sharing and co-ownership, including partnerships with friends and family, see Fractional Vacation Property FAQs. And to see whether you vacation home or condominium might sell best as a fractional vacation offering, or whether you might benefit from selling a fractional share of the home to others, see Analyzing The Fractional Ownership Potential of Individual Vacation Homes and Condominiums.
ABOUT SIRKIN & ASSOCIATES
SirkinLaw APC has focused on real estate co-ownership since 1985, and has been involved in the creation of more than 5,000 co-ownership arrangements throughout the United States and the world. This breadth of experience allows us to draw on a huge library of fractional project documentation as well as extensive knowledge of marketing and registration requirements for virtually any location where a project might be located or potentially marketed. We pride ourselves on our ability to write legal documents in plain English, develop simple and elegant usage and organizational structures, and offer efficient, reliable and cost-effective services for fractional projects ranging in size from a single house or condominium up to hundreds of factional interests. Our firm currently has five attorneys spread among our offices in San Francisco California, Evergreen Colorado, and Paris France.
D. Andrew Sirkin is a recognized expert in fractional real estate ownership, residence and destination clubs, and other shared vacation home arrangements. Although his practice includes some large fractional real estate projects, he frequently advises and prepares contracts for small groups of families and friends who buy and share vacation homes as partners, and for fractional sales of individual vacation homes and condominiums. He has worked on homes all over the world, including most U.S. States, as well as Italy, France, Spain, Portugal, Ireland, Argentina, Nicaragua, Costa Rica, Panama, Dominican Republic, Nicaragua, Belize and Mexico. He is an accredited instructor with the California Department of Real Estate, the author of The Condominium Bluebook, published annually by Piedmont Press, and The Equity Sharing Manual, first published by John Wiley and Sons in November 1994. Andy can be contacted via our contact form.