The Golden Rules of Fractionals
The rewards from fractional are considerable, but so is the investment, so the right choices early on are vital; as Nick Turner explains
Developers hoping to convert projects for fractional sales have a lot to consider – and the earlier the better. The golden rule is to engage a lawyer conversant with the language and the property ownership laws of the country in which you plan to develop and ensure all legal documents are translated into your own language. Any temptation to save money at this stage is likely to prove very costly in the long term.
While the fractional model is a world away from standard timeshare in virtually every aspect, it is still governed by timeshare legislation. Many of the funding challenges are also similar. Banks and lenders need educating carefully as to how the ownership model will work and how it will affect the security they are holding over the land and properties. You must ensure that their demands for retention of security are not incompatible with the legality of the ownership model. One way round this in the UK, for example, is to use owner/developer buy back options in the sales agreement to ensure that, if sales don’t go according to forecast, fractionals can be bought back by the developer and brought back within the bank’s security without negatively impacting either developer or purchase.
When considering a property it’s important to investigate any possible restrictions on fractional development, particularly if it’s a single family home. Make sure you can do what you want to do, down to the simple matter of checking whether neighbouring properties have access rights across the property. Most fractional sales are deeded, most commonly on the basis of a long leasehold interest. In some countries the law states that only four people can be named on a property title so a different ownership title structure will need to be found. Using a company structure enabling the purchaser to became a shareholder is a popular solution and one often used in France.
Law of the land
Knowing the law of the country in which your development is sited will help. For example, in France the classic structure is sale and leaseback and a purchaser of a French unit putting it back into rental qualifies for a VAT saving. This has been used successfully in reducing purchase costs and is especially useful when selling into the US market where there is no VAT.
Tax implications must be considered for both the developer and the purchaser. Local VAT rates vary and there are many different local taxes in different countries, as well as estate agents’ fees in some cases. Establishing a residential use will attract less tax than a commercial accommodation, but the reality is a fractional will be treated as the latter. It is possible to negotiate tax levies across Europe with local rating offices.
Contractual structures must be future-proofed in many ways. For example, foreclosures by the operating company for non-payment of fees can prove very difficult with a fully deeded ownership model but easier with a leasehold title.
Limited purchaser awareness of what is a relatively new concept in Europe is another challenge when looking to enter the fractional market. Educating purchasers and setting out how the scheme works through clear and transparent marketing materials in the purchaser’s own language will be crucial to sales success and well worth the investment.
Location is everything in the success of a fractional development. Remember, you can’t create a market; it has to be there already and if a destination doesn’t have a strong second home market, forget it. You should only consider those sites where high-end properties are scarce to secure the affluent buyer.
The mixed-use environment better utilises resources and is more cost effective, as it will support a greater number and range of retail and restaurant outlets on site than a single-use site – thereby creating a better lifestyle fulfillment experience for guests (essential when selling at premium prices, as well as greater revenue-generating opportunities for the developer).
The key is getting the balance right between the number of units in a fractional development that will deliver the ROI while providing the expected level of exclusivity to the purchaser. There’s no place in this market sector for luxury resorts with hundreds of units. It has been found that an average of 40 to 50 units per development works well. Ideally, you should conclude that you could have sold more units, and at a higher price.
It’s impossible to build on a large scale in many of Europe’s top locations as sites with the necessary planning permission are simply not available. European developers often have to refurbish and develop an existing hotel or property, using the advantage of a rich historical and cultural offering sought after by the affluent purchaser, but facing the challenge of providing the space per apartment.
Do your due diligence
Remember, because something worked in one country, it doesn’t mean it will work in another – and with such a lot to play for, it’s worth finding out the rules at the earliest possible stage.