How a Real Estate Concept From the Middle Ages Can Still Backfire

Robert Herr blames himself for what was his worst real estate investment. As a mortgage broker and real estate agent, he said, he should have known better than to buy a quarter-share in a beachfront condo.

But like many others before him, he could not resist the siren call of sea air and an ocean view, all without the costs and aggravation of owning an entire piece of property himself. Instead, Mr. Herr could buy 13 weeks, drive the 90 miles from his home in British Columbia to use the weeks he wanted and put the rest of the time into the rental pool to cover his costs.

Or so he thought. Most years, Mr. Herr and his wife cleared a couple of hundred dollars more than they paid in dues and maintenance. But they started to think the underlying investment, those 13 weeks, was losing value.

When Mr. Herr sold his share in May, for 75 percent less than he had paid for it, his suspicion was confirmed, and he was furious for buying it in the first place.

“It’s titled real estate, and it’s waterfront. Why couldn’t you resell it?” Mr. Herr, 72, said. “That’s the theory. But in practice, that’s not what happens.”

The value of fractional real estate has long been debated. Critics see it as a hustle, while supporters argue that it is a smarter way to use vacation real estate, because most second homes are used for only a few weeks a year.

The contemporary version of fractional ownership started with time-sharing in the 1960s, when the first properties opened across Europe and later in Hawaii. The idea — that people could buy designated weeks that they could use at a resort or trade for other destinations — spread to vacation spots around the United States, Mexico and Europe. By the 1990s, large hotel operators like Marriott and Hilton had gotten into the business.

But like many real estate ideas, time-sharing went out of fashion. As it lost a bit of its allure, fractional ownership came on the scene in the 1990s. At the high end, condos were replaced by luxury ski chalets and beachfront villas.

The industry is now organized into three subsectors: fractional ownership, private residence clubs and destination clubs. According to Ragatz Associates, which tracks the industry, the first two are basically the same, but private residence clubs are a more upscale version of fractional ownership. Destination clubs are more like country club memberships, in which people pay an initiation fee for access to rent and stay in luxury homes.

Mr. Herr bought his share in 2008 in the Beach Club Resort in the town of Parksville on Vancouver Island. He and his wife had selected Victoria, another town on the island, to retire.

“There was a train from Victoria to Parksville, and we thought, ‘Wouldn’t it be cool to take a train two and a half hours away?’” he said. “It was something new.”

But within a few years, the train had lost so much money that it closed, and Mr. Herr’s feeling about his investment soured. Having bought his share as the real estate bubble was bursting, he held on as most of the value went out of the fractional market.

The fractional industry in North America peaked in 2007, with $2.3 billion in sales, but it has been in decline ever since. Last year, sales were $471 million, with 61 percent coming from destination clubs.

In its annual report, Ragatz Associates said several factors had aligned against fractional ownership. Among them were a decrease in home equity, which buyers had previously been able to tap to buy fractional shares that were tough to finance; a glut of vacation homes for sale and the lowering of prices to sell them; and competition from home-sharing sites, like Vrbo and Airbnb.

The problem of how to sell property that is owned communally is not new. In fact, it dates to medieval times.

Some of the first fractionalized dwellings were castles in 13th-century France, said William N. Goetzmann, the Edwin J. Beinecke professor of finance and management studies and director of the International Center for Finance at the Yale School of Management.

Eschewing the law of primogeniture, in which the firstborn child inherited everything, the French opted for equal inheritance. But if the only asset to divide was the family castle, the siblings owned it together.

“When you divide it up, what do you do with it?” Professor Goetzmann said.

There were three options in medieval times, which were pretty much the same as they are today. The heirs could divide up the castle and live there together, which Professor Goetzmann said marked the first use of the word “condominium.” They could also create time-sharing out of the castle or operate the castle lands as a business and split the revenue, often from rents paid on the land.

The French, he said, developed rules to allow people to sell their shares in the castle. But disputes ensued, the same kind that have persisted into modern times.

Part of the difficulty in selling fractional or vacation homes is that people value them incorrectly, said Christopher J. Mayer, a professor of finance and real estate and a co-director of the Paul Milstein Center for Real Estate at Columbia Business School.

“Most of the return comes in using them,” Professor Mayer said. But fractional shares, along with vacation condos and houses, are not great investments.

There are a lot of beachfront locations in the United States and the Caribbean where you could own a property, he said, and they’re not all that different unless you’re looking at exclusive locations like Miami Beach. The same goes for ski resorts, because there is plenty of land on and around a mountain to build more condos.

“You should not buy any vacation real estate assuming the value will go up, because if it does go up, the guys sponsoring these properties will build more,” Professor Mayer said. “It’s not about appreciation for the existing buyers. They’re going to build more and sell them.”

Before selling his share, Mr. Herr said, he tried to rally his fellow owners — more than 300 of them — to convert the Beach Club Resort into condominiums. It was an effort, he said, to recoup what they had lost in the value of their shares. He got only 23 proxies, and his motion failed.

His lawyer, Michelle Karby, legal counsel at Oreck Karby in Vancouver, said such resistance with properties owned fractionally was common. Many owners buy their shares for emotional reasons and are content to use their weeks, she said.

“People don’t understand just how much it’s costing them,” Ms. Karby said. “They pay their management fees and they haven’t looked into selling their share, so they don’t know they’d have to sell it at a loss.”

Yet one real estate owner’s loss could be another’s good fortune. Rick Brunette, general manager at Palm Island Properties, a barrier island on the west coast of Florida, said sales of existing fractional shares had picked up this year.

The community, which began in the 1980s and consists mostly of condos, duplexes and houses, has 12 units divided into 48 quarter-shares. None sold last year, but four have already sold in 2019, Mr. Brunette said. Of the six currently listed, sales are pending on two, he said.

“This has been a good year,” he said. “They have good years, and all of a sudden, it’s quiet.”

The prices are nothing like they were in 2005 and 2006, when quarter-shares on Palm Island sold for more than $100,000, Mr. Brunette said. But prices have stabilized in the past five years around $25,000. As in any effort to move a piece of property quickly, though, price matters. A second-floor quarter-share had been listed for $30,000, but the price has been reduced to $23,500.

“You never make money in real estate when you sell it,” Mr. Brunette said. “You only make it when you buy it, if you buy it at the right price.”

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