Fractional Real Estate Investing: Weighing the Risks and Rewards

A new wave of startups like Arrived Homes are offering fractional real estate investing to open the asset class to more investors. But does splitting ownership of properties truly benefit small retail traders? In this in-depth guide, we'll analyze fractional investing pros, cons, risks, and alternatives.

Fractional real estate platforms allow buying a portion of a property rather than the entire asset. With minimum investments as low as $100, it's touted as a more accessible way to invest in real estate. Companies like Arrived Homes handle purchasing, management, and even finding tenants.

For many, especially younger Americans priced out of home buying, fractional investing appears to offer access to rental income. Arrived Homes CEO Ryan Frazier shared that 40% of their investors are renters themselves.

The Risks of Fractional Ownership

But fractional real estate has significant risks and downsides, especially for less experienced retail traders:

• High fees - Platforms can charge up to 25% of rental income in management fees. This cuts into profits significantly more than alternatives like REITs.

• Lack of diversification - Unlike REITs, fractional platforms allow picking individual properties. But this concentrates risk instead of diversifying.

• Illiquidity - Selling your fractional stake when desired can be difficult compared to publicly traded REITs. You're locked in.

• Inconsistent returns - Reported yields ranged from 2-8% for Arrived Homes last year. Leverage and scale influence returns.

• Misaligned incentives - Critics contend fractional startups are more focused on amassing fees from traders than delivering returns.

Alternatives Offer Better Risk-Adjusted Returns

REITs provide exposure to a basket of real estate assets and income-producing properties. As publicly traded securities, they offer far greater liquidity than fractional ownership stakes. Though buying a single company's stock is riskier than a broad index fund, the same principle applies to fractional real estate. REITs allow diversification at a similar low investment threshold without the exorbitant fees.

Index funds similarly help diversify stock market risk rather than picking individual stocks. The fractional model tries to sell the idea that choosing specific properties yourself is better than REIT diversification, contradicting proven investing principles. For most retail investors, a low-cost REIT ETF offers superior risk-adjusted returns compared to fractional real estate platforms.

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The False Promise of Democratized Investing

Fractional real estate purports to "democratize" investing, but many platforms exploit dreamy perceptions of owning property. In reality, fractional stakes are not equivalent to home ownership. While increased access to alternative assets is beneficial, better policy solutions exist to make housing itself more affordable and stable for families rather than encouraging profit-seeking mentalities. If choosing fractional platforms, small retail traders should weigh risks versus potential rewards carefully.