What Happens If the Property Remains Vacant in a Fractional Ownership Model?

One question that arises when people consider fractional ownership of commercial real estate is What happens if the property does not have a tenant? After all, rental income is the driving force behind many commercial real estate transactions. At the same time, the risks of fractional ownership, including the inability to occupy the property, do not disappear. Vacancy is a risk factor that affects all of the investors in a fractional ownership structure. Let’s take a closer look at the consequences. What Does Vacant Property Mean? A vacant property is defined as an asset that is not leased to a tenant and does not generate any revenue. For example, a commercial property that is empty after the termination of a lease agreement with a business that took a unit on rent can be considered vacant until a new lease agreement is signed and a new tenant moves into the property. When a commercial property is vacant, there are no rental payments unless a tenant signs the lease agreement. It is essential to distinguish between the ownership of the property and the ability to generate revenues with it. Would the Rental Income Cease If the Property Becomes Vacant? It can, depending on the terms of the agreements and the responsibilities of the parties. If there is no tenant that pays rent, there may be no source of rental income for the time being. However, there may be sources of revenue in the form of

• security deposits,
• lease payments,
• insurance,
• reserves,
• rent from other tenants, and
• any other source of income. In reality, these details should be specified in the investment documents, and not all of them are necessarily applicable here, so it is vital to take a closer look at them. Who Would Be Affected by the Vacancy? The impact of the vacancy on the investors depends on the ownership structure at the moment. For example, if 100 investors own a fractional interest in a property that has become vacant, it does not mean that only one of them will experience the loss of rental income. The vacancy rate affects the overall value of the asset, and thus the situation of the property owners at the moment. This nuance is another reason why the choice of the right asset is so important. What Happens to the Property When It Is Vacant? While the property is vacant, the owner (or the manager, depending on the structure of the agreements) is obliged to maintain it in good condition, attract new tenants, and cover all the costs associated with the vacancy. Therefore, expenses may arise that would not arise if the property were leased. Expenses such as maintenance and repair of the property, security, insurance, utilities, management of the property, repairs, and other costs associated with being vacant may be incurred when the property is vacant. That is, the property owner faces two problems at once: a decrease or even the complete loss of rental income and additional costs. How Is a New Tenant Attracted? It is up to the property manager, asset manager, or another organisation to find a tenant willing to rent the property. Finding a tenant involves several steps, including marketing the property, showing the property to potential tenants, selecting qualified applicants, discussing and finalizing the terms of the lease agreement, tenant screening, and handing over the keys to the property. The vacancy period can last as long as it takes to go through this procedure, which can be different for different cases and vary from several months to several years. Finding a tenant for a commercial property located in a favourable area is much easier than finding a tenant for a property located in a problematic area and suitable for a specific category of businesses. What About the Property’s Value? The value of the property itself is also of great interest to the owners. If the property has a good tenant, it may have more value than another similar property that is vacant. However, the situation is not that straightforward since the value of the property also depends on several other factors, including the property’s location, its class, the rental rates local to the area, tenant demand, and leasing terms. How Important Is the Tenant? When reviewing a commercial property, apart from the income that can be obtained from it, it is also vital to pay attention to who the tenant is. For example, the stability of the tenant’s business, the length of the lease, and any additional terms and conditions that the tenant must meet are essential to the property’s value. It is also necessary to take a closer look at the lease agreement and, among other things, see how long the lease agreement is, how long the tenant is contractually obligated to stay, whether there is a security deposit, how much rent increases during the life of the lease agreement, whether it is possible to renew the lease agreement when it expires, under what conditions it is possible to terminate the agreement early, and who is responsible for maintaining the property. Can a Property That Has a Tenant Become Vacant? Yes, it can. Today, the property may have a tenant, but tomorrow, this tenant may decide to move, change the location of their business, or move their business to another property. Therefore, when reviewing a particular property, it is vital to consider the possibility that the tenant will move, as this may affect the future of the property. Conclusion and Things to Consider This is probably the most exciting part of the consideration — what investors should look at when examining an option for the fractional ownership of commercial real estate. Before making the decision to invest, it is vital to understand the risks of a property vacancy and the ways in which the investors will be affected. Specific questions that can be asked include: Is the property leased currently? If this is the case, it is essential to examine the tenant and the terms of the lease agreement. Another question is the length of the lease, as this information will help understand how much rental income the property generated in the past and how much it will generate in the future. In addition, it is vital to understand what happens when the lease expires — who is responsible for finding a new tenant and any additional costs in this situation. What are the occupancy statistics? Historically, how often has the property been vacant? This information can help understand how often vacancies arise. If such information is not available, it is essential to find out who is responsible for finding a tenant — the platform, the asset manager, or the property manager. Are there any reserves? The existence of reserves that can cover some of the operating costs when the property is vacant is also a factor that needs to be considered. Who covers the costs when the property is vacant? This question is especially relevant to answering questions about the costs of maintaining the property, management, security, utilities, and other operating costs. Does fractional ownership eliminate the risk that the property may go vacant? Vacancy risk cannot be eliminated when buying a property with fractional ownership. Fractional ownership only allows investors to cover a part of the costs and participate in a share of the profits. By contrast, the investor with full ownership of the property bears all the costs and risks. However, investors who use a fractional ownership structure are faced with all the challenges of a vacant property — the loss of a tenant and the associated costs. Vacancy risk is a normal challenge that commercial real estate owners face. Whether the property is fully owned or fractionally owned, this problem must be addressed. However, when using the fractional ownership model, the consequences of the vacancy of the property are distributed among the investors according to the terms of the agreements. That is, the vacancy risk becomes less significant for each owner. Nevertheless, when choosing a particular property for fractional ownership, the main focus should be on the income that the property can generate rather than just the income. The ability to answer questions about the tenant, the lease, the occupancy statistics, operating costs, management, and the exit mechanism will be much more informative than knowledge about rental yields.