South Africa: Fractional Ownership - A Rose Or A Thorn By Another Name?

Last Updated: 6 December 2005
Article by Frans Van Hoogstraten

A new buzz word has hit the property market. In an apparent endeavour to avoid the perceived stigma (which if it does exist, is not necessarily warranted) attaching to property share block and property syndication schemes, the property marketing fraternity has come up with the term "fractional ownership".

But precisely what is fractional ownership? Is fractional ownership a new concept or is it no more than a generic term for a number of existing legal and commercial concepts whereby ownership and/or use of immovable property is acquired jointly by a group of persons and whereby the use or income of such property is shared by them on an agreed basis?

Probably the oldest of these schemes, but which has for reasons that are outlined hereunder largely fallen into disuse, is joint ownership whereby the property is acquired by the individuals comprising the group or syndicate in undivided shares. Each member of the group receives transfer of his specified undivided share in the property. Typically the co-owners will enter into a "Co-Owners Agreement" which regulates their respective rights and obligations as co-owners of the property. Issues such as their obligations to contribute to common expenses by way of levies or other payments and their rights to the receipt of income or the use of the property are addressed. Although such direct ownership vests in the participants the strongest form of title possible in terms of our law, it has the distinct disadvantage that the transfer of ownership of an undivided share in immovable property can be effected only by way of a deed of transfer registered in terms of the Deeds Registries Act with adverse cost implications. Such a transfer attracts both legal fees and transfer duty or VAT.

As an alternative a number of schemes exist whereby a purchaser can acquire indirect title to the property concerned (whether for purposes of investment or personal use) through an intermediary "vehicle" such as a company, close corporation or trust. All of these schemes allows for flexibility and ease of transfer of ownership. Unfortunately such schemes do have the potential of subjecting the purchaser to risk. Simply put the chosen "vehicle" acquires ownership of the property concerned and the purchaser or investor acquires an interest (in whatever legal form it may take) in that vehicle. That interest is generally readily transferable with minimal formalities having to be complied with and at minimal cost. The main risk however lies therein that the purchaser may have little or no control over liabilities to be incurred by, or other activities of, the chosen vehicle.

The simplest form of such indirect ownership entails the acquisition of immovable property by a close corporation with investors/purchasers acquiring a member’s interest in that close corporation. Such transactions are subject to minimal regulatory or statutory control and, in particular, are not subject to the requirements of the Share Blocks Control Act. But there are no free breakfasts – ownership of a member’s interest in a close corporation is restricted to natural persons. Accordingly such a member’s interest cannot be held through another legal entity (ie investment company, family trust or the like) which may be advisable for any of host of other financial, taxation, practical and/or legal reasons.

This leaves me to briefly consider the most commonly used forms of joint or shared property ownership.

Property syndications have again become popular, possibly because of the relatively high returns offered by such investments. In a nutshell, property syndications entail the acquisition of (usually) an income producing property (or properties) by a company with investors acquiring shares in that company. Again a "Syndication" or "Shareholders" agreement is entered into between the shareholders in terms whereof their respective rights and obligations as shareholders are regulated. Because in terms of such schemes the share merely confers on the investor the right to receive a dividend or other return on his investment and does not confer on the investor the right to or an interest in the use of the property, such schemes are not regulated by the Share Blocks Control Act. Syndication schemes do however remain subject to the provisions of the Companies Act including restrictions against the offer of shares to the public without the issue of a prospectus.

Share block schemes on the other hand entail the acquisition of property (whether through ownership or a lease) by a share block company with purchasers acquiring shares in the share block company on the basis that ownership of such shares will confer on the owner the right or interest in the use of the immovable property or any part of the immovable property owned by the share block company. Such right of use is regulated by a "Use Agreement" entered into between the share block company and its members. Share block schemes have the advantage that they afford the purchaser or investor significant protections in terms of the Share Blocks Control Act. Furthermore, from the developer’s or promoter’s perspective, share block interests may be offered for sale to the general public without the issue of a prospectus. However a number of property practitioners and developers continue to endeavour to devise ways of avoiding the provisions of the Share Blocks Control Act. One of such schemes is founded on the exclusion from the definition of a "share" for purposes of the Share Blocks Control Act of "a right to or an interest in the assets of the company derived from a lease in respect of such assets". The argument is, quite correctly, that if a person acquires a right to use the company’s property, whether or not he is a shareholder, through a lease then that does not constitute a share block scheme as defined in the Share Blocks Control Act. But the position is very different if the so-called "lease" is in reality no more than a simulated use agreement with rentals being payable instead of levies being payable and where the quantum of rentals is determined in an amount equivalent to such levies as would otherwise have been payable. In substance, if not in form, the right to use the property is derived by the owner of the shares through such shares and is not derived from a lease. Accordingly such schemes remain subject to the Share Blocks Control Act.

So, fractional ownership is nothing new. It encompasses various existing legal and commercial concepts whereby the shared ownership and/or use of immovable property is acquired by a group of individuals. If the coinage of the term is motivated by (in my opinion misguided and unfounded) perceived negative connotations with regard to property syndications and property share block schemes and which if correctly structured and managed present sound investment and ownership opportunities, then we are dealing with a rose by another name. If on the other hand the real motive is to avoid existing consumer protection legislation then the rose becomes a thorn. It is far more preferable to invest in a share block company with the benefit of the protections afforded by the Share Blocks Control Act than in a company where, through some or other fancy footwork, such protections are avoided by the promoter and are lost to the investor.

We will, in a future article, deal with the risks and dangers, both to the investor and the promoter and both legal and commercial, inherent in property syndication and property ownership schemes and how these risks and dangers can be minimised. We will also outline the salient taxation consequences of these various forms of shared or fractional ownership.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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