Fractional ownership – an alternative residential property investment vehicle

Braam Lowies (School of Commerce, University of South Australia, Adelaide, Australia)
Robert Brenton Whait (School of Commerce, University of South Australia, Adelaide, Australia)
Christa Viljoen (School of Commerce, University of South Australia, Adelaide, Australia)
Stanley McGreal (Built Environment Research Institute, University of Ulster, Belfast, UK)

Journal of Property Investment & Finance

ISSN: 1463-578X

Publication date: 3 September 2018

Abstract

Purpose

The purpose of this paper is to determine the profile of the typical online fractional residential property investor in Australia. This study also seeks to understand the motives for engaging with and investing in alternative residential property investments.

Design/methodology/approach

This study employs a survey-based design via an online questionnaire to gather information on investor age, gender, type, education levels, time horizons and investment history and risk and return expectations. It also gathers information regarding investors’ financial literacy including tax implications of fractional property investment.

Findings

The findings of this study suggest amongst others, that fractional property investors tend to be younger, although the platform also attracts older investors including older females. The study also found that investors do not select alternative investment platforms in anticipation of super-normal investment returns. Return expectations are realistic and are based on a balance between capital growth and income.

Practical implications

This study indicates that alternative investment platforms lowers the barriers of entry into residential property for first time investors. It therefore creates opportunities to allow many first time individual investors to invest in property, often as an alternative to bank savings or investing in the stock market.

Originality/value

This study enhances our understanding of the influence of alternative investment platforms on investment decision-making. More specifically, it contrasts fractional property investment with more traditional investment opportunities to understand the motives of investors for diversifying into online investment vehicles.

Keywords

Citation

Lowies, B., Whait, R., Viljoen, C. and McGreal, S. (2018), "Fractional ownership – an alternative residential property investment vehicle", Journal of Property Investment & Finance, Vol. 36 No. 6, pp. 513-522. https://doi.org/10.1108/JPIF-02-2018-0013

Download as .RIS

Publisher

:

Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited


1. Introduction

Fractional ownership involving less than a 100 per cent interest in a property is a long-established concept that has raised specific issues regarding valuation, perceived risk and greater liquidity stemming from reduced levels of control and marketability relative to full ownership rights. Various structures, vehicles, partnerships or other legal entities have been used to manage fractional investment interests. Indeed, real estate investment trusts (REITs) constitute a form of fractional investment. However, with new technologies spurning the growth of digital platforms and the FinTech sector, a raft of alternative finance investment products has emerged. Many of these, such as crowdfunding, have enabled individuals for the first time to invest in property (Lowies et al., 2017). Indeed, O’Roarty et al. (2016, p. 2), reflecting upon the commercial real estate sector, observe that the industry “has not been immune to the transformative effects of technology, with disruptive forces leading to a re-evaluation of how real estate is bought, sold, leased and priced”.

Arguably one of the most comprehensive studies on alternative finance platforms is a series of reports from the Cambridge Centre for Alternative Finance which examines, on a regional basis, the application, update and impact of these platforms. The report for the Asia-Pacific region (Zhang et al., 2016) identifies crowdfunding as the main opportunity for real estate investment while digital-based platforms have opened-up the opportunity to enter into fractional property ownership. However, to date, there has been an absence of any empirical studies that analyse investor behaviour in terms of the motives for engaging with, and investing in, such vehicles.

This paper, in seeking to address this gap in the literature, focusses on investors in one particular form of fractional investment offered through a residential property platform. This internet-based platform gives an investor the opportunity to purchase a “brick”, representing the fractional interest in a residential property. Such a “brick” is held in trust which can be sold in an approved secondary market. The internet-based platform is unique in being completely online and available worldwide to invest in high end residential property. Even though the fractional interest is divided rather than undivided, the potentially disruptive nature of this residential property investment vehicle raises the question as to the type of investor that is attracted. The purpose of this paper is to explore the profile of the online fractional residential property investor, analyse motivation and assess the relative contribution of fractional investment.

The paper is structured as follows. Section 2 examines the relatively limited literature based on fractional property investment, draws upon complementary literature from crowdfunding and explains the structure of fractional ownership in property. Section 3 provides specific detail on the research methods including the internet-based platform used. Section 4 presents a detailed analysis of the findings on a thematic basis focussing upon motivations, return/risk expectations and perceptions of risk, and respondents’ level of financial literacy. Section 5 expresses final thoughts on the way forward using fractional investment vehicles and Section 6 draws conclusions from the study and seeks to position where these alternative investment platforms may sit vis-à-vis more traditional forms of investment in property.

2. Literature review

Investment in real estate may take numerous forms, but due to institutional constraints and regulations can be a relatively expensive option compared to alternatives such as the stock market (Ziets et al., 2008). Also, residential property has become increasingly difficult to invest in due to its owner-occupier bias which has priced many out of the market (Beer et al., 2007; Yates and Milligan, 2007; Newell et al., 2015). Furthermore, the various indirect investment vehicles that enable alternative investment paths in real estate for first time investors or for those wishing to diversify, such as REITs or unlisted funds, are generally orientated towards commercial property, though residential REITs exist in a number of countries including the USA and the UK (Newell and Peng Hsu, 2007).

These different vehicle structures, including REITs and listed property companies whereby a property is beneficially owned by more than one investor, are essentially examples of “fractional” investment (Fife and Newell, 1995). While investors may trade some or all of their fractional ownership in these indirect vehicles on a secondary market, there are other fractional interests of an undivided nature such as ownership of real estate through limited liability companies and limited partnerships (Davidson, 1992; Webb, 2001; Lewis, 2014). Combinations of structures are becoming increasingly common, such as two or more REITs investing in a property as a joint venture (Hess and Liang, 2004). A further type of undivided fractional investment known as a tenancy in common (TIC) has become prominent in the USA due to favourable tax rulings from the Income Revenue Service (Rose and Brinckman, 2006; Kaschube, 2006; Franklin 2007; Hopson and Hopson, 2008). A TIC is not an entity but rather a direct form of ownership that requires at least two common owners where each investor individually owns a physically undivided part of the entire parcel of real estate and has non-exclusive right of possession of the entire property (Updike, 2007).

The literature on fractional investment has focussed predominantly on valuation and taxation issues. In the USA, valuation has been required to determine estate and gift tax liability (Hall and Polacek, 1994; Lewis, 2014) and in Australia, the need for valuation has arisen due to the increasing popularity of such investments as a way to manage specific risk (Fife and Newell, 1995; Fife 2003; Hess and Liang, 2004) but neither jurisdiction has developed a suitable approach (Fife and Newell, 1995). REITs use fractional investment at an individual real estate level to spread risk but can lead to control, possible discounting and valuation issues. Furthermore, simply multiplying the value of the underlying asset by the fraction of ownership does not take into account problems with liquidity, the specific ownership structure and potential disagreements with co-owners surrounding the use and misuse of the underlying property and determining appropriate capital and income distributions and expense allocations (Hall and Polacek, 1994; Fife and Newell, 1995; Fife, 2003; Lewis, 2014). Due to these “burden[s] inherent in joint ownership” (Fife and Newell, 1995, p. 467), many argue that fractional interests should be valued at a discount compared to the value of the underlying asset (Davis et al., 1983; Hall, 1989; Thompson and Dogbjartsson, 1994; Davidson, 1992; Webb, 2001; Lewis, 2014) although a premium may also be appropriate under the right circumstances (Fife and Newell, 1995). In the USA, the courts have favoured discounts supported by empirical data rather than expert opinion of valuers (Hall and Polacek, 1994). In Australia, valuation methods involve consideration of a variety of factors including the value of the underlying investment, but the appropriate weighting of these factors has not been settled (Fife, 2003).

Much of the literature on the subject predates the advent of alternative investment platforms and the changing concept of fractional investment though issues relating to market liquidity, security of investment and holding period are relevant to the risk that investors are taking when deciding to utilise new digital investment vehicles. Indeed, the recent origin of alternative real estate investment platforms mean that there is little research available on who is investing, their motivation for investing and their expectations from the investment, though some literature is emerging on crowdfunding. From a consumer marketing perspective Ordanini et al. (2011) suggest that investors in crowdfunding like engaging in innovative behaviour, are attracted by the novel way of using the underlying platform and by the appeal of interactive tools. Such investors are largely drawn to crowdfunding platforms characterised by low to medium risk/return ratio which appeal to a broader set of potential payoffs including emotional rewards. Kang et al. (2016), using a questionnaire survey of a crowdfunding based platform in China and employing trust theory, analysed the factors that influence funders’ perceived trust in crowdfunding. It was apparent that crowdfunding users had rich online experience and thus security of online investment was not a concern, though it was found that short-term interaction cannot completely acquaint funders/investors with fundraisers. In Australia, it was shown that property crowdfunding is perceived as having relatively low to medium risk, attracts a mix of investor types with the main appeal being the ease of entry for a potentially relatively small outlay of capital (Lowies et al., 2017).

Although fractional ownership in property has been prominent in a number of countries including the UK, Spain, India and Thailand, it has been a recent addition to the Australian property market. Furthermore, the digital platform approach to fractional ownership is a relatively new innovation both globally and in Australia.

Fractional ownership in property is very similar to a patent developed by Vicino (2008), which allows several investors to invest in a high-yielding physical asset, in this case, residential property. Investors own a fraction, or a share, in a high value residential property and benefit from the rental income as well as capital appreciation of the asset. Shares are purchased through the online platform that initially acquires the asset. The online platform pays all fees, including stamp duty and transfer fees, to buy the asset with investors only paying a small administration fee in purchasing a fraction of the ownership of the property asset.

In Australia the fractional ownership model functions similar to a property trust. Tax is payable on rental income (as a dividend) and on the capital gain once an investor sells their share of the property. In selling their share, investors list their fraction for sale on the platform site and wait for a willing buyer. The platform therefore also acts an exchange where investors can buy and sell shares in several residential properties.

It is evident that fractional investment through online platforms is in its infancy. This paper, in addressing investment in fractional property ownership, seeks to add to the emerging literature on alternative investment platforms and in particular the next section considers the survey approach based on investors using an Australian fractional residential property platform.

3. Research method

This study employs a survey-based research design and in doing so follows an investigative approach that has been employed extensively in property research (French, 2001; Gallimore and Gray, 2002; MacCowan and Orr, 2008; Gibler et al., 2009). The purpose of the online questionnaire was to investigate perspectives in fractional property investment as an investment vehicle. More specifically, the aim was to gather information on key issues including age, gender, investor type and education demographics; investor time horizons and investment history; return expectations, risk perceptions and likely holding period of the fractional investment as well as financial knowledge and tax implications of fractional property investment.

This study adapted an earlier questionnaire developed by Lowies et al. (2017), investigating investors’ perspectives on property crowdfunding in Australia, to the current study on fractional property investment. A pilot study was conducted to ensure the effectiveness and robustness of the questionnaire.

At the time of writing there was only one significant fractional property investment platform operating in Australia, although smaller start-ups are entering this market. The questionnaire was initially distributed through the platform to an active investor database of 1,700, using Survey Monkey. This yielded a return of 150 responses, or a 9 per cent response rate, which is in line with response rates for online surveys (Nulty, 2008). All responses were collected in exactly the same manner to avoid bias. The analysis identified key patterns in the data with inferential statistics employed (χ2 and t-tests) to test for sub-group differences.

4. Survey findings and results

The findings of the survey are considered under a number of thematic sub-sections starting with an overview of the respondents’ profile which forms a benchmark for further analysis of the data set. The key thematic issues explored are experience of fractional property investment, return expectations, information on fractional property investment, risk, financial literacy and fractional property investment.

4.1 Respondent profile

Respondents’ gender is strongly skewed towards males perhaps reflecting the perception that men have a greater propensity to explore alternative investments particularly those associated with digital platforms (Table I) In terms of age profile, fractional property investment has greater appeal to a younger profile of investors with two thirds of respondents in the survey aged below 45 years. Thus, only 15 per cent of the sample were aged 55 or above, reflecting the likely perception of risk by older respondents, their more conservative attitudes in terms of investment behaviour and potentially a lower knowledge base of alternative investment platforms. A number of these issues are further addressed in the subsequent analysis, though it is interesting that of the older investor cohort there was a disproportionate representation of female respondents: 26 per cent of all women in the survey were in the older age category compared with 11 per cent of their male counterparts. Indeed, disaggregation of the data set by gender and age reinforces the younger male profile of the investors.

In relation to gross household income, there is a high representation of respondents in low to middle employment with 33 per cent earning between AU$50,000 to $100,000[1] and 31 per cent between AU$101,000 and $150,000. Whilst the analysis indicates no significant difference in income bands between female and male respondents, it is apparent that there is a greater percentage (33 per cent) of the female cohort in higher income groups relative to males (15 per cent). Furthermore, there is evidence of a high level of education amongst respondents with 38 per cent holding an undergraduate degree and 27 per cent a postgraduate degree. Thus the survey is composed of a well-educated and informed cohort.

4.2 Experience of fractional property investment

Reflecting the characteristics of the respondent profile, most interviewees (78 per cent, n=93) were existing investors with only 22 per cent indicating that they are new investors and that the investment through a fractional property investment platform was their first financial investment. Some gender differences are apparent with only 16 per cent of females utilising this fractional investment platform as their first investment compared to 27 per cent of the male respondents. Again, such subtle differences, whilst not reaching a statistical confidence level required for scientific analysis, does at least suggest that male respondents are more likely to be responsive to alternative investment platforms and may be more inclined to take higher risk. Ease of access to the fractional investment platform, confirmed by 92 per cent of respondents, was important in attracting investors and assisting in investment decision-making.

Regarding the level of financial exposure, the distribution has a significant positive skewness with individual investments ranging from as low as AU$70 up to US$40,000. The mean investment (AU$2,898) suggests that most investors have a limited exposure to risk and use their investment to test the potential of fractional property investment. For the new investor cohort, as expected, the mean level of exposure is lower (AU$2,314) than for existing investors (AU$3,078) and characterised by lower investment spreads AU$3,845 and AU$5,559, respectively.

Regarding other asset classes, it is apparent that respondents were otherwise largely exposed to mainstream asset classes. Direct property (37 respondents), stocks (27 respondents) and cash (28 respondents) were predominant investments with females holding a slightly higher percentage in cash (31 per cent relative to 27 per cent for males). In relation to age profile, while there is certain variation in the allocation to different asset classes, the only significant difference is the lower percentage of cash held by those 55 or above (14 per cent) compared to the 18–34 age group with a 35 per cent allocation to cash. Those aged 55 or above had a higher allocation (49 per cent) to direct property as an investment asset.

4.3 Fractional property investment and return expectations

Most respondents (87 per cent) suggest returns of 10 per cent and lower (Table II), which are broadly realistic compared to general savings products. Certain differences are apparent by gender with 52 per cent of females compared to 41 per cent of males expecting a return of 5 per cent or below, whilst a higher percentage of males (47 per cent) suggested returns in the 6–10 per cent range compared to 32 per cent of female respondents. The younger investor (18–34) had higher return expectations, 50 per cent suggested 6–10 per cent compared to 39 per cent of the investors aged 55 and above, but no statistical significance is evident. New investors had higher return expectation with 21 per cent of this cohort expecting returns of 11 per cent and above, again no statistical significance was found.

Ownership expectations in relation to fractional property investment are based on continuing future ownership and expected returns that reflect both annualised capital growth and rental income in the form of monthly payments according to the fraction owned. This is the preferred position of the clear majority of investors (70 per cent). In terms of the sustainability of the fractional investment platform, it is interesting that only a minority of respondents were interested in short-term speculation. Female respondents showed a slightly higher tendency for short-term speculation (13 per cent compared to 10 per cent for males) and capital growth only (19 vs 13 per cent for males). Analysis by age group indicates that those aged 55 and above were the strongest (77 per cent) in expecting capital appreciation and rental income as their investment objectives. There was little difference in ownership expectation between new and existing investors.

The analysis (Table III) indicates, the main motivation for using fractional investment was general saving, possibly indicating an alternative to mainstream banks with the prospect of an added return. However, 23 per cent saw the investment as a deliberate strategy of gaining access to investment in property. This was highest (37 per cent) amongst the 18–34 age group and the new investor group (38 per cent).

4.4 Information on fractional property investment

Information concerning fractional property investment appears to be strong, which is to be expected from a survey of actual investors. Equal numbers (46 per cent) considered that they were either well informed, this is highest amongst the 35–54 age group (57 per cent) or had some idea as to how fractional property investment works. Surprisingly for an investor cohort, 8 per cent of respondents did not have any knowledge about fractional property investment. This opinion was paramount in the new investor cohort, 17 per cent of whom seemed to lack a knowledge base on fractional property investment. Importantly, the difference in the information base between new and existing investors is statistically significant (0.05 level).

The internet was the primary source of information (62 per cent of the sample), though printed media (19 per cent) was still important for an appreciable number of respondents (n=23). Surprisingly, for female respondents (68 per cent) the internet was an even stronger source of information than for males (59 per cent). Age differences are also apparent with 69 per cent of the 18–34 group quoting the internet compared to 56 per cent of the 55 plus age group. The age differential is also apparent in the use of printed media, quoted by 10 per cent of those in the 18–34 age group compared to 33 per cent for respondents 55 or over (statistically significant at the 0.05 level).

Information on the tax implications of fractional property investment are varied with 72 per cent of respondents (n=86) claiming to be familiar with tax consequences, though an appreciable number, circa 28 per cent of the sample (34 respondents), were unaware of any taxation issues. Significant differences (at 0.01 level) arise by age group with the percentage of respondents in the 18–34 age group who are unfamiliar with tax implications rising to 40 per cent.

4.5 Risk, financial literacy and fractional property investment

Table II shows that respondents’ willingness to take risk in an investment situation lies between a risk averse/moderate risk-taking position with 44 per cent prepared to take average risk in the expectation of receiving average return, whilst an equal representation showed an appetite for above average (high) risk in seeking above average returns. Female respondents showed a wider spread of risk-taking behaviour with a lower percentage (32 per cent) taking an above average (high) risk position. The spread of risk behaviour on a gender basis is statistically significant (χ2 =9.861, p=0.05). Likewise, a distinct variation in risk profile is apparent depending on the age of respondents with the 55-plus cohort seeking to minimise their risk positions (56 per cent opting for average risk and a further 11 per cent below average risk). Those new to investment were more cautious, with 52 per cent indicating average risk-taking, though differences are not statistically significant.

Relatively strong appreciation of financial literacy was apparent when respondents were tested across a range of financial concepts. However, as financial concepts become more sophisticated, seemingly, the level of knowledge is declining. Reflecting this variation in knowledge, 81 per cent of female interviewees claimed to have a fair to a lot of knowledge in relation to interest rates, finance charges and credit terms (72 per cent for males) rising to 83 per cent of those aged over 55. For existing investors 81 per cent expressed similar knowledge levels but significantly this decreased to 55 per cent for the new investor cohort (χ2 13.891, p=0.008).

The expected investment time horizons of respondents, 36 per cent (n=43) medium term and 47 per cent (n=56) long term, reflect the differing levels of risk appetite particularly the tendency to be either risk averse or willingness to accept a modest degree of risk. A minority indicated a desire to invest over a short-term horizon (17 per cent, n=21). In this respect, age differences were significant at the 0.05 level with 21 per cent of the 18–34 cohort taking a short-term perspective while 68 per cent of the 55 plus age group envisaged a long-term holding period of over five years.

5. Residential fractional ownership – the way forward

The paper shows a gender bias towards males in the use of fractional property investment, similar to that observed by Lowies et al. (2017) for property crowdfunding. Researchers and other groups interested in social inclusion may be particularly keen to determine the reasons for the gender and age biases found in the investor profile. Even though an investor is more likely to be female as age increases, the observation that ease of access aided many respondents in their decision to invest suggests that older females were in general not able to access the platform as easily. Future research could investigate this and other potential barriers inhibiting older people and females investing in the platform.

In addition to the above there is evidence of an over-representation in the younger investor age group. This might create an opportunity to actively direct marketing to engage with this cohort. Of particular commercial interest is the finding that many use the platform as a general savings vehicle rather than a way for those who are otherwise locked out of the residential property market to gain entry to it, perhaps due to the liquidity offered by the platform combined with its ease of its use to this younger cohort.

The valuation of the fractional interest is a major issue with many arguing that it should be valued at a discount due to the burdens of co-ownership and the lack of liquidity. Since the online fractional property investment platforms remove many, if not all, of these burdens and are more liquid investments, valuing at a discount may not be appropriate. An opportunity for improvement exists in investigating valuations of the online fractional interests compared to the proportion of the underlying property to determine the amount of discount, if any, and explain the reasons for the amount of any discount.

Online fractional investment appears to offer a number of advantages over traditional fractional investment due to greater liquidity and reduced burdens of co-ownership. The evidence in this paper however suggests that fractional investors have a medium to long-term investment time horizon providing a clear indication that fractional investment platforms are not transitory vehicles.

6. Conclusion

Disruptive technologies and the growth of digital based alternative finance platforms have widened the scope for alternative investment vehicles. This paper has shown that the opportunities available have allowed many first time individual investors to invest in property often as an alternative to bank savings or investing in the stock market. Of particular importance are those platforms that enable fractional ownership of property; however, to date, there has been little research about these vehicles, who is using them and what the expected investment outcomes are. Webb’s (2001) argument that co-ownership attracts a certain type of investor raises the question as to what type of investor is investing online in fractional property. In this context, this paper, using a fractional ownership platform, is breaking new ground with the originality of the study stemming from an analysis of investor profiles and their decision-making behaviour.

The survey captured a wide age-gender-financial literacy spectrum of opinion amongst this investor group. For a new innovative investment style vehicle this spread is perhaps wider than might have been anticipated and while investment amounts are generally relatively modest, reflecting the nature of fractional investment, it is significant that this vehicle has attracted such a range of investors. The analysis shows different motivations of largely risk-averse/modest risk-taking domestic-based[2] investors towards the merits of fractional property investment.

The specific contribution of the study is the positioning of fractional investment alongside more traditional investment opportunities and understanding investors’ attributes and motives for diversifying into online vehicles and the perception of the risk involved. Indeed, it seems highly probable that fractional investment will become an embedded feature on the wider investment landscape alongside traditional investment routes with a notable impact on future investment strategies.

Respondent demographics

Respondents (%)
Gender
Male 75
Female 25
Age
18–24 8
25–34 37
35–44 22
45–54 18
55 and above 15
Income distribution ($)
Below 50,000 13
50,000–100,000 33
101,000–150,000 31
Above 150,000 23
Highest qualification
Secondary school 7
Diploma/certificate 25
Undergraduate degree 38
Postgraduate degree 27

Return and risk expectations

Respondents (%)
Expected return
5% or below 44
6–10% 43
11–15% 11
Above 15% 2
Expected return
Very high 11
High 43
Average 44
Below average 2

Investors’ motivation in using fractional investment

Motivation Respondents (%)
Gain access to investment in property for the first time 23
Save for a deposit to buy a house 7
General saving 53
Other 17

Notes

1.

At time of writing the exchange rate between the AU$ and the US$ was AU$1 AUD =US$0.79.

2.

Very few of the respondents had investments outside of Australia, for example 6 per cent (n=7) held investments in the USA.

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Corresponding author

Braam Lowies can be contacted at: braam.lowies@unisa.edu.au