The timeshare industry has ballooned in the past 20 years. According to the American Resort Development Association, total sales volume for timeshares in the United States was $8.6 billion in 2005, up 9 percent since 2004. There also is an accessible finance market for timeshare paper, which is actively securitized.

Comparatively, fractional shares have little secondary market, but this type of investment has many lower-risk characteristics. Fractions are typically sold in one-quarter of share or 12 weeks a year; one-eighth of a share or six weeks; one-tenth of a share or five weeks; or one-twelfth of a share or four weeks of ownership. Therefore, the underlying real estate values are less diluted by sales and marketing expenses.

For timeshares, it is expensive to sell a single condo to 52 different buyers, and timeshare developers often expense at least half of their cost for marketing. A single unit of timeshare or a 1/52 share might sell for $10,000 a week -- or $520,000 for the whole property. It's real estate value might be $250,000, however.

A one-quarter share of the same condo might sell for $75,000, or $300,000 for all shares. This represents a 20-percent increase over the whole-ownership real estate value. As the fraction size shrinks, so does the lender's real estate asset as security.

Clearly, any form of fractional real estate carries an increased default and liquidation risk. As such, timeshare notes often carry interest rates in the low to mid-teens and amortize over 10 years or less. The price point of timeshare also attracts many vacation-home-owners who may not be able to afford fractional ownership, as most fractional shares are on luxury properties with a price tag of more than $150,000 per share.

Other risks

Most fractional properties are sold complete with furniture, fixtures and equipment. This is a great convenience for buyers. But it poses another challenge for mortgage lenders, which want to lend on appreciating real estate, not on depreciating sofas. This added risk eliminates many lenders from the market and increases interest rates for consumers.

Financing fractional ownership also adds a level of complexity that many lenders are not prepared to accept. For instance, what happens when one of the four owners in a quarter-shared home defaults? How will this impact the ownership experience and the value of the other three owners? What if the developer cannot sell two out of four shares?

Risks are higher for fractional lenders and must be clearly understood. For this reason, fractional interest rates are higher (150 to 300 basis points over market), and loan-to-value ratios (typically 65 percent to 80 percent) are stricter.

As 78 million baby boomers reach retirement in the next 15 years, fractional properties may become a more popular and common-sense choice for those who want luxury at an affordable price and in the best locations. As lenders balance this potential with fractional lending's risk, the sector bears watching for brokers.

Bob Waun is CEO of Vacation Finance, America's first second-home lender, which specializes in vacation-ownership financing and has pioneered the condo-hotel-finance market. Vacation Finance is a wholesale lender in key resort markets with a unique line of vacation loan products, including condo-hotel, fractional and timeshare-receivable financing. Waun can be reached at bwaun@vacation-finance.com or (248) 722-9286. The company's Web site is www.vacation-finance.com.

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