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Fractional Real Estate Investing: Democratization or Regulatory Grey Zone?

 

   Fractional real estate investing has become a popular entry point for retail investors seeking exposure to real estate with minimal capital. Platforms such as Arrived promise passive income and long-term appreciation, allowing users to invest as little as $100 into individual rental properties.

 

    Yet, beneath the sleek user interfaces lies a complex web of securities regulations, investor risks, and unresolved legal questions. This article explores the regulatory framework behind fractional investing, highlights recent enforcement actions, outlines investor risks, and proposes a path toward a safer, more transparent market.

 

The Regulatory Framework: Reg A+ and Arrived

    Arrived structures each property offering under Regulation A, Tier 2 of the Securities Act of 1933. This exemption permits companies to raise up to $75 million annually from both accredited and non-accredited investors. Each property is typically offered through a Delaware Series LLC or Special Purpose Vehicle (SPV), with the offering qualified by the SEC.

 

    While these offerings appear compliant, investors must recognize they are not buying direct ownership of property – they are buying shares of the company owning the property.

 

Potential Legal Risks: Are These Platforms Unregistered Exchanges or Broker-Dealers?

    A key unresolved question is whether fractional real estate platforms function as unregistered securities exchanges or broker-dealers.

 

• Under the Securities Exchange Act of 1934, any platform that matches buyers and sellers of multiple securities may need to register as a national securities exchange or as an Alternative Trading System (ATS).
• Platforms earning transaction-based fees, soliciting investments, or providing investment advice may also fall under broker-dealer registration requirements.

    If platforms evolve to allow real-time trading or investor-to-investor resales, they could trigger SEC scrutiny.

 

Enforcement and Platform Failures: Real-World Examples

1. Addy Technology Corp. (Canada). In 2024, Addy, a Real estate investing platform, was fined CAD $100,000 by the British Columbia Securities Commission for operating an unregistered securities trading platform, having facilitated over $26 million in investments without proper licensure.
2. Landa (U.S.). Landa faced severe operational disruptions in 2024. Users reported losing access to accounts and dividends, with the company unresponsive for months.

Investor Risks Beyond Regulation

    Even if platforms comply with the securities regulations, investors face risks beyond regulatory uncertainty:

 

• Illiquidity: The securities at issue are not freely tradable, often locking investors in for years.
• Lack of control: Since the investors do not own the property directly, they have no say in management or sale decisions. In a lawsuit against Landa, lenders claimed mismanagement of properties, including failure to pay property taxes and failure to collect rent.
• Return uncertainty: Marketing often emphasizes “passive income” while downplaying vacancies, expenses, and turnover.
• Custodial risk: If the platform fails, investors may struggle to recover funds or documentation.

Food for Thought: Disclosure Arbitrage and Portfolio Strategyv

    Fractional platforms may also create opportunities for real estate sponsors to raise capital without the heavy disclosure obligations of a traditional IPO or REIT.

 

    Under current rules, a sponsor can structure a Reg A offering through a Series LLC, segmenting properties to access retail capital under lighter reporting rules. This raises important questions:

 

• Could sponsors use fractional structures to strategically avoid stricter disclosure thresholds?

 

• Should regulators require aggregate disclosure for sponsors managing multiple Series offerings?

Conclusion

    Fractional real estate investing offers opportunities but exists in a regulatory grey zone. Certain platforms supposedly operate within the law by using Reg A+, but expansion into secondary trading or fee-based solicitation could trigger broader compliance requirements under the Exchange Act.

 

    As the line between real estate investing and securities regulation continues to blur, investors must perform careful due diligence, and regulators must provide clearer guidance.