FEATURE ARTICLE, APRIL 2006

TIC INDUSTRY SHEDS ITS SECURITY BLANKET
A serious dialogue is occurring in the real estate industry regarding the structuring of tenant-in-common transactions as real estate instead of as securities.
Kevin Jeselnik

When Gary Leavitt founded RealtyNet Advisors, a principal seller of properties in the tenant-in-common (TIC) market, and 1031 Exchange Place, a broker of 1031 like-kind properties, in 1997, the industry was still very new. In the time since the companies began operations, the TIC industry has expanded exponentially, and was solidified as a viable investment option by the Internal Revenue Service (IRS) in 2002 through the issuance of Revenue Procedure 2002-22.

A majority of the first TIC sponsors to enter the marketplace in the mid-1990s were entities coming from a securities background and had sponsored public limited partnerships in the 1970s and 1980s. These sponsors handled TIC transactions in a manner similar to the one implemented for limited partnerships. These real estate deals were structured as securities and marketed by securities broker-dealers. Since the idea of multiple individuals owning a single property was similar to those limited partnerships of previous decades, it seemed sensible to follow the existing model in structure TIC transactions.

Leavitt entered the TIC market for numerous reasons. “I hated to see people pay the tax; I hated to have somebody with, say, $200,000, pay the tax because they were unable to find a suitable replacement property,” he explains. From the outset, RealtyNet Advisors has carved out a specialty niche in the TIC marketplace. The firm primarily acquires and markets single-tenant, net-lease retail properties with no debt. “When I first started out in 1997, there were very few alternatives for those with a minimal amount of 1031 dollars,” Leavitt explains. “I noticed that there were people falling through the cracks if it was a securitized TIC [transaction], because the investors were either non-accredited or wanted to assume no debt.” These investors, both accredited and non-accredited, often have no debt leveraged and want no debt in their replacement property. RealtyNet offers debt-free properties typically ranging in worth from $1 million to $3 million. The average equity ticket size for each investor is approximately $175,000. These non-leveraged deals are less common in the 1031 exchange market than deals with debt replacement involved.

A solo investor in net-lease real estate engaging in a 1031 exchange must typically have an initial investment of $1 million or more. Allowing individuals to invest in net-lease real estate through tenancy-in-common can bring in investors for as little as $50,000. It allows investors to acquire institution-level commercial assets at a feasible price and enjoy the steady income of a passive, net-leased investment property.

While RealtyNet seems to be a typical TIC sponsor/principal seller, there is one significant detail that separates the firm from most sponsors: the company treats the TIC transaction as real estate, not as a security, from start to finish. By structuring the deals in this manner, RealtyNet avoids having to go through the traditional securities broker-dealer channels when transferring the purchased TIC property to the investors. The TIC-as-real-estate transaction hinges on a number of factors that keep it from becoming a security. One of the primary factors is that there are no collateral arrangements after the closing. Often, on the securities side, an agreement is reached between the sponsor and the investors regarding the providing of property management, asset advisement or other services before the transaction is closed. When the deal is structured as real estate, once the principal seller transfers the asset to the TIC investors, they are no longer involved in the management or ownership of the property in any way. “When you close, your relationship [with the buyer] was that of principal seller; the new buyer has 100 percent control of the asset,” Leavitt explains. “And if that happens, I believe that it is real estate every time.” To ensure that all tenets of Revenue Procedure 2002-22 are respected and followed, RealtyNet obtained a legal opinion stating that the firm is in compliance with the 15 criteria set by the IRS.

Completing TIC transactions as real estate avoids the drawback that has kept many real estate companies from entering this market: the issue of compensation. When deals are completed as securities, it is channeled through broker-dealers, which receive the commission generated from the acquisition. Often, a contributing real estate broker, who may have aided the investor or investors in the search for the replacement property, is left uncompensated. Leavitt is encouraging real estate agents across the country to give increased attention to the TIC market.

Currently, there are approximately 75 TIC sponsors in the United States completing transactions as securities as opposed to approximately 25 that are structuring TICs as real estate. Leavitt hopes to encourage more principal sellers to emerge from the real estate side over the coming years. He estimates that approximately half of all 1031 exchanges completed by individual (not institutional) investors during the next 10 years will be TICs. A tenant-in-common multiple listing service (TIC MLS; www.tic-mls.com) was launched on the Internet earlier this year as a means to market and expand the TIC real estate industry. “Our goal is that, by the end of this year, the approximately 1.5 million real estate agents in the country will know that, if they have a client in a 1031 exchange, a tenant-in-common investment would be appropriate,” Leavitt says. “[The broker] can go to the TIC MLS Web site and most or all of the principal sellers of TIC property will have their properties on the site — properties from which the real estate agent or broker may receive a referral fee or commission.”

The TIC MLS is a launching point for the expansion of the TIC-as-real-estate structure. It will serve to increase awareness of the viability of real estate agents’ involvement in TIC deals and offer a platform on which hundreds, or perhaps thousands, of properties can be marketed. Since the asset involved is initially real estate, that industry is now working to increase its stake in the TIC marketplace. “I firmly believe that TIC is first and foremost a real estate [transaction],” Leavitt says. “It is my opinion that this is a turf war and [the real estate community] is not in the battle yet.”

The TIC Real Estate Association has been launched to market the TIC MLS and bring more real estate agents into the fold. The association is an effort to organize the real estate community and ensure the survival of the industry and that those that are structuring TIC deals as real estate are not ignorant of security laws.

“I think that the TIC MLS and the TIC Real Estate Association will illustrate that we can do TIC deals as real estate and start giving more and more credibility to our industry,” Leavitt says. “It would help the industry to have securities sponsors and real estate principal sellers selling TIC properties side by side.”

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