FEATURE ARTICLE, DECEMBER 2004

TIC INVESTMENTS SWELL WITH INVESTOR INTEREST
Lenders contemplate how to deal with this expanding category.
Faron Thompson

TIC investments, or tenant-in-common ownerships, are becoming a popular choice among investors seeking replacement property for their 1031 tax-free exchanges. A typical TIC investment in real estate involves a number of individuals, each with as little as a few hundred thousand dollars of capital gains from a sale of a property to invest. Through a TIC promoter, these individuals are able to pool their money and buy a larger commercial property, realizing the tax advantage afforded by a 1031 like-kind exchange.

The growth of this area is significant. According to Omni Brokerage Inc., which tracks the TIC industry and its sponsors, the marketplace has grown from placing $167 million in pure (no limited liability company monies included) TIC equity in 2001 to a projected $2 billion in 2004.

For property owners looking to sell, TIC buyers will be some of the highest priced buyers out there. But the owner should be aware that TIC buyers are not easily financed. At the Mortgage Bankers Association’s Commercial Real Estate/Multifamily Finance Board of Governors’ Meeting last February, it was reported that some lenders and special servicers/investors are opposed to TICs.

“Freddie Mac has not yet gotten comfortable with syndicated TIC structures primarily because of the bankruptcy issues, but also due to some of the variables surrounding the management of the property, the cumbersome nature of the borrower structure and the economics of the tax motivated transactions,” said Michael Meers, southeastern regional director for Freddie Mac.

TIC advocates claim that the structure offers huge advantages by allowing investors to invest in substantial, institutional-grade properties through a tax-free exchange. Since investors are freed from the management issues, they feel a price should be paid. They say investors are paying retail for these institutional properties, which are marked up by the intermediate parties, but everyone makes some money in the process.

According to Meers, "Freddie Mac has worked with limited TIC structures in the past where there are relatively few TIC borrowers, where there is some commonality among the parties, and where we believe that the borrowers are experienced and capable owner-operators of multifamily property.”

In 2002, the Internal Revenue Service set 15 requirements for TIC transactions.

“These guidelines have opened up the 1031 market and provided smaller investors with the opportunity to exchange into investment grade real estate,” said Alan Vaughn, partner of the southeastern regional accounting firm Habif, Arogeti & Wynne, LLP.

Last summer, the $148 million purchase of Puente Hills Mall in the City of Industry, California, was cited as the largest acquisition made by a TIC group to date. It was positioned as a model for individual investors to compete for major pieces of commercial real estate. Thirty-two individuals pooled $56 million in a TIC structure and Greenwich Capital committed a $92 million, 5-year CMBS loan.

Greenwich was the only CMBS lender to pursue the deal, and the $92 million loan ranked as the largest loan in the CMBS securitization pool that Greenwich assembled. Had problems arisen with the large TIC loan, Greenwich would have split the loan in two and sold one of the notes outside the pool at a higher interest rate. However, the rating agencies and GMAC accepted the full loan for the pool and the acquisition was made.

Investing in a TIC comes with a cost, and that cost is a loss of control, stated Vaughn. The individual owner has absolute control over all decisions, while in a TIC, all owners must agree on major decisions.

There are firm guidelines with TIC exchanges. The number of co-owners cannot exceed 35 and the exchange must be set up in the proper business format (LLCs have been the most successful). Investors must be certain the exchange qualifies for the tax deferral. Unless the exchange obtains a private letter ruling from the IRS, its tax status is not certain.

“We are going to see more large deals as larger properties become available,” said Marc Goldstein, principal with Creekstone Companies, a TIC sponsor in Houston. “The challenge will be that investors have only 45 days to identify their 1031 property and 180 days to complete their transaction, and there is a finite number of investors with $1 million or greater to invest in large deals.”

Goldstein adds that many investors don’t have that many gross dollars to invest or they want to diversify into more than one deal. Typically TICs collect $400,000 to $800,000 per investor and are currently filling two to five deals at any one time.

At the TIC Real Estate Symposium in March 2004, attendees didn’t agree on the loans involved in TIC transactions, which in most cases are sold through the CMBS market. It was stated that the goals of the lenders are much different than the goals of the investor and the sponsor. One lender said that TICs want it both ways — they want the ownership of real estate, but they don’t want the responsibilities of real estate.

The IRS recently issued a ruling on the tax treatment of a Delaware Statutory Trust (DST), which enables TICs to be more easily financed. However, the circumstances are narrow, for use only with triple-net leased property and certain master leases. But if a DST can be used, it protects the lender against serial bankruptcy.

“Prospectively, the Delaware Statutory Trust structure may help manage the bankruptcy risks of TICs, but the other risks remain and will need to be assessed on a case basis, including reaching a comfort level with the asset and property management experience of the TIC syndicator," said Meers.

While TIC investments have their advantages, a clear dilemma is emerging since lenders are responding slowly to finance these types of investments.

From a lender’s perspective, the issue continues to be that while investors have their names on the title, they claim to be passive and don’t have control over issues such as negligence or mismanagement of the property. The investors say they cannot be held responsible. So who is the actual borrower? And where does that leave the lender?

These issues and more will need to be hammered out among the sponsors, financial planners and lenders in the coming future.

Faron Thompson is managing director of Atlanta-based Primary Capital Advisors.


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