COVER STORY, FEBRUARY 2006

TIC INDUSTRY HERE TO STAY
A number of measures are being taken to ensure the viability of the emerging tenant-in-common market.
Brian Eliason

The tenant-in-common (TIC) industry seems to be growing up quickly. Increased numbers of sponsors, deals, brokers and buyers, coupled with more equity and more exposure, have established the TIC market as a viable investment tool in the real estate market. However, there has remained some degree of skepticism within the commercial real estate industry as to the viability of the TIC market. Since 2001, the structured tenant-in-common market has grown more than 100 percent year-over-year, from approximately $160 million of equity raised in 2001 to more than $4 billion of equity in 2005. This huge growth can be attributed mostly to the issuance of Revenue Procedure 2002-22 by the IRS. This procedure gave sponsors 15 guidelines outlining how a deal should be structured in order to not be classified as a partnership, thus allowing investors to purchase TICs with 1031 tax-deferred exchange funds.

This huge growth could be viewed by outsiders as a frenzy, where there have been more buyers than sellers. However, today there are approximately 60 sponsors that are actively in the business of bringing TIC properties to market, and there are approximately 30 TIC deals currently on the national market. The market has come much closer to equilibrium, and buyers can be much more discriminating when choosing a deal and a sponsor.

There are three factors that can possibly make this investment tool the premier vehicle for purchasing and owning institutional grade real estate in years to come: Tenant-In-Common Association (TICA) and Best Practices, quality sponsors, and NASD (National Association of Securities Dealers) and SEC (Securities and Exchange Commission) involvement. These factors are leading the industry to complete better deals, establish safer investments for real estate owners, and ensure the continued involvement for real estate brokers for a long time.

TICA and Best Practices

The Tenant-In-Common Association is an organization that was formed by TIC sponsors, securities broker-dealers and tax specialists in order to have a national lobbying presence to ensure the viability of the industry, and to provide a healthy exchange of information for the benefit of investors, sponsors, and broker-dealers. TICA conferences are held twice per year, where there is always healthy debate on topics ranging from what types of deals are being offered to what the best structure is and what type of financing is available.

TICA has been in the process of endorsing a Best Practices memo that has been debated by the sponsors and the broker-dealers. The document outlines the process for bringing TIC deals to market, finding customers and closing transactions. What is revolutionary about this Best Practices memo is that it has been looked at and discussed by players on all sides of a TIC transaction. Tax lawyers, accountants, securities broker-dealers and sponsors, all with different goals and incentives, have come together to settle how these deals should be put together and distributed, keeping the real estate investor at the forefront of every conversation. If investors are treated well, the industry will survive.

Quality Sponsors

Many sponsors in the TIC industry have been in the real estate business for a long time and have gone through the days of limited partnerships, recessions and regulatory changes — and they really do not want to experience those tough times again. The fear of deals going badly has put considerable constraints on loan-to-value ratios and the types of deals that are being done. There will always be questionable deals in a billion-dollar market such as this one, but overall the TIC industry is quite selective when it comes to offering property. The product typically offered to TIC investors is institutional, Class A quality, with high-growth potential and solid credit-tenants.

The typical loan-to-value ratio in a TIC deal is between 50 and 65 percent, which is low given today's interest rate environment and lenders' willingness to invest capital into real estate. TIC players like the extreme safety of these low loan-to-value ratios. Everyone involved is happy if investors can get a 6 percent cash-on-cash return with relatively low risk. Transactions can be completed with no management headaches, as investors can piggyback on the management expertise of the sponsors and third-party management companies. Some structures include a master lease, where the investor net leases the property back to the sponsor to protect against any operational risks of the property.

NASD and SEC Involvement

TIC deals are predominantly sold as Reg D Private Placement Securities. There has been considerable debate within the industry whether or not these deals must be issued as securities, but currently, most deals are. In real estate vernacular, this means that sponsors are not allowed to pay commissions to real estate brokers for referring customers. Because many sponsors feel that they need to issue the TICs as securities, most TIC deals fall under the SEC and NASD radar screens. The essence of both of these organizations is disclosure, which is of great value to the customer.

The Private Placement Memoranda (PPMs) that are distributed to potential investors disclose everything the sponsor knows about the real estate and the deal. If something is omitted, the penalties for the sponsor are dire, much more so than in a typical real estate deal. As such, sponsors as a group are interested only in completing high-quality deals without significant challenges. In TIC deals, the popular phrase is “disclosure, disclosure, disclosure,” not “location, location, location.”

Regarding the dilemma surrounding real estate commissions, sponsors would love to pay real estate brokers commissions because they have the relationships with the owners of real estate. Unfortunately, the SEC does not allow this. Regardless, real estate brokers still need to understand the TIC market in order to give their clients the best information. Instead of pushing sellers of real estate away from a TIC because there is no commission on the purchase of the TIC, brokers need to have a bigger picture in mind. If the customer is happy with the TIC investment (deferral of taxes, cash flow with no headaches, and minimal risk), then there will be more property sold, more referrals, and many more listings available for the broker to sell.

Also, TIC sponsors are significant buyers of high-quality real estate. Usual closings take place within 45 days (30 days for due diligence, 15 days to close). Financing is typically not a problem because most sponsors are reputable and experienced real estate players. Sponsors are also repeat buyers; many sponsors purchase hundreds of millions of dollars of real estate every year. Often, if a broker can establish a close relationship with a sponsor, the broker will be able to be paid commissions on a few deals every year. With an average deal size of $20 million, the commissions on the purchasing side of the business really add up.

The TIC industry is here to stay. The industry as a whole is making the right moves to ensure a lasting future. Through TICA, quality sponsors and heavy regulation, the TIC market has established itself as a viable mainstream investment, while keeping the real estate broker community well served for a long time.

Brian Eliason is CEO of St. Germain, Wisconsin-based Eliason 1031 Properties Corporation.

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