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COVER STORY, NOVEMBER 2006
UP-TIC IN THE MARKET
TIC investors look to Southeast for next hot spot.
Daniel Beaird
The Tenant-in-Common (TIC) market traces its beginnings back to the West Coast with a strong base in California. Soon, the TIC market began to spread to the East Coast and is gaining a foothold in the Southeast today. The last few years have created a hot marketplace in the Southeast for TIC deals as more investors realize the potential of the region and its ideal property types, like a large number of office buildings, distribution centers and industrial facilities, for TIC deals. TICs allow investors to take advantage of the benefits of 1031 exchanges and fractional ownership of real estate, and as the deals begin to take off in the Southeast, Southeast Real Estate Business studies the ins and outs of TICs and why they are gaining steam in the region.
TIC sponsors have taken notice of the Southeast and began purchasing properties for fractional ownership and pre-packaged investments in the region. The Southeast’s commercial real estate products are attractive to TIC sponsors because most fit the sponsors’ ideal acquisition price, which is much lower than what is offered on the West Coast and in the Northeast. The TIC market also relies on small- to mid-sized commercial property assets for fractional ownership and the Southeast has plenty of this type of property.
“The market is very competitive in the Southeast, especially in the Carolinas,” says Todd Harrison, managing director of Arlington, Virginia based-Bonaventure Realty, which focuses on the multifamily market. “There is a lot of supply coming online.” According to Harrison, rents for multifamily properties had been flat for 6 years causing concessions to rise. And because of increased concessions, supply continued to grow in the Southeast.
Increased job growth in the region has also directed the real estate market. More companies are choosing to locate in the Southeast, and more office and industrial properties are needed, which creates an opportunity for TIC investors. “Deals are migrating from primary markets to secondary and tertiary markets as population and workforce grows in these new markets,” Harrison says.
Population demographics are very favorable in the Southeast for TIC investors. A significant number of baby boomers are moving to warmer climates in the Southeast to enjoy their retirement, creating more residential developments throughout the region, particularly on the coast. Cities like Charleston, South Carolina, are experiencing a rise in population for this very reason. Other Southeastern markets like Charlotte, North Carolina, and Nashville, Tennessee, are also experiencing a rise in population as some corporations have relocated their headquarters in these cities.
As more TIC sponsors recognize the possibilities of the Southeast, more TIC investors are seeking sponsors with properties in the Southeast to diversify their real estate investments. As long as they are working with a sponsor that is familiar with Southeast properties, outside investors have not been hesitant to enter the region. However, sponsors typically spread their real estate offerings across the country for significant diversification. Sponsors sell their properties through different broker dealers, many which come from a securities background.
“My best guess is that probably 80 percent of registered representatives for broker dealers have a securities background,” says Ron Raitz, a registered representative based in the Atlanta area for OMNI Brokerage. “However, you are starting to see the number of registered reps with a real estate background grow. There are more commercial real estate brokers who have decided to get involved in this particular area.” Raitz himself comes from a real estate background with a CCIM designation.
The TIC debate between real estate and securities is intricate, and the biggest difference is one of regulation. According to Raitz, the buyer must beware in real estate as brokers routinely include disclaimers that protect offering brokers and sellers from any liability concerning the presented product. In contrast, securities are highly regulated by the SEC. Those selling securities must be licensed and registered, and they must conform to security requirements. There has been no definitive ruling on TIC transactions between real estate and securities. “While there are differences in interpretation as to which structures the SEC will accept, the penalties for unauthorized securities sales are steep and commercial real estate professionals should not take this issue lightly,” Raitz says.
Another issue that investors should be aware of is liquidity options are limited with TIC deals. “Even though most TIC interests can be sold independently to other accredited investors, there is not a ready re-sale market,” Raitz says. “Also, all transactions are not created equally. Some broker dealers take a conservative approach and weed out the properties that do not make sense. Others are not as conservative and may sell investments that do not have realistic assumptions.” So, exit strategies can be tricky and may not inspire confidence as investors take on a property with other investors they may not know very well or at all.
So, while TIC transactions are gaining momentum in the Southeast and across the country, more commercial real estate professionals are getting involved in the process. But, they should be aware of all the securities laws that apply to this type of investment before they cross over to the securities world. TIC interests are not perfect replacement properties for all investors, but they do meet the objectives of certain smaller 1031 investors, who want a hands-off approach.
For the Southeast, large amounts of affordable and attractive real estate along with a strong job market have made investing in the region very accessible. As investors begin to look beyond the typical primary markets on the West and East coasts, the target on the Southeast will grow larger and larger. The region has proven its sustainability and TIC investors are relocating every day.
What Makes it TIC?
A TIC can be defined as real estate or a security. Some sponsors offer their TICs as real estate because the underlying product is property. However, other sponsors classify their TICs as securities because the sponsor provides and supervises the entire bundle of services for the investors. There is even a difference in definition between the IRS, which refers to a TIC as real estate, and the Securities and Exchange Commission (SEC), which defines a TIC as a security. However, it was the IRS’ Revenue Procedure 2002-22, issued in March 2002, that sparked interest in the TIC ownership as a replacement property for 1031 exchanges. The procedure allowed for TIC deals to be classified as co-ownerships and not partnerships. Co-ownerships allow each owner to independently cash out or execute an exchange whereas partnerships do not qualify for 1031 exchanges.
An estimated 40 percent of all 1031 exchanges involve capital amounts of $250,000 or less. TIC ownership is available for as little as $50,000, while the net lease market usually begins at $1 million. So, TIC ownership is popular for the smaller investor seeking a hands-off approach. More investors are accepting TICs as a primary choice of investment vehicle rather than an investment of last resort.
Each co-owner in a TIC must hold title to the property as a tenant-in-common under state law. The number of co-owners is limited to 35 and the co-ownership may not file a partnership return. The co-owners share in the proceeds and liabilities upon the sale of the property as well as all profits and losses. The typical co-owner, or investor, is approximately 65 years of age and has gained wealth through the real estate industry. The investor is interested in using the tax benefits of a 1031 exchange to keep his investments in real estate while shedding the day-to-day responsibilities of managing a property.
Meanwhile, TIC sponsors can range from real estate investment trust subsidiaries to ongoing real estate investment companies. A TIC sponsor puts the deal together and purchases the real estate that will be divided into individual TIC interests. The sponsor then hires an attorney to prepare all of the legal paperwork for purchase and securitization, reviews all property inspections, prepares financial projections, hires the sales force, and negotiates all leases and management services. The SEC requires that a securities broker/dealer sell property considered a security. However, each individual state has separate requirements relating to the sale of real estate and the licensing requirements. So, a TIC sponsor either hires a securities broker/dealer to sell its TIC interests or opens it up to a number of securities broker/dealers to sell the TIC interests.
— Daniel Beaird |
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