Tenants-In-Common Real Estate Investments
What is a tenants-in-common real estate investment? Where did it come from? Why haven’t I seen it before in my thirty-year career in commercial real estate?
Tenants-in-common real estate investments originated in Old England in the 1600’s when
it became possible for the commoner to own land. The quality farming acreage was too expensive for the former serfs to purchase so several joined together as “tenants-in-
common” to purchase the tracts. They would pool their money and purchase the property but since land ownership was so new to them, they wanted to own the land themselves and not be obligated to others.
Investors have been able to do the same ever since but a major hindrance has existed in the United States when trying to do this type of transaction: the Internal Revenue Service. When reviewing a tenants-in-common real estate investment (TIC), the IRS has looked to see if the owners were truly independent to make their own decisions and, therefore, able to treat the property as their own or if the owners really acted as a partnership, limited partnership or a syndication. Since there were no clear guidelines, the risk of having the IRS rule that, for income tax purposes, the investment was really one of these other three ownership forms was a real danger that could totally change the tax structure of the investment.
In 2002 as a result of some creative accountants and attorneys on the West Coast requesting private rulings from the IRS to set up TIC transactions that would not be challenged by the IRS, the IRS came out with Revenue Procedure #2002-22. This Rev Proc gave 15 guidelines for structuring the investment so as to reduce the likelihood of them ruling that the investment was a different type of ownership for tax purposes.
Since this financial transaction involved a group of investors coming together to pool their money to make an investment, the security dealers saw an opportunity to create a new segment of the securities industry with a new product involving real estate which has become one of the hottest segments of the investment industry. They researched the requirements and packaged the investments as securities and began offering them.
Similarly, real estate entrepreneurs also saw an opportunity to acquire properties and sell them to investors as deeded, fractional, undivided interests just like the commoners in England. They reviewed the IRS guidelines, researched how to structure the deals as real estate transactions and started a new segment of the commercial real estate industry.
The securities dealers got a head start on the entrepreneurs and were the first to bring their product to the market. Because of the very hot real estate markets in California and the rest of the West Coast, interest grew rapidly and many more people are aware of the TIC investment there than in other parts of the country. Most of the real estate entrepreneurs began by only offering TIC’s to their private investors. Soon they realized
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that if they involved more investors, they could buy more and better properties and they could diversify their portfolio into even more types of properties and in more locations.
The TIC investment is a fantastic vehicle for purchasing high quality, institutional grade properties that the small real estate investor could only dream of acquiring because they would be competing with the insurance companies, pension funds and REIT’s. But now the “commoner” no longer has to sit on the sidelines and watch the class “A” product be
purchased by such “gorilla” investment groups, but can actually participate in the market.
These quality investments are purchased by the sophisticated corporate investors because they hold their value so well in the real estate cycles, the income is secured by the leases with large creditworthy tenants, and the locations are excellent. For the same reasons, the smaller investor would like to invest in these more secure properties rather than take the risks in class “B” and “C” product.
But this investment is certainly a major change for the investor who has been the only decision maker for his real estate. He was able to make all the decisions including to whom he would let rent his property to what color the bathrooms would be. He also had all the responsibilities for addressing changing market conditions, capital improvements, rent collections and pesky tenant problems.
The four strongest investor groups that are finding TICs to be attractive are older real estate investors, professionals, wealthy investors and foreign investors. With the rapid appreciation of commercial real estate in the last five years, small time real estate investors are now finding themselves to be real estate rich. But as they approach retirement, they find themselves trapped in aging properties that are becoming more management intensive and troublesome so they decide to reap the benefits of their investing wisdom. However, the IRS returns to the picture with two taxes: capital gains and deprecation recapture. The other alternative is to do a 1031 tax-free exchange into another property; all the while the investor is hoping that he can find another investment property and that he is acquiring a less troublesome property, with better cash flow, and not overpaying for it.
Now he has the third alternative: the TIC real estate investment. He can exchange into an interest in a TIC investment, which will be a well located, class “A” property with creditworthy tenants and large enough to afford professional leasing, management and in some cases even asset management and earning a very good return on the cash invested. Cash flow problems, troublesome property issues, tenant complaints and capital improvement issues don’t come directly to the owner. Instead, now he has competent
real estate professionals advising him of the issues and making good business recommendations as to how to handle them. In addition, he has the benefit of his fellow co-owners who will add their insights to the decision-making process. All the co-owners have invested in the TIC for the same reasons and goals: maximize cash flow and improve the value of the asset.
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For the professional who is building a career in real estate, law, medicine or whatever, he now has the opportunity to invest in solid, stable commercial real estate just like some of their high profile clients. He avoids the tenant complaints and maintenance issues interrupting his busy schedule and receives excellent advice just as he provides it to his own clients.
The third type of investor who finds the TIC transaction attractive is the well diversified investor but who lacks real estate in his portfolio. With stocks and bonds being so risky over the last five years and returns not being what we became comfortable with in the late 90’s, real estate provides for greater diversification. In addition to a return on his cash investment, he is able to benefit from the deprecation and the appreciation of the property and have some control over his investment.
A fourth group of investors that find the TIC investment very attractive is the foreign investor that wants to place cash in American real estate. Most often, they buy either condominium units or small commercial properties: apartment buildings, shopping centers or office buildings. The condominium investment requires constant cash investments for condo fees, taxes and insurance. Dealing with unprofessional condo boards of directors is a new challenge for most of them. The small commercial properties require business decisions which they may not be familiar with. They then engage local professional advice which sometimes cannot solve the built-in obsolescence of the properties purchased. The TIC investment typically covers all the costs of ownership and provides for a cash return on their investment. They have very professional advice and can learn from the input and advice of the co-owners.
Obviously, the TIC investment is not for those investors who must have absolute control over their investments. They may have been partners or limited partners in real estate transactions in the past and have found that they do not like being in the position of having little or no control over their investment. Investing on their own does limit the size and quality of the investment they can make, but they are happy to do so because they will not have to deal with other decision makers. Some investors want to invest only in the markets that either they are located in or they know well which greatly limits the number of properties that the investor can consider. TIC sponsors often look at hundreds of properties across the country to find the few reasonably priced, well located, well tenanted properties that they eventually acquire – a luxury few individual investors could
afford. The individual investor also has to front the costs of the due diligence for any properties he pursues paying for the environmental inspection, building inspection, engineering review, title report, financing fees and other costs, often only to find out that the property is not suitable for them to purchase or they must spend additional fees to make it suitable. The TIC sponsor has already paid for these costs when the TIC property is offered to potential investors so the investor gets all the benefits of the due diligence without having to pay for it (these costs are included in the acquisition price to the investor if he chooses to invest).
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The real estate industry is changing and the creation of the tenants-in-common real estate investment meets the needs of many smaller investors. The challenge today is for this investor to learn about TICs and develop a comfort level with the product to make the investment decision.
Paul L. White CCIM is Regional Director in Miami for SCI Real Estate Investments LLC specializing in tenants-in-common investments. White can be reached at (305) 279-1111 or emailed at: email@example.com.
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