Tenant In Common Risks
The marketplace has seen a significant increase in the number of loans with a Tenant In Common (“TIC”) structure. One only needs to look at the classified ads in the Wall Street Journal to understand the popularity of the 1031 exchanges advertising investments from $50,000 to $5,000,000. The sponsors of the “Syndicated Tenants In Common” investments have apparently tapped a significant pool of capital for commercial real estate. While the “conduit world” is trying to accommodate the
marketplace, there are increased risks associated with this structure that need to be understood, accepted or rejected, and if accepted, priced appropriately.
There are a number of similarities between today’s “Syndicated Tenant In Common” structure and the syndications in the 1980’s that concern Centerline:
; Smaller unsophisticated investors will be a significant part of this pool of capital.
Currently Centerline has 46 loans that are specially serviced. Of that total, 26 (or
56%) are loans that are $3.5 million or less. These loans often have borrowers
who are not financially strong or who do not have a great deal of commercial real
estate experience. Problem loans with this type of sponsorship invariably take a
disproportionate amount of time and money to resolve.
; The more TIC’s, the greater the likelihood of dissatisfied investors, litigation, and
; These individual TIC’s do not know each other and may not have aligned
We believe there is a strong potential for paying too much for a property as there ;
is a tax driven component to the price, i.e., the investors are not using “100%
dollars” because of tax deferment.
; Sponsors may not have much at risk in terms of dollars invested nor have the
appropriate level of financial capacity or “hands on” management experience
relative to the transaction size. This was a hard lesson in many of the older
syndications. Many sponsors, however, are using qualified third party
management companies to address the management concern.
In addition to the above concerns, the TIC structure overlays incremental layers of risk:
; Each TIC’s credit history and financial capacity must be underwritten. When
numerous TIC’s are involved, there is an increased burden to underwrite each
TIC not only on the front end but also throughout the life of the loan because
the TIC structure allows each to freely transfer their interest, subject to the
loan documents. A fact of life is that once a loan is closed, the degree of
scrutiny is less, borrowers are often not as cooperative in providing required
information, and problems are addressed on an exception basis; therefore, the
potential for admitting a “bad borrower” into the investment is increased.
; We anticipate that we will see many loans presented for securitization before
the TIC interests are fully subscribed (or in many cases none of the interests
will be sold). In other words, we will be asked to accept a loan without
knowing who our borrowers are, without having the opportunity to
underwrite their credit history or financial capacity. The argument will be
made that with established criteria and standards, diligent sponsorship, and
required approval of the TIC’s by servicers, this risk is minimized.
Centerline is not convinced others will exercise the same level of due
diligence as B-Piece buyers, established criteria or not. Servicers do not have
the same flexibility or “stroke” as B-Piece buyers to reject questionable TIC’s.
; Centerline is concerned about the ability of the TIC structure to make capital
calls of the numerous TIC’s to address any eventuality. While this risk exists
in any real estate investment, we’re not entirely clear about the ability to
dilute a TIC interest if an individual TIC either refuses or does not have the
capacity to meet the capital call.
; Because each TIC owns an undivided interest in the real estate (multiple
borrowers), each has the ability to file bankruptcy to stay the lender’s
foreclosure action. On a worst-case basis, one could see the possibility of
having serial bankruptcy filings as a strategy. This risk alone has the potential
for significantly increasing costs (and time) to resolve defaulting loans.
Again, Centerline wants to accommodate the marketplace and at the same time address
the above concerns. Centerline is proposing that the following criteria be met in order for
a TIC Structure to be acceptable:
; Limit the TIC structures to higher quality real estate with lower leverage ; Centralized management and control
o Acceptable management
o No amendment without lender consent
o Waiver of right to terminate or prohibition against termination
; Waiver of right of partition and/or prohibition/covenant in loan documents ; TIC to own interest in single member LLC which meets SPE criteria
o More stringent requirements (e.g. non-consolidation opinion and
independent director) where appropriate, using the same
underwriting criteria as for traditional borrowing entities
o No amendment of organizational documents
; TICs to meet appropriate underwriting standards
o Quality credit history
o Must have a minimum net worth of $1,000,000
o No prior bankruptcy, foreclosure, etc. without full disclosure and
review on a case-by-case basis
; Recourse carve-out guaranties
o Sponsor recourse in his/her individual capacity for all carve-outs.
Sponsor must have acceptable financial capacity, liquidity, and
experience relative to the loan size.
o Individual TIC carve-outs for voluntary bankruptcy, involuntary
bankruptcy without dismissal, filing of action for partition,
violation of SPE provisions, attempted termination of
management, fraud, misrepresentation on part of TIC – limited
to offending TIC
; Lockbox arrangement preferred (hard or soft, depending on review of other
; Loan structured with funded reserves
o Due to the potential difficulty for future capital calls, funded
rollover reserves are required for commercial properties and
replacement reserves are necessary for all properties. ; Sponsor maintain an ownership interest
o Sponsor to retain at least a 5% ownership interest in the property
to ensure that sponsor is financially motivated to protect the
; Minimum TIC Investment of $500,000
o Serves as a limit to the number of TIC interests that can be
; Limits on assignability of TIC interests
o Assignee must meet underwriting and SPE criteria
o Assignee must execute all agreements
o Appropriate underwriting fees (1% assumption fee pro-rata on
TIC ownership basis under consideration)
o Updated opinions and title policies
; Other loan document requirements
o Centralized notice provisions
o Assignment in favor of lender of TIC agreements
o Prohibition against TIC agreement amendment