Tenant In Common & 1031 Tax Deferred Exchanges
Helping investors understand TICs & 1031 Tax Deferred Exchanges
Tenant In Common Market Growth
November 7th, 2006 by Troy
Growing Pains
October 31st, 2006
Although the tenant-in-common (TIC) market continues to rake in a staggering amount of money, the industry finds itself in the throes of some major changes. Securitized TICs alone are responsible for raising $1 billion in equity per quarter during the third and fourth quarters of 2005 and the first quarter of 2006, according to data from Salt Lake City-based Omni Brokerage Inc.
But the meteoric rise of TICs is beginning to show signs of leveling off. The amount of equity raised slipped to $908 million in the second quarter, and initial projections for the third quarter called for $890 million to flow into TIC investments (see chart).
The TIC industry has experienced incredibly rapid growth — roughly 100% per year since 2002. So, a change to more moderate growth was inevitable, say industry experts. “This is a year where we reached some equilibrium in the market,” says Marc Paul, president and founder of Los Angeles-based SCI Real Estate Investments. Paul estimates that total transaction volume for TIC properties industry wide — both securitized and non-securitized transactions — will rise about 20% in 2006 to between $15 billion and $20 billion.
Demand remains strong, particularly for high-quality properties, Paul adds. SCI recently filled the $29 million equity commitment for ITC Crossing South in Morris County, N.J., in less than 90 days. Built in 2000, the 372,789 sq. ft. center is anchored by strong credit tenants such as Lowe’s Home Improvement, Old Navy and Bed Bath & Beyond. The power center, which sold for $65 million, will deliver first-year returns of about 6%.
Buyer’s market
Even though the robust transaction volume indicates a healthy market, those numbers don’t tell the whole story. The time it takes to fully sell out a TIC investment has doubled and even tripled in the past year. As of Aug. 31, securitized TIC investments needed an average of 87 days to raise the equity capital, according to Omni. That is actually a huge improvement compared to July, when the average shelf life for TIC deals was a whopping 154 days.
Properties are sitting on the shelf longer for a variety of reasons. A jump in the 10-year Treasury yield earlier this spring coupled with incredibly low cap rates has caused investors to become cautious. The lull also is a reflection of more deals coming to the market. As of Aug. 31, there were 48 securitized TIC properties on the market — more than triple the 10 to 15 options that were the norm a year ago, according to Omni.
Another factor contributing to slower deal flow is a narrow distribution channel. “The sponsor community continues to grow at a fairly rapid pace, but the broker distribution channels have not expanded,” says Manuel A. Nogales, director of business development at Omni. Securitized TIC deals are dependent on licensed broker/dealer firms. About 60 broker/dealer firms represent 80% of the securitized TIC transactions.
Buyers are benefiting from the more competitive market with a wide variety of deals to choose from and plenty of time to make decisions. The increased competition also is expected to weed out some of the weaker sponsors and less-than-stellar TIC offerings. Omni is currently tracking 63 active securitized sponsors. Eight sponsors left the TIC marketplace during the second quarter, and five more sponsors have suspended TIC activity for the time being.
The industry-wide shakeout is expected to continue into 2007. “I think you will see a pretty stable product flow and continue to see some more of the marginal people exit the business,” says Clay Womack, CEO of Santa Monica, Calif.-based Direct Capital Securities Inc.
Calling all investors
As TIC properties continue to flood the market, the industry is clearly working to boost demand for its product. One goal is to bring more licensed broker/dealers to the table. Another option is to broaden the target client base.
So far, TICs have been fueled almost entirely by 1031 exchange investors. In 2002, the IRS issued guidance that qualified TICs as “like kind” properties eligible for use in 1031 tax-deferred exchanges. The ability to defer capital gains taxes has proved to be a huge draw. Yet other TIC attributes appear to be striking a chord with non-1031 investors.
One of the big incentives of a TIC structure is that it allows investors to buy a fractional ownership interest in higher-quality properties than what they could afford on their own. Investors also like TICs for the predictable income stream and low management responsibilities.
Initially, about 95% of the capital flowing into deals brokered by Direct Capital Securities came from 1031 exchanges. Now 15% to 20% of that equity is coming from cash investors, and Womack expects that percentage could rise as high as 40%. TICs appeal to older, more established investors who have built their wealth and are in the wealth-preservation stage.
Womack adds, “My prediction over the next two to three years is that if we continue to see quality TIC offerings and a price adjustment to where interest rates are, we will see even more cash investors.”
Source: Prism Insight
Publication Date: October 20, 2006