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
1031 Exchanges: Keep your real estate profits for investment in new properties
November 7th, 2006 by Troy
1031 Exchanges: Keep your real estate profits for investment in new properties
Original Publication: Monday, October 9th, 2006
Investors are turning in growing numbers to Section 1031, an 80-year-old-plus part of the Internal Revenue Code (IRC), to defer taxes on commercial real estate properties where prices have jumped in recent years. Rather than selling outright and getting hit with a large tax bill, they are instead trading into another property to defer the tax bite well into the future — perhaps indefinitely.
“A 1031 tax-deferred exchange is a powerful tax deferral strategy,” says Jeffrey Cederberg, from the New York office of CapWest Securities, Inc. “Taxpayers should never have to pay capital gains tax on the sale of investment property if they intend to reinvest the proceeds into similar or like-kind property.
“With the 1031 exchange, you defer three things: federal capital gains tax, state capital gains tax and depreciation recapture. If you ‘swap ‘til you drop,’ upon death your heirs will inherit the property at its market value — the capital gain is erased — so it is an effective estate-planning tool.”
Given the clear benefits of the 1031, it is gaining in popularity. “Our pipeline of 1031 requirements continues to be active as the sales market has continued to be vibrant,” says Kenneth L. Zakin, senior managing director of Newmark Knight Frank’s Capital Group in New York.
“The objective to defer gains taxes and to trade into replacement properties goes on unabated, and we have solidified our role as one of the most active providers of such advisory services in New York.”
Chad Brue, managing director of the private client group of CB Richard Ellis (CBRE) in New York, concurs. “Activity from 1031 exchange buyers remains very strong throughout the country, and is elevating commercial property values to new highs due tothe aggressiveness of this buyer type,” he explains. “CBRE’s unique access to 1031 exchange buyers through our proprietary database ensures that the sellers we represent will achieve top dollar for their property.”
The Qualified Intermediary
IRS rules for 1031s are exacting. “The taxpayer cannot receive or constructively receive any of the proceeds from the sale of the relinquished property; otherwise the proceeds are taxable as ‘boot’,” according to Marie Flavin, Northeast regional manager, IPX 1031, in Armonk, N.Y. “Boot” is any non-like-kind property received in a 1031 exchange. Therefore, the taxpayer will require the services of a Qualified Intermediary or QI: a third party, unrelated to the taxpayer, who participates in the 1031 exchange and holds the money from the sale of the property in escrow.
To find a QI, Dennis P. Helmick, president, Exchange Facilitator Corporation in Seattle, Wash. and president of a trade association of QIs, the Federation of Exchange Accommodators (FEA) in Philadelphia, Pa., suggests clicking on the association’s web site at www.1031.org, which lists hundreds of QIs around the country.
Margo Mucha McDonnell, president and CEO. of the 1031 Corporation in Royersford, Pa., co-chaired an FEA committee that helped create a nationwide qualification program to certify QIs. “Many people do not realize that our industry is unregulated. You need to look at the company’s credentials. One way to choose a QI is to ensure that there is a Certified Exchange Specialist® or CES® on staff.”
People who have been growing their retirement nest egg by investing in and renting out real estate need the absolute correct information regarding 1031 exchanges. A highly experienced QI can be invaluable in this role, stated Bettye Matthews, president, Exchange Professionals in Westminster, Md.
“The taxpayer should choose the exchange accommodator carefully,” warns Lori DeMartini, president, OREXCO, of Oakland, Calif. “There have been many cases of embezzlement and bankruptcies among exchange accommodators. There are hundreds and hundreds to choose from. Make sure the exchange accommodator is reputable, bonded and insured.”
Selecting a Replacement Property
A critical step to successfully completing a 1031 is to find a suitable replacement property. Many helpful resources can assist in this. For example, Alan Fruitman, president, www.1031tax.com in Denver, Colo., manages a database of single-tenant, triple-net-lease properties and shopping centers for those undertaking 1031s. The list is constantly updated by 25,000 brokers, sellers and developers from around the United States.
Time is of the essence in 1031s: from the time the initial property is relinquished, a new one must be identified within 45 days and the deal closed within 180 days. In a real estate1031, as long as the replacement property is used in business or held for investment, raw land can be replaced with a shopping center or a warehouse with apartments. Another replacement option is a single-tenant, triplenet-lease property. The great benefit of a triple-net-lease or simply net-lease property is that the tenant is obligated to pay all expenses of the property being leased as well as the rent.
While triple-net-lease property is a highly desirable 1031 replacement choice, not everyone can afford the price tag. For the smaller investor, a tenant-in-common (TIC) property could be a good alternative. Ryan Bristol, CEO of PropPoint in Santa Monica, Calif., is a consultant to the 1031 market. He points out that with the TIC, a taxpayer can exchange a property for fractional ownership in an investment-grade property owned with other 1031 investors. Dan L. Werry, managing director 1031 & TIC Investments of Minneapolis, Minn., agrees: “If an individual sells a property for between $300,000 and $600,000, we would typically recommend a tenant-in-common ownership. The reason is that they have an opportunity to buy into high-quality, institutional-grade real estate that they would normally not be able to. The credit quality of these tenants can be very high.”
Naturally, before exchanging one property for another, investors must not only research the new property but also those with whom they would do business — particularly if theyare investing in a TIC. Richard Kaplan, president, Syndicated Equities, Chicago, Ill., said that investors must find someone they can trust — and feel comfortable working with. “The most important research is the track record of the sponsor. One place where people get hung up is that they pick a TIC sponsor, they identify one of its properties to trade into, and then the TIC sponsor does not consummate the transaction. We are proud to say that we have never had a person not complete a trade because we did not close on a property.”
Another option, suggests Peter J. Behr, vice president of investment property sales, Trustreet Properties, a real estate investment trust (REIT) located in Orlando, Fla., is to look into the benefits of investing in restaurant properties. “We are the single largest REIT focused on the restaurant sector in the United States, with over $2.5 billion in assets. We have over 2,000 restaurant properties in our portfolio — including over 170 concepts and 500 tenants in 49 states.
This advertising supplement is sponsored by participating advertisers. The material was prepared by Ron Derven and did not involve the reporting or editing staff of The New York Times.
Source: New York Times
Publication Date: 10/02/2006
Beware of Tenant-in-Common schemes with 1031 Tax Deferred Exchanges
October 30th, 2006 by Troy
The article below was written in April/May of 2003 back when TICs as 1031 tax deferred exchanges were still extremely new. I feel that the industry has regulated itself quite a bit and weeded out the undesirables. However, the majority of the article still contains solid information.
Troy Remelski
The market for fractional ownership of commercial real estate (popularly known as Tenants-In-Common or TICs) is expanding its reach – and look out!
These new ownership programs allow individuals, who normally may not have access to the institutional real estate market, to buy interests in large scale commercial real estate. In March, 2002, the IRS released Revenue Procedure 2002-22 which set forth the conditions and guidelines under which the IRS will allow a small group of single owners to invest into large real estate projects such as: office buildings, apartment complexes, shopping centers, even the neighborhood Wal-Mart store. But there are some inherent drawbacks, such as no established secondary market for selling your TIC interest, resulting in a less liquid investment.
As soon as the ruling came out, TIC promoters began appearing out of the wood work. It sometimes seems as if a new promoter climbs out from under a rock every day. It has gotten so bad that at times it feels like the old tax shelter days from the early 80s. I’ve been helping clients with taxes and investments my entire adult life, and I’m always amazed that when it comes to paying taxes, a person’s common sense and normal sense of caution are immediately forgotten.
It’s time for investors to put the brakes on and approach these schemes with caution. Let me discuss the ruling first, and then I’ll tell you how to avoid the pitfalls.
First, the ruling merely sets forth the guidelines for applying to the IRS for approval. It does not give automatic approval to these types of schemes, a fact that most promoters gloss over. In addition, each investor must hold fee simple title to their interest. This makes them a tenant-in-common with the other investors. You are not allowed to hold title as a partner in a partnership, or any other investment entity set up by the promoter. Yet I’ve seen a number of deals where the lender requires the property to be held by a single asset entity, which forces each investor to become a part of the lender’s single asset entity to obtain financing. Either the developer claims that this is OK’d by the ruling (which it is not), or they have the investor take fee simple title and then immediately flip that interest into the lender-required single purpose entity, which is also fatal. (Remember, for a successful 1031 exchange you cannot immediately sell or change how the title is held – or the exchange will be disallowed – saddling you with taxes, interest, and possibly penalties.)
The ruling also requires that each investor have the right to sell their unit without restriction from the other investors, and must annually approve the promoter’s management agreement. Yet again, I’ve seem some deals in which the investors can not get out of the project for a minimum length of time, some where they must sell back to the promoter, and many where there is no way to get rid of the promoter. These, too, can be fatal flaws.
The list of problems goes on and on, but I think you get the drift. So how do you protect yourself? First and foremost, use common sense. Ask yourself: “If this is such a great deal, how come they need a little investor like me to make it work? Why didn’t the promoter just buy the property themselves?” I know one large promoter that is owned by a real estate company. They buy a building from the seller thereby earning large real estate commissions. Then they sell the building at a marked up price to TIC investors, earning a large profit and more commissions. Their management division manages the property which earns more fees. And they even have a 1031 intermediary division, which earns more fees and interest for handling the transaction. Who pays for all of this? You do!
The other problem I have with most of the promoters is that they push only one product. For example, they only sell office buildings built by one builder and managed by one management company. When you look at their TIC program, you only see their products with nothing to compare it to. You have no way to compare the cash flow or appreciation history of their product to that of similar properties with another promoter, or a different type of investment.
Some promoters offer a smorgasbord of investment opportunities and have schedules that compare the different products so you can zero in on the one that is best for you. An experienced 1031 exchange specialist should be able to guide you to some of these alternative TIC promoters. Do your homework and use caution before you invest in one of these schemes.
By Gary Gorman,
Beware of Tenant-In-Common Schemes with 1031 Exchanges
Can I do a 1031 tax exchange of Real Estate into a Tenant In Common TIC being sold as a security?
October 26th, 2006 by Troy
Can you sell your real property and do a 1031 tax deferred exchange into a securitized Tenant in Common (TIC) Property?
The answer is…Yes…at the moment. For quite some time the rule of the 1031 tax exchange required someone to exchange similar investments. ie. real estate for real estate OR security for security. This was never an issue until 2002 when the almighty IRS began allowing a TIC purchase as a viable means of a 1031 tax exchange on investment property as a way to defer capital gains taxes on real property. Many TIC properties are securitized, however, they are real estate. Because they are real estate the tax deferred exchange is allowed and you won’t have to worry about the IRS knocking on your door.
However, this has been a source of several questions over the past few years and this ruling could ultimately be changed. Therefore, please be sure to ask your CPA or Real Estate Attorney what the current ruling is before considering a securitized TIC as an option for your 1031 tax exchange.
To buy into a TIC or not to buy into a TIC
October 24th, 2006 by Troy
To Buy into a TIC or Not — That is the Question
by Clifford A. Hockley
As baby boomers get older and closer to retirement, and the stock market continues to underperform, many investors have been driven to real estate investing. This demand has created a ‘boomlet’ that has significantly increased the pricing, and thereby the purchase cost, of real estate in many parts of the United States.
At the same time many investors are tired of being “hands-on” with their investments. This has created a significant desire to give someone else their money, letting others manage their real estate investments while waiting for the monthly check.
The combination of age and lack of desire to manage has created significant demand for single tenant investment properties like, post offices, medical buildings, restaurants, banks, etc. where you are the sole owner. This also holds true for Tenant in Common (TIC) investments in which you share ownership with others. This demand is particularly driven by investors selling an existing property and wanting to use the 1031 tax deferred exchange mechanism to trade into another property.
Such pressure in the market has energized sponsors who assemble properties and investors. Typically they select properties and then assemble a group of investors that must hit a drop dead date to close their sales.
These sponsors are similar to the entrepreneurs who assembled syndications in the 1980s to share tax benefits and depreciation. Nowadays the model is more robust and banks are much more demanding before they lend money.
Due Diligence
As investors place their money with TICs, they need to consider asking some hard questions. We have assembled some below for you to consider:
Are the sponsors reliable?
Does the sponsor (and/or its principals) have a track record in TIC’s (how many TIC’s have they done) or at least a track record in commercial real estate?
Does the sponsor have an organization, staff and infrastructure to properly close the transaction (if not already owned by the sponsor) and manage the TIC?
How long projects are typically held?
Does the sponsor already own the property, or will it close on the property with the TIC investors’ funds?
What is the closing date (if not already owned by the sponsor) and what is the sponsor’s ability to close if the offering is not fully subscribed (remember, if you are a 1031 Exchanger, you must identify within 45 days and closed within 180 days)? What kind of deal structure is being implemented?
Is this a real estate investment or a security?
Who manages the properties?
Is there a master lease (sponsor, or an entity formed by the sponsor, that leases the property from the TIC’s and then subleases to the tenants) or is there a management agreement?
Deal Structure
Is this a real estate investment or a security?
How does the sponsor make money? Do they charge an asset management fee?
Are there upfront charges?
What are the closing costs (almost all TIC investment properties have closing costs, and some are more than others)?
Do the TIC owners get the appreciation on the sale of the property?
Do they share the upside with the Sponsor?
What is the total “equity raise”?
How much of the offering has already been bought by investors, how much is left and how long has the offering been on the market?
How much money are you trying to raise over what time frame?
What is the “load” (percentage and dollar amount) the sponsor is placing on the property? (In other words, how much is the sponsor marking up the property for resale to the investors), and what is the sponsor’s purchase price and the total sale price to the investors?
Does the sponsor have an appraisal for the property, and is it higher or lower than the sponsor’s purchase price and the total sale price to the investors?
What is the TIC investment property purchase minimum? (Some are below $200,000 and range up to over $1 million.)
Risk to investors
Are the loans non-recourse to the investor? Who has first right to buy the shares? Investors? TIC Sponsor?
What is the long term exit strategy to the TIC sponsor? If a key employee of the sponsor gets ill or retires what happens to the investments? Who takes over?
Are there any major tenant lease expirations or exits during the projected holding period and, if so, what reserves are being set up for down time and new tenant improvements?
If I need to sell my share of the TIC investment, how is that done?
What kind of return is being forecasted?
(Cash on Cash) Cap rate? What is the purchase cap rate and what is the cap rate for sale of TIC’s to the investors (”loaded cap rate”)?
What is the projected exit cap rate (when the property is resold) and is it larger or smaller than the purchase cap rate and the loaded cap rate and, if smaller, does the sponsor believe the property can be sold at a cap rate lower than the other “going in” cap rates and, if so, why?
Why did the sponsor choose the property out of the hundreds most sponsors look at before making a decision to buy?
What is the “play” (In other words, is the property a one credit tenant occupied triple net property with a long term lease thereby providing a stable return to investors, is it in an improving area where the sponsor thinks values are increasing, is there some vacancy the sponsor thinks he can fill and thereby increase returns, etc. What was the strategy)?
What are the demographics of the area in which the property is located (population growth in the area where the property is located, declining or improving area where the property is located, competition, surrounding rent rates, etc.) and is the market area a primary, secondary, tertiary, etc?
When was the property built and, if applicable, when was it renovated, and is there any deferred maintenance (roof condition, paint, HVAC, parking lot, etc.)?
What is the amount of mortgage being placed on the property by the sponsor (loan to value ratio or LTV)?
Is the mortgage interest only, what is the interest rate (and is it variable), is it amortizing, when does it mature, etc. (and is there a refinancing anticipated during the holding period before resale)?
Is the property located in a high or low income tax state?
Is the property residential (greater depreciation deductions) such as apartments or non-residential like office, retail and warehouse/industrial or land?
Do the pro-forma projections for operation make sense (look out for overly rosy occupancy and rent increase projections, declining costs projections, etc., but these things can differ depending upon the “play”, etc.)?
How do rents compare with similar properties in the area (market rent) and how does vacancy compare with similar properties in the area (market vacancy)?
What is the Exit Strategy?
Typically between five and seven years, but can go out ten years or maybe longer.
Understand the dissolution clause of the TIC.
For all of these investments there are requirements for unanimous consent of the TIC members. How this is achieved is different in each TIC. You typically need some sort of unanimous consent to allow for the dissolution and sale of the TIC’s assets . You must understand this clause and be comfortable with it before entering into a TIC investment.
As you can see from this list of questions, as an investor, you want to avoid cash calls, as these are complicated investment vehicles. A strong reserve fund is important. In addition I prefer investments that are of a retail nature.
In my mind the most important things to consider are as follows:
The strength of the sponsor
The track record of the sponsor
Your return on investment
The risk of the deal
Your exit strategy
Summary
For all of these investments there are requirements for unanimous consent of the TIC members. How this is achieved is different in each TIC. You typically need some sort of unanimous consent to allow for the dissolution and sale of the TIC’s assets. You must understand this clause and be comfortable with it before entering into a TIC investment.
These investments can be great. Many people have had favorable results pooling their funds with other investors, but some of the organizations are so deal driven that making deals drives transactions rather than the best return on investments.
Multiple tenant office TICs make me more nervous. Some TICs are designed with a lease-back component in which the sponsor takes the risk of the tenants paying their rent and guarantees specific return to the investor. This might be a successful formula to get around the risk of buying an office building.
Just like any investment you make, it pays to take the extra time to check out the investments and the sponsors before you decide to invest. Sponsors that use the securities vehicles to sell their investments deliver a massive amount of information. I would encourage you to read it.
It is definitely worth the look and to compare them to other investments — especially if you don’t want to manage your property (or the property manager) any longer. But please read the fine print!
Published: September 27, 2006
www.realtytimes.com