Investors who are trying to gain a better understanding of the finer points of the tenant-in-common structure can obtain a wealth of information in a new book titled Effortless Cash Flow: The ABC’s of TICs (Tenant in Common Properties). The author, Kathy Heshelow, is an experienced commercial real estate broker who specializes in triple-net leased properties, often for properties involved in 1031 tax-deferred exchanges. Heshelow also is a licensed securities representative with CapWest Securities Inc. Based in Florida, Heshelow works with TIC investments daily, and she is personally invested in several TICs. She spoke with NREI about issues surrounding this emerging investment vehicle.
NREI: Why has tenant-in-common ownership become so popular?
Heshelow: TICs are popular for the no-hassle, no-management aspect. TICs are usually institutional-grade, so an investor is typically stepping up in quality. TICs are also popular because of the flexibility and diversity involved. TICs also are a popular choice in the 1031 tax-deferred exchange model. Because TICs are pre-packaged — all due diligence studies have been completed, the non-recourse loan has been negotiated, all legalities have been dealt with — they are ready for an almost immediate investment.
NREI: What type of investor is poorly suited to the TIC structure?
Heshelow: First, the investor needs to be what is termed an accredited investor as defined in the Securities and Exchange Commission’s Regulation D. (Reg D sets clear rules for the buying and selling of private placement exemptions, which include TIC investments.) The investor should not be living solely on the income from the specific TIC investment, and it should not represent a high percentage of his or her net worth.
TICs are not suitable for an investor who wants to maintain control and day-to-day involvement with the real estate. TICs are not for investors who feel the need to negotiate everything. These deals are set and negotiated already. TICs are not right for short-term investors. The typical hold may be five to seven years, but reselling the building will depend on the real estate cycles, and you may end up holding the property for 10 years or more.
NREI: OK, who are good candidates for TIC ownership?
Heshelow: Investors who are tired of managing their real estate, but want to continue with real estate ownership — and all the benefits that come with it — are ideal candidates. Investors who want to diversify outside paper investments could be ideal candidates for this institutional type of real estate. Those who want to upgrade to institutional-grade real estate, and investors who might want to diversify across asset types such as office, retail and multifamily are ideal. Also, investors in a 1031 tax-deferred exchange can be ideal.
NREI: What is the potential downside of TIC ownership for investors?
Heshelow: There are real estate cycles and economic factors that can affect your investment. Real estate is illiquid, and there are unforeseen events such as a tenant going out of business and breaking a lease. Specific TIC ownership downside includes being in a group ownership format. When all goes well, everyone is happy. When there is an event, such as an offer to sell the property, perhaps not everyone agrees. The sponsor or manager will lead an orderly process, but it could happen that there are disagreements among investors who are unknown to each other.
NREI: Are TIC investors adequately recognizing and evaluating the risks?
Heshelow: Many sophisticated real estate investors know and understand the risks, but there have been quite a few investors who perhaps glossed over the risks while being excited about the benefits and ease of ownership. Certainly the PPM (Private Placement Memorandum), which is the full disclosure book covering each deal, lists the risks, potential issues and all relevant information. The registered reps and broker/dealers study the properties and help the investor evaluate these risks in order to reach a comfort zone before they decide whether to invest.
In 2002 and 2003, when the industry was just starting to grow, there might have been only five TIC deals available at any one time, and far too many people wanting in. It was a frenzy. Investors would often rush to get into a deal, which might fill up in just a day or two, and they might not have studied the investment closely. Now, there are usually about 50 to 60 deals available for investors at any one time, so there is more time to study the deals. Having said that, I can bet you that not every investor reads the PPM. They really should.
NREI: What steps should investors take when evaluating TIC properties?
Heshelow: They should first evaluate if a TIC is right for their investment personality. If they decide that they do wish to proceed, careful evaluation of the real estate fundamentals as well as evaluation of the sponsor are prime. Analyzing the TIC structure is essential. Your cash flow and payment of expenses comes from the tenant, and resale price is based in part on the net operating income and tenant income down the road.
The location of the building, demographics, and every detail about the property is important to review. Reserves are a big issue. There should be adequate reserves put aside to care for the asset and to handle unexpected emergencies.
NREI: What are the biggest challenges facing the TIC industry?
Heshelow: Sponsors have challenges finding good deals that make sense and that feed the cash-flow appetite of investors. Another challenge facing the industry is the way sponsors handle deals that go awry. The industry is harder for sponsors now. There is more competition. They must have the financial wherewithal to handle deals that might not fully close for some months. They must have the expertise to find and analyze solid offerings, and they must have the back-office client support to answer questions and provide meaningful quarterly reports to investors.
There may be other challenges facing the industry, including financial ones coming from Washington D.C.
NREI: Why do some real estate veterans perceive TICs so negatively?
Heshelow: Because TICs are sold as securities, they have front-end fees not customary in real estate. Some veterans don’t like to see these fees attached to deals. Veterans who are realtors and not dually licensed don’t like that they cannot be compensated, or broker a securities deal, or be involved in the transaction.
Another negative for veteran investors might be an association with the limited partnership debacles of the 1980s. I believe that there are differences.
Yes, TICs are tax-advantaged investments in a group format. However, in those investments the limited partners had absolutely no say in the investments. The general partner ran the show. In TICs, the investors, while passive and not involved in the day-to-day management, have a deed, rights of ownership and a say.
In the limited partnership days, the banking industry was different. Many of those deals were highly leveraged, even 100%. There are more controls on that industry today, and the leverage for TIC deals is typically 60% to 65%. However, if an investor feels very uncomfortable with any correlations to the limited partnership days, I would steer the investor away from a TIC.