What is Tenant-in-Common Ownership?

Tenant-in-common ownership is often initially mistaken for a limited partnership, blind pool, or other real estate syndication structure common in the later 1980's.

A TIC is a deeded interest, representing a proportional interest in a specific property.  This interest has voting rights and can be purchased, sold, gifted, bequeathed by will, or inherited, and is subject to property taxes, gift tax, estate and inheritance taxes in the same manner as a sole ownership property.  The TIC owner receives an income statement for the property each year.

Why a Tenant-in Common Property?

• Simplify your estate.  The older investor in particular may worry about the ability of surviving family members to manage property, should the investor suddenly pass away.  A TIC simplifies property ownership to a triple-net check every month.  And, upon the death of the surviving spouse, the children inherit the property interest, and receive a step-up in basis.  As such, the TIC can provide a tax, investment, and succession solution to a difficult estate problem.

• Passive Management.  Many investors desire a real estate investment, but are simply exhausted by the headaches of property management.  A TIC is a viable solution.

• Diversification.  The typical real estate investor is overexposed to a local market.  A TIC offers diversification into different geographical markets, and upmarket into larger, institutional tenants with longer leases, and non-recourse financing.  The value of such diversification will become more apparent as interest rates increase and local market conditions change.

• Yield.  California investors, in particular, often suffer poor net cash flow yields as compared to the value of the property.  An exchange into a TIC property, offering market cash-on-cash yields, may mean the difference between retiring and continuing to work.

Anatomy of a Tenant-in Common Structure

The TIC industry is fairly new and very fragmented.  Many local real estate developers have rapidly created TIC structures to accommodate the current high volume of exchange money desperately searching for replacement property.  Such deals often contain highly favorable developer terms, and are indeed reminiscent of those dreadful real estate limited partnerships from the 1980's.  The sophisticated investor will closely examine the property AND the deal terms.

All TIC properties structured and sold as securities require each co-owner to be an accredited investor, defined as 1) individual adjusted gross income of $200,000 (married couple adjusted gross income of $300,000) for each of the past two years; OR, 2) net worth of $1 million.

 Real estate structure: 

• Properties are managed to maximize total return (yield plus capital appreciation)
• Sponsors historically sell a typical property within 4-7 years, upon vote of the co-owners.
• Properties are currently conservatively leveraged, ranging from all-cash deals to about 65% debt/value.
• Debt on property is generally non-recourse to individual co-owner.
• The typical TIC minimum investment is typically $300,000-$500,000.
• The maximum investment depends on size, terms of particular property.
• A TIC can be used to satisfy the entire proceeds of an exchange, or to place just the remaining piece of a larger exchange, instead of paying tax on boot.

Finance/refinance risk deserves additional emphasis.  Often a very desirable property, with a prominent tenant and long lease, may be unacceptably risky due to the bank loan terms on the property.  The best loans are amortizing, longer term, with a fixed rate of interest.  A short-term, interest-only, or variable rate loan carries considerable refinancing risk, as interest rates will almost certainly be higher in the future.  In particular, many deals offering an above-market yield will often contain such refinancing risk.

Tenant-in-common agreement

• TIC investor has voting rights, specified in Offering Memorandum
• Anti-holdout provisions prevent a small minority from thwarting the will of the majority.
• Capital calls are relative to percentage ownership.  If a co-owner cannot meet a capital call, the property manager generally will lend the investor the funds.
• Individual deeded interest can be sold at any time, subject to certain restrictions.
• Maximum number of investors allowable in any particular TIC is 35.

Property management agreement

• Property manager charges annual fee, contract subject to annual renewal
• Co-owners purchase 95%-99% interest in the property.  The property manager purchases (with their own cash) the remaining percentage.
• The deals are structured as securities, not real estate transactions.  As such, the disclosure, initially and ongoing, is exhaustive.
• Properties are marketed within a limited subscription time period.  Demand can be overwhelming for the best properties from the largest TIC sponsors.  Early planning and preparation is critical.
• The real estate sponsor is a critical component of a successful TIC venture. 

A flurry of calls over the past few weeks, from past and prospective TIC clients and brokers, prompted me to write the following piece on my approach to TIC investments in general:

1.  The sponsor is everything.  TIC sponsors have multiplied like mosquitoes on a humid summer day (there's a vision), with beautiful glossy brochuresand a brilliant management team.  However, at this point in the cycle, it is much better to pay the taxes than to trust an unknown management team with our passive investment.  I'll take a "B" property with an "A" manager any day.  A national sponsor is big enough to fill an empty building or refinance in a tough market.  A new, smaller sponsor lacks the heft (for my money) to perform in a tough market.

2.  Only buy securities.  TICs registered as private placements with the SEC are required to provide exhaustive disclosure, initially and on an ongoing basis.  And if the sponsor acts inappropriately in one deal, the SEC comes in and investigates every deal.  Wonderful incentive to behave.  Non-securities TICs, such as those offered by SCI or FOR1031, simply do not offer the protection against fraud or misrepresentation that a securities-registered deal does.  I have heard a number of sponsors have co-mingled funds and stopped distributions.  This is unacceptable.

3.  Niche properties.  Huge multi-tenant office buildings or the ubiquitous luxury apartment complex currently everywhere, contain too much macroeconomic risk.  These projects blow with the economic winds, and may perform poorly in spite of heroic efforts.  I prefer smaller properties targeted to a specific niche, which has an arguable chance for success even if real estate as an asset class does poorly.

4.  Cap rates 101.  Property in rural Montana or Arkansas is supposed to yield more.  Less appreciation potential, more risk.  Yield whores are chasing 7% properties in 10-12% markets, which will become evident in the next downturn.   A lower initial yield in a better market will have a better back-end, and offer higher probability of greater total return.

Many clients I have spoken to are making rapid and ill-informed investments strictly to meet the 45 days.  Particularly smaller investors with $50,000-$200,000 to re-invest.  If the investor is not sure about a TIC, or is unwilling to trust you or do a little homework, better to pay the damn taxes.

Financing the Care of a Disabled Child
By Mohammed Hadi

The Wall Street Journal
February 4, 2007 

Parents of children with severe disabilities can turn to their doctors for medical advice, their religious leaders for spiritual guidance, and their communities for encouragement.

They should also turn to a financial adviser and an attorney to create a lifeline for their child.

This is especially critical for families of children who are unlikely to be able to support themselves as adults and who may never be able to live independently.

While family needs vary widely, on average parents need to accumulate $350,000 to $400,000 to ensure that personal care will be provided for the rest of such a child's life, says Chris Sullivan, manager of special-needs financial services for Merrill Lynch.

Mr. Sullivan's program works with clients whose children are in "very severe situations," such as severe cerebral palsy and severe autism. Such families need considerable savings, he says, because "it is now very common for a disabled child to live another 40 or 50, or sometimes 60 years."

Planning for a disabled child's future isn't just about saving enough, though. There are also pitfalls to be avoided, and opportunities for parents to create some peace of mind for themselves.

Disabled individuals typically receive benefits from the federal and state governments in the form of Supplemental Security Income and Medicaid. Without such assistance, a family's savings would need to be far greater. Families can use a "special needs trust" to provide additional dollars for a disabled individual's future care without threatening those government benefits.

It's Easy to Mess Up

But loved ones with the best of intentions can inadvertently disqualify a person for disability benefits. That's because it takes only $2,000 in assets in the child's name, rather than that of the trust, to lose government benefits.

"Oftentimes, unintentionally, the grandparents will make out a will that makes a direct contribution to the child," says Mr. Sullivan. "That will create a calamity for the parents because it will automatically disqualify the child for government support."

Despite these complications, many parents of disabled kids aren't seeking out the proper advice, says Joyce Gordon, a vice president of the wealth strategies group at MetLife. In a 2005 survey, MetLife's Division of Estate Planning for Special Kids found that 88% of such parents have not established a special-needs trust, and nearly a third have made no plans for how to provide for their kids after their own deaths.

Pain…But Also Comfort

Ms. Gordon speculates that parents want to put off difficult decisions — such as choosing a guardian for the child — and she notes that these tough decisions are only "compounded by all of the stress they are under."

That said, actually making a plan — often including a letter of intent spelling out day-to-day details as simple as the child's preferred brand of toothpaste — is "going to provide the security that they need when thinking about that child's future," Ms. Gordon says.

Both Merrill Lynch and MetLife offer free consultations with their special-needs financial advisers. These and other financial firms can make money charging fees to develop financial plans, managing assets in special-needs trusts, and selling life-insurance policies to provide a lump sum upon a parent's death.

To be sure, parents trying to finance the care of their child 30 or 40 years from now have time on their side. Sometimes, what's more difficult is finding money for immediate expenses.

"One of the problems is that when you need the money — when the child is young and you need all those extra services — you don't have it. And when you have it, and the child is older, you don't need it," says Emerson Dickman, a special-needs attorney in New Jersey whose son was born with Down syndrome.

Mr. Dickman recently created a group, the Dickman Consulting Alliance, to provide parents and others with resources on special needs.

Ask For Help

What can hard-pressed young parents do to meet their immediate financial needs? Mr. Dickman offers a suggestion from his own experience: Ask for help.

Mr. Dickman says he and his wife "didn't have enough money for the speech lessons that my son needed." So he asked a local fraternal organization to pitch in.

"We asked for charity because when you have a child with a disability, you do things for them that you would not do for yourself," he says. "And that's what these groups are there for. They want to help."

It's a better option than jeopardizing your financial security.

"We have families who sell their houses, who take out second mortgages or cash in IRAs to pay for their children's therapy," says Alison Singer, senior vice president at Autism Speaks, a group that raises funds for research and advocates for autistic children.

Ms. Singer, whose 9-year-old daughter is autistic, notes that therapy for autism, which can cost thousands of dollars a week, isn't typically covered by insurance. "When parents have a child that is diagnosed with autism, it's a double whammy," she says. "First, they are hit with all of the emotional issues associated with having a child with disabilities and then they are told that they have to pay for the treatment themselves."

A little research might turn up some unexpected sources of funds, though. The state of New Jersey, for example, has a program called the Catastrophic Illness in Children Relief Fund that helps families foot medical bills.

The New Jersey program gives away about $8 million a year and the awards are based on financial need, says executive director Ralph Condo. (Go online to nj.gov/humanservices¹ and click on "Disability Programs.")

The fund is unique to New Jersey, Mr. Condo says, but other states and the federal government have expressed interest in creating similar programs.

Private annuity trusts are a highly specialized tool that have been over-marketed as a tax strategy to owners of appreciated real estate.   Financial planners love them because the technique involves, to oversimplify, a tax-deferred exchange from real estate to a portfolio of securities.  And, of course, financial planners want to manage that portfolio.

Repositioning investment real estate is a two-part process:  tax-deferral on the property just sold, and reinvestment of the proceeds into a new asset.  In my experience,  clients tend to focus on either one or the other, or often confuse the two parts.  For example, I am often asked if a private annuity trust can invest in real estate.  The client wants to avoid taxes, but prefers another real estate investment.  The more appropriate question is:  if the objective is tax-deferral and reinvestment in real estate, is the private annuity trust the proper tool?

 A private annuity trust is an exit strategy for someone who wants to cash out of real estate, and "exchange" into stocks and bonds.  The tax deferral requires creation of a trust (cost and potential complication), and produces an income stream from the securities portfolio, requiring competent asset management (potential cost and uncertainty).

The investor who prefers a tax-deferred exchange from investment real estate to investment real estate does not want a private annuity trust.  They want a 1031 exchange.  The IRS tax-deferral rules are straightforward, and real estate is a familiar investment vehicle.  The advent of the TIC industry has been a particular boon to investors seeking an estate planning tool that offers a tax-deferred real estate investment without management responsibilities.

A private annuity trust may arguably have a role in the sale of a multi-million dollar personal residence, in which the capital gain far exceeds the $500,000 (for married couples)  personal residence exemption. However, all such strategies are currently on hold until final resolution by the IRS and the Treasury.

The Tenant-in-Common industry has exploded since the IRS clarified the guidelines for a 1031 exchange.  Each year, an increasing volume of TIC properties are marketed through the securities industry to individual property owners.  Investors have responded en mass as replacement property is sought within the 45-day identification period.

TIC industry participants believe the tax-shackled investor now has a compelling alternative for yield, diversification, and relief from active management.  Other real estate professionals accuse sponsors of overselling fee-laden property through unschooled brokers eager for a commission.

Why we diversify

Money managers counsel diversification for the prudent investor, as every asset class is influenced by ever-changing economic and market cycles.

In some respects, real estate is unique.  It is inherently risky and illiquid.  The dollar cost is quite high.  It is often leveraged.  Such capital-intensive investments are particularly vulnerable to macro-economic conditions, i.e. those outside our control.  

When the economic winds blow in our favor, it can be wonderful.  When the winds change, it is not.  And the tax law offers compelling incentive to reinvest our capital gains into more real estate.

In every market cycle, there is a time to take risk, and a time to protect capital

Many investors now have the predominance of their net worth in a single asset class, often in a specific geographic location.

Real estate – they’re not making any more of it.  Maybe not, but even the most passionate investor must anticipate the inevitability of rising interest rates and the effect on property valuations.

Simply another tool

Wall Street designs financial products to address investor needs.  In this respect, a TIC is no different than a mutual fund or REIT.

A mutual fund or REIT has broad managerial discretion.  A TIC is far more transparent and offers more control to the investor.  All fees, terms and conditions are fully disclosed, including property issues, tenant and lease terms, financing terms, etc.  The owners vote on all material decisions, including the annual management contract of the sponsor.

Dozens of TIC sponsors now offer a multitude of properties.  Many are quality properties from reputable firms, many more are not.  As in any investment, due diligence and even common sense are still required.

Strategic application

Money managers diversify by balancing risk and reward among many asset classes, and often engage other managers to access expertise in different market segments.

The property owner has significant tax incentive to reinvest in real estate, but the necessity for diversification remains the same.  

As such, a TIC may be a preferable alternative to sole ownership or a local partnership.

•    A national sponsor may be in a more favorable position to re-lease or refinance.
•    Institutional properties may offer more stable value in a difficult market.
•    Annual net cash yield may prove more certain than capital gains.
•    Relatively small investments can be diversified in many markets.
•    No lender recourse, no management.

Other basic investor goals are also addressed:

•    Simplify estate.  Property ownership is simplified to a monthly triple-net check.  Children inherit property interest, receive step-up in basis, providing a tax and investment solution for difficult estate problems.
•    Passive Management.  Many investors are simply exhausted by the headaches of property management.
•    Yield.  California investors, in particular, often suffer poor net cash flow as compared to the value of the property.