The Common Way

The Common Way

Real estate trend by Rod Thomson | Executive Editor

A new and mostly unknown method of commercial real estate investing, tenants-in-common, is exploding thanks to an IRS ruling and strong demand.

There are always new wrinkles in the ever-evolving real estate market. But one of those wrinkles has been doubling its growth for the past four years and offers the potential to bring or keep more money in real estate along the Gulf Coast.

Tenants-in-common, or TIC, is perhaps the hottest new trend in commercial real estate investing, if you have the net worth to qualify. About $357 million in equity in TIC deals were closed in 2002. This year, nearly $5.5 billion will be closed, according to Omni Brokerage.

Despite that eye-opening growth, TICs aren't well known. And of course, $5.5 billion makes up only a fraction of the nation's annual $275 billion market in commercial real estate sales.

TIC arrangements allow individual investors to pool their money to buy commercial properties and other large real estate holdings. Each investor owns a piece of the real estate and gets all the pros and cons of real estate ownership - with the huge exception that these investors do not have to worry about property management. This allows people who do not have enough money to actually buy a shopping center or an office building to still invest in one. And it creates an investment avenue for people who may have the finances, but simply do not want all the management headaches.

"It's attractive to many investors today who do not want to manage property," says Kathy Heshelow, a TIC specialist based in Pinellas County. "They can sleep at night and let someone else deal with the tenants."

The average annual return on the investment is 6-8% until a sale, when any equity created during the investment years is divvied up.

Everyone in the industry has seen the explosion of growth.

"It's a wonderful way to get real estate into a portfolio," says Jefferson Riddell, a Sarasota lawyer and TIC specialist. "It's the busy man's way to get into real estate."

Two primary factors are fueling this growth: Demand and a 2002 IRS ruling.

TICs have been around for a while, but most investors were hesitant to plunge in because they feared that it would be viewed as partnerships by the IRS, which could create a substantially larger tax burden.

In 2002, the IRS officially labeled TICs real estate and not partnerships. That made them much more attractive to investors for tax purposes and also qualified them for the popular 1031 real estate exchange - a significant tax shelter. The 1031 IRS law allows investors who sell real estate to defer capital gains taxes by plowing their equity from a sale into more real estate. In 2002, TIC investors qualified for that shelter and the floodgates opened.

But the demand was already there from the second driving fuel.

A considerable percentage of the investors are baby boomers that have invested in real estate and are ready to dump the sweat-equity portion of owning and managing property and still reap the primary benefits of the investment. But most TICs are created under the auspices of securities dealers and follow Securities and Exchange Commission rules.

TICs are passive investments. The return is going to rest largely in the hands of the "sponsor," the organization or individual that puts it together. That is why most are securities and done by securities dealers. (Both Heshelow and Riddell have securities licenses.)

To even qualify to invest in a TIC, the individual must have a net worth of at least $1 million and the TIC must be only a portion of the person's investment and income. These are long-term investments and like all real estate, not particularly liquid.

The IRS "wants sophisticated investors, not mom and pops," Heshelow says. "An enormous amount of due diligence goes into this."

And there are drawbacks.

"The downsides are the load at the front end and the illiquidity of them," Riddell says. No secondary market has been created from them because, he says, "no one is selling." Plus, it is still a relatively small, young market.

In addition, if real estate declines, so does the investment. And if a major tenant pulls out, the annual income could be impacted.

Like most new fads, TICs were born in California and that is still where most are. But Texas, Florida and other Sunbelt states are seeing more of them and the industry will grow considerably once the Northeast and Midwest catch on to them.

There are several TIC properties on the Gulf Coast. Netpark in Tampa is a TIC, as well as the Sanctuary at Highland Oaks in Brandon and the FTP building in Clearwater. There are two TICs in Lakewood Ranch, including the Lake Ranch Center, and two in Naples.

Heshelow is so sold on the concept, she has written a book, "Effortless Cash Flow: The ABCs of TICs." More information can be found at www.tic-investments.org. Riddells says he is working on a book, also.

Review summary

Trend. Tenants-in-common real estate investing

Industry. Commercial and large, multi-family residential investing.

Key. Allows mid-size investors to pool money to invest in larger commercial properties.

At a glance

TIC Equity Growth by Closing

Year Equity amount

2002 $ 356,600,000

2003 $ 750,000,000

2004 $1,719,713,284

2005 $3,229,018,208

2006 $5,487,000,000

Source: Omni Brokerage

TIC pros and cons

Benefits

Simplicity. Eliminates the headaches of managing a property.

Taxes. Can depreciate the property and roll over capital gains into other real estate through 1031 exchanges.

Monthly Payments. Most TICs distribute income monthly.

Appreciation. Investors get their share of any property value growth.

Drawbacks

Illiquid. It is not easy to get out of a TIC if you need to quickly. There is no secondary market.

Cost escalation. The cost of a building may be higher than whole ownership because of the expenses involved with creating the TIC pool.

Financing. If the loan comes due without the building selling, the TIC needs to refinance, with the associated risks.

Management. Two-edged sword. Bad management will hurt the property.