TENANT IN COMMON
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Posted On :
Nov-10-2010
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Article Word Count :
1440
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Tenants in Common (TICs) can be an effective way to invest in institutional quality real estate.
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Tenants in Common (TICs) can be an effective way to invest in institutional quality real estate for those looking for little to no-management responsibility. Because the investor owns a fraction of the property the amount of equity (cash) needed is considerably less than what would be required to own the entire property outright. One of the major strengths of Tenant in Common properties is the ability for smaller investors to more fully diversify their real estate holdings to reduce risk.
A Bit of History
Tenants-in-common real estate ownership originated in Old England in the 1600's when it became possible for the commoner to own land. The quality farming acreage was too expensive for the former serfs to purchase on their own so several joined together as "tenants-in-common" to purchase land.
Today this same concept allows real estate investors to purchase a fractional ownership interest in institutional grade real estate. Unlike investing in a REIT or mutual fund, investors can exchange their smaller and frequently management intensive real estate for an interest in larger stable no- management properties.
In 2002 the Internal Revenue Service released Revenue Procedure 2002-22. This set of 15 guidelines reduces the risk of an IRS challenge if an investor wished to do a 1031 exchange from a sole ownership property to fractional ownership. The offshoot of Rev Proc 2002-22 was the birth the Tenant in Common industry.
Benefits of Tenant in Common Investments
* Little to no-management responsibility.
* Long term leases with multiple credit tenants can reduce risk.
* Ease of diversification to reduce risk.
* Each Tenant in Common owner has the same rights as an individual owner.
* Fee-simple deed at closing.
* Pre packaged real estate with debt frequently in place.
* Pre packaged due diligence to facilitate the selection process.
* Pro-rata share of all net monthly income, tax benefits, and appreciation/depreciation.
* Potential deferred current and future capital gains taxes.
* Investment can be scaled to fit 1031 exchange requirements.
* Property and asset management reports to each owner.
Income typically distributed monthly with periodic operating reports.
Exit Strategy
Tenant in Common owners typically exit when the entire property is sold. Owners may also sell their individual interest at any time. On sale the owner can either pay capital gains and recapture taxes or do a 1031 exchange. As with all real estate, tenant in common interests are not liquid like a stock or bond. The degree or liquidity or lack of liquidity will vary with each individual investment.
Sponsors
Sponsors assemble the initial Tenant in Common offering. Good sponsors provide a valuable service in selecting properties, arranging financing, helping to assemble due diligence material etc. Sponsors’ post closing roles can vary. It is important for investors to remember that they are investing in real estate, not the sponsor or the sponsor's business.
Common Sense Approach to Tenant in Common
As with all investments the investor would be wise to follow their money. For Tenant in Common what this means is that at the end of the day the safety and performance of the investors money is dependant on the quality of the real estate they are investing in.
As with any other real estate investment, investors should be proactive in fully understanding each property's real estate fundamentals. These include but are not limited to quality of tenants, leases, rent roles and expiration/option dates, price being paid for TIC interest vs. similar whole properties, past operating performance, operating projections with assumptions, loan terms and documents, third party reports, demographics, physical characteristics, and risk disclosures and assessments.
The TIC Sponsor's qualifications and historical performance should also be carefully considered to help evaluate their credibility as a source of information, and as a property provider.
Common Objection to Tenant in Common Ownership
The most common objection investors have to Tenant in Common ownership is that they don't have 100% ownership. Investor’s do have a deeded fractional real estate ownership interest and a proportional vote on major issues.
Losses from Tenant in Common Investments
Recently two large Tenants in Common Sponsors encountered serious financial difficulties that have adversely impacted their investors. While many of these investors will eventually recover because their investment was in well performing real estate they are now burdened with potential cash flow interruptions and legal fees as they untangle their interest from those of the distressed sponsors.
The common characteristic of both of these sponsors was that they offered their properties under a master lease program. The appeal of master lease programs is that they promise the investor a consistent rate of return unrelated to the performance of the real estate they invested in. In theory the investors is protected from the highs and lows of the market. In the case of the two failed sponsors when the market declined they were unable to sustain their commitments to the investors.
The investors had given up the upside of their investment in exchange for predictable income which turned out to illusionary. When the market declined beyond the sponsors ability or wiliness to make up the difference the investors cash flow were interrupted. Master lease programs while appealing ultimately can not be counted on to make up for the reality of the market or poorly performing real estate. Master lease programs vary widely and should be carefully examined for benefits and risk before investing.
With master lease programs both the quality of the real estate being invested in needs to be carefully reviewed and the adequacy of reserves for both the property being invested in and the total reserves held for all properties the party holding the master lease manage. In the case of the failed master lease programs only some of the properties failed to perform causing a cash shortfall for all those in the master lease programs.
It is important that investors understand that the safety of their investment is ultimately a function of the quality of the real estate being invested in and not mistakenly rely solely on the sponsor or some other third party’s efforts on their behalf.
Sponsor Fees
Fees charged by the sponsor and other third parties should be carefully looked at and compared to other offerings. The three areas to examine are the fees associated with the original offering, fees during the hold period, and any exit fees on sale.
A comparison of the total price paid for the Tenant in Common offering should be carefully compared to the price that would be paid if the investor were to purchase the entire property as a non Tenant in Common investment. This comparison will give the investor a good sense of the cost of investing in this form of ownership, any added risk to their capital, and any degradation to the income stream from the property that could be caused by over paying.
The advantages of Tenant in Common ownership come at a price, the question being, is the price being paid worth the added benefits of this type of ownership. The fees should be reasonable for value delivered and compare favorably to other offerings and investment alternatives.
Diversification
To avoid concentrating risk in one property or location investors should consider diversifying their risk by investing in different types of properties (multi family, industrial, assisted living, office, retail, etc.) and geographic location. Further diversification of sources of cash flows can be achieved by investing in multi-tenant properties. While single sponsors may offer multiple properties, investors would be wise to consider multiple sponsors to minimize the possibility of future sponsor performance issues.
Investors should carefully weigh the pluses and minuses of Tenant in Common ownership before investing.
In addition to understanding the real estate they are considering investing in the investor should carefully review Tenant in Common ownership agreement and other related documents with their legal and accounting professionals before making a final investment decision.
Tenant in Common Alternative
100% ownership of Triple Net Lease (NNN) properties provides many of the same benefits (little to no management, potential predictable monthly income) as Tenant in Common, with the investor not sharing control of the property.
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Article Source :
http://www.articleseen.com/Article_TENANT IN COMMON_41138.aspx
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Author Resource :
For more information about Tenants In Common please move on www.tm1031exchange.com/
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Keywords :
Tenants in Common,
Category :
Business
:
Business
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