The Risk of Investing in a TIC Venture in Today's Real Estate Environment

A recent article published in the Wall Street Journal by Jennifer Forsyth, illustrated perfectly the risk inherent in investing in a tenant-in-common (TIC) real estate venture. The article, titled "How 1 Property Sank the Savings of 35 Investors," was published on July 10, 2008 (page D1) of the WSJ and chronicled the troubles of a small TIC real estate venture in which the sole tenant of a building went bankrupt, leaving the TIC investors holding the bag.

In a TIC ownership structure the investors buy a fractional ownership in a commercial property. Each fractional interest is recorded by separate deed, can be bought and sold, can be mortgaged separately and, assuming strict compliance with IRS regulations, can be utilized in a 1031 like-kind exchange. It was this latter feature that made the structure attractive to some. A real estate investor that has sold his/her investment in a commercial property may reinvest the proceeds in a like-kind property within a limited period of time and defer the taxes on such sale. These are called 1031 exchanges and are subject to many IRS requirements. 1031 exchanges are worthy of their own post on this blog sometime in the near future; so stay tuned.

The beauty of a TIC structure is that an investor can pool his or her sales proceeds with other investors by acquiring a fractional ownership of a much larger piece of commercial property than could otherwise be afforded by the investor. A management company hired by the TIC investors then manages the property for them.

However, the IRS has quite a few requirements to be met if the TIC investors want the structure to be recognized by the IRS and accepted as an appropriate investment vehicle for their tax-free exchange. These IRS requirements includes that certain critical decisions must be decided unanimously, and the delegation of decision making authority to one representative must also be unanimously approved. With a large group of TIC investors, the ability to obtain that unanimous agreement is difficult at best and can take a considerable amount of time to achieve. Essentially, one investor can play the spoiler and there is nothing one can do about it.

In the situation that was the subject of Ms. Forsyth's article, the commercial property was a Phoenix bottling plant that housed Le-Nature's bottling company. When the company went bankrupt and its lease was terminated, the TIC investors learned that in additional to no longer receiving their portion of the rent proceeds, they would be responsible for the mortgage payments after the interest reserves ran out.

Most of these TIC arrangements have a sponsor that puts the deal together. In this case the TIC sponsor attempted to find a new tenant, but the TIC investors could not unanimously agree on lease terms in any timely fashion and the potential tenant went elsewhere. The TIC sponsor also tried to line up a sale of the building, with the same disastrous result as the TIC investors could not come to any unanimous agreement. Many of the investors were over 65 years old and have lost a significant portion of their investment.

The story of this venture gone awry perfectly illustrates the downside of a TIC investment structure when the real estate market is shaky. While TIC investments are likely to remain a viable option for many, it is not without its risks and needs to viewed carefully.

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