Commercial Real Estate
Tenant in Common

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TENANTS IN COMMON  

   TENANT IN COMMON

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"Twelve Mistakes Tenant in Common Investors Make"

Tenant 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 non Tenant in Common 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

Tenant 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 Tenant in Common to purchase land.

Today the Tenant in Common 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 do a 1031 exchange with their smaller and frequently management intensive real estate for Tenant in Common interest in larger institutional grade real estate.

In 2002 the Internal Revenue Service released Revenue Procedure 2002-22 regarding Tenant in Common ownership of investment real estate. 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 or Tenants in Common. 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 Tenant in Common interest at any time (one of the guide lines in Rev Proc 2002-22). On sale the Tenant in Common 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 Tenant in Common property.

    Sponsors

    Sponsors assemble the initial Tenant in Common offering. Good Tenant in Common sponsors provide a valuable service in selecting properties, arranging financing, helping to assemble due diligence material etc. Sponsorsí 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 Tenants in Common

    As with all investments the investor would be wise to follow their money. For Tenant in Common investments what this means is that at the end of the day the safety and risk to the investor's money is directly related to the quality and price the investor paid for the underlying real estate.

    Who sold the Tenant in Common investment to the investor, who the sponsor was or what some third party might say or promise will not correct the risks associated with subpar and/or overpriced real estate. The investor's money is going into a deeded interest in real estate and is not ultimately dependent on the efforts of others so understanding the intrinsic value of the real estate is crucial before investing.

    To see the truth of this statement one need to look no further than the two master lease Tenant in Common sponsors who failed in the recent economic turn down. Those who invested in poorly performing Tenant in Common real estate with those sponsors and depended on the sponsorís master lease programs are struggling while those with a deeded interested in solid well performing real estate continue to enjoy the benefits of their investment.

    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 rolls and expiration/option dates, price being paid for Tenant in Common 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 Tenant in Common 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% control of the property. Investorís 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 Tenant 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 Tenant in Common sponsors was that they offered their properties under a master lease program. The appeal of master lease Tenant in Common 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 Tenant in Common 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 Tenant in Common master lease programs both the quality of the real estate being invested in needs to be carefully reviewed and the adequacy of reserves for all properties the party holding Tenant in Common master lease has. These reserves need to be in the form of provable cash deposits or irrevocable letters of credit that can not be diluted, In the case of the failed Tenant in Common master lease programs only some of the properties failed to perform causing a cash shortfall for all Tenant in Common owners in the failed sponsors master lease programs.

    It is important that investors understand that the safety of their Tenant in Common 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 partyís 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 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 excessive fees.

    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 and services 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 Tenant in Common 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 Tenant in Common 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 investor should carefully review the Tenant in Common ownership agreement and other related Tenant in Common documents with their legal and accounting professionals before making a final investment decision.

    Tenant in Common Alternative

    100% ownership of NNN Properties provides hands free income as Tenant in Common properties while retaining 100% control of the property and avoids the fees associated with Tenant in Common ownership. The major advantage of investing in Tenant in Common properties is the ability to diversify to reduce the risk associated with any one property.



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