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Investing in a 'Tenant In Common' -- Is it for You?
Understanding the “pluses and minuses” of investing in a “Tenants In Common” (TIC) commercial property can be a challenge.
The pluses include: no management responsibility, lower barriers to entry for institutional grade property, diversification, and high certainty of close for 1031 exchange investors.
The two most common areas of concern for investors when considering TIC ownership are lack of liquidity and lack of control relative to sole ownership properties.
As the Tenant in Common industry matures, investors enjoy a greater selection of competitive TIC properties. Increased inventory also provides more time for investors to consider their choices.
It is often said that investors make their money when they buy, not when they sell. What this means is that if the investor makes a wise decision at the time of purchase, their chance of doing well is far higher. If they don’t understand fundamentals of the underlying real estate, investors are at a greater risk of throwing fate to the wind.
Holding title as “Tenants in Common” doesn’t make an investment more or less risky. Risk lies in the underlying investment. Careful study and understanding of demographics, tenant quality, lease terms, and appropriateness and condition of the improvements is critical to success.
One way to make sure that the investor is focused on what is important is to ask what would happen if the TIC Sponsor (the people who put the “Tenants in Common” offerings together) was no longer involved with the property. The best answer is “nothing material would happen.” If the answer is that the investors equity would be at greater risk, a better understanding of the true nature of the investment, if it truly qualifies for a 1031 exchange and if the compensation justifies the risk is a must.
TIC Sponsors earn fees by identifying and packaging investments that generate competitive cash returns and appreciation on a risk adjusted basis. Many Sponsors have experienced acquisition teams who scour the country for attractive opportunities. A Sponsor thoroughly investigates the property, takes care of the normal “moving parts” (ie. financing and performing due diligence), and creates a package that includes all pertinent information to make an informed decision. Investors can expect to pay a premium for this “prepackaged” investment, averaging 5% to 7% above what it would cost them if they were to buy the property outright.
Is the investor getting their money’s worth? Are the premiums justified? The fee structure, and in particular how and when a sponsor is compensated, requires careful consideration. In many (but not all) cases, the additional fees are a good investment relative to the alternatives on a risk-adjusted basis.
A “reality check” on the premium can be done by comparing the amount TIC investors are paying for the entire property to the amount other properties in the same asset class and location sold for. Other considerations are lease rates being paid by tenants in the property being considered vs. the lease rates in similar properties in the same market.
The cost and method of financing impacts risk, cash flow and build up of equity. Loan to value (LTV) can impact both risk and return. Common LTV ratios for TICs are in the 60 percent range and are considered conservative. This level of LTV takes advantage of leverage (magnifying the potential appreciation and cash flow) while not being excessive. While leverage can have favorable results in a rising market it can also have inverse or negative effects in a declining market.
If refinancing is a possibility, associated costs should be reflected in the due diligence provided by the TIC Sponsor. Loan assumption and TIC interest transferability affects the liquidity of investors’ separate shares and sale of the property as a whole. Terms and conditions of financing must be clearly understood prior to investing.
Although most TIC programs are income oriented, returns vary greatly by market, asset type and level of risk. In many respects a TIC performs like a bond; no management and a monthly check. It is important to remember that a TIC is not a bond, but a hard asset subject to multiple market forces and performance or lack of performance is dictated by quality of the asset and the market it resides in.
Finally, a clear exit strategy must be in place. Each TIC investment has different fees and charges taken out of the proceeds prior to disbursement to investors. They can include selling commissions and sponsor “organization” fees which directly impact profit and should be clearly understood before investing.
TICs can be great investments and certainly have a place in many portfolios. At the end of the day, they are real estate, and the same principles of “real estate investing” apply to them as to any other property.
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