More investors are buying into TICs, but should they?

Sperry Van Ness has just produced a white paper is to explore the pros and cons of the TIC investment.

As market conditions continue to slide from overheated to uncertain, I am very concerned that this type of investment could cause the same kind of real estate turmoil as that created by the limited partnerships of the 1980s.

While TICs (Tenants in Common) are one of the oldest forms of interest in real estate, they've only recently gained significant popularity, with TIC funds increasing by more than 700 percent in just four years.

The Internal Revenue Service's Rev Proc 2002-22, authorized in 2002, has driven TIC investment. It created the opportunity for undivided fractional interest in real estate and more importantly qualified TICs as like-kind properties eligible for use in 1031 tax-deferred exchanges.

The popularity over the last 15 years of investing in real estate among high net worth individuals or so called "private investors" has resulted in the involvement of private investors in approximately 85 percent of all commercial real estate transactions since 1990. Main Street, not Wall Street, is now the driving force behind the commercial real estate investment market.

Contrast this with the fact that most investors in the stock market are institutional or mutual funds. In fact, of the almost 2.9 million households in the United States with a net worth over $1 million (excluding one's house), almost 50 percent own investment property. Appreciation of the billions of dollars in commercial real estate owned by aging baby boomers has created huge demand for selling these highly appreciated properties to create cash flows through other sources, without the headaches associated with managing and owning a property.

But investors need to be cautious--now more than ever. The insatiable demand for real estate investments, combined with the motivation to defer taxes, in a market that is uncertain at best, could be a recipe for disappointment for investors in TICs.

The market has demonstrated that the need for a TIC-like product is overwhelming. But regulators need to move out of the political arena and create a structure that allows for the benefits of a TIC-like investment without the huge risk involved in the current structure.

The commercial real estate market, buoyed by a strong economy, controlled development and investment dollars returning back into the stock market, is headed for a soft landing. Once the frenzy dies down, investors will once again need to exhibit prudence and good judgment when it comes to buying and selling real estate.

It may seem like a lot of effort, compared to the experiences of the last 10 years where just about anyone could make money simply by getting into the game, but the risks involved with investments like TICs are far more dangerous than most investors realize.

Consider the following before investing in a TIC:

* Do your own due diligence. Meet the sponsors in their offices and get an overview of the firm. You will learn a lot by visiting the organization firsthand. After all, you are investing in them as much as in the property. Contact other investors who have invested in their previous offerings and ask hard-hitting questions. Carefully review the reports that are provided to investors. Do they make sense? Compare actual performance to any projections of previous deals. How much of the return depends on a high sales price down the road? Real estate typically provides benefits from cash flow, appreciation and tax benefits. Is the opportunity in balance, or is it heavily dependent on one of the three? Again, diversification and balance are important.

* Whether sold as a security or real estate, hire a real estate investment consultant or agent who works solely for you to review the transaction with you. Have them advise you on the local market conditions, competitive properties and comparable deals sold.

* If you do not want to actively manage a property and want to do a tax-deferred transaction, consider other low-risk real estate investments such as single-tenant net lease deals. These types of deals are "management free" as well and usually backed by strong credit of the tenant.

* Have the structure and tax implications carefully scrutinized by your legal counsel and tax accountant early in the process. Do not rush into the investment. Do not be "sold" to move quickly or miss out. There is plenty of opportunity. And there is nothing worse than having your accountant and/or attorney advise you on the problems and implications when it is too late.

* Do not consider this type of investment to be low risk. "A no-headache or passive investment" does not equal lower risk. It could actually be higher risk and much less liquid than you ever imagined.

* Often times TIC fees can equal the amount of taxes you would have paid by just liquidating the property. Understand every single detail of the fees being charged. As much as one cringes at the thought of paying taxes, sometimes cashing out and diversifying one's portfolio is the best long-term strategy.

To view the White Paper in its entirety, log onto: http://marketing, svn.com/DE/ SVNTICwhitepaper.pdf

DAVID FROSH, PRESIDENT, SPERRY VAN NESS COMMERCIAL REAL ESTATE ADVISORS