What makes investors "TIC"; TICs are growing in popularity among an increasing number of investors. But what's driving the boom in TICs?

For centuries, the "tenancy in common" (TIC) has been one of the standard legal ways in which more than one person may own the same piece of property. With a TIC, each owner holds title to a fractionalized share of a property that the owner may sell, give or bequeath.

But recently, the TIC was cleverly reinvented as a real estate-securities hybrid that offers investors an annualized monthly cash flow of roughly 6 percent to 8 percent. In 2002, when the government gave its approval for use of the TIC in a 1031 exchange, the TIC's popularity surged.

What was not even a $200 million industry in 2001 grew exponentially to more than $3.2 billion in 2005, according to data compiled by Salt Lake City-based OMNI Brokerage Inc. Over the past year, TIC equity has piqued at roughly $1 billion per quarter. Manuel Nogales, OMNI's Director of Business Development, explained that "the industry's growth rate has reached its period of maturation, and it is showing no signs of weakening."

More TIC, Less IRS 

TICs attract investors who wish to reap the tax-friendly benefits of a 1031 "like-kind" exchange (named for the Internal Revenue Code section on tax-deferred exchanges that came to life 85 years ago, as part of the Revenue Act of 1921). In short, Section 1031 lets taxpayers who sell investment properties defer paying tax on their capital gains--and avoid depreciation recapture--if they reinvest their gains into one or more properties of equal or greater value. As long as investors follow the rules, they may perform as many 1031 exchanges as they want over their lifetimes. Upon an investor's death, the investor's estate would enjoy a stepped-up basis and therefore not be liable for taxes on any of the investor's deferred gains.

As capital gains tax rates rose in the late 1980s, more investors took the somewhat risky position of using TICs for 1031 exchanges. Fortunately for them, the IRS responded on March 19, 2002, with Revenue Procedure 2002-22. This procedure gave the green light to use TICs for this purpose as long as investors comply with certain rules, such as limiting the number of TIC investors to 35 per deal. The typical number of investors in a TIC ranges from 20 to 25.

The procedure "opened the floodgates to many investors who were eager to take advantage of this tax-friendly development," said Michael L. Murphy, Vice President and Senior Investment Advisor with LaSalle St. Securities LLC, who specializes in TIC transactions.

Chicago-based Harry Jongsma was one of these investors. When he sold his 120-acre, 150-site mobile home park in December 2004, Jongsma didn't want to see his profits go to the IRS. His search led him to discover TICs, and by March 2005, he rolled over the proceeds of his sale via a 1031 exchange into seven TIC properties. "We paid no capital gains, and we picked up the depreciation in the new properties," said Jongsma, who now is part of seven TIC properties, which he described as a mix of high-end residential and commercial.

In addition to these tax advantages, TIC investors also enjoy the usual tax benefits of real estate ownership. They may deduct mortgage interest and taxes for their proportionate share of the property.

No More Mister Little Guy

Many individual investors don't have the financial means to acquire properties worth $20 million to $50 million or more on their own. By pooling their money with others' money into a TIC deal, investors can "get into properties they never would dream of owning," said Louis J. Rogers, President and Board Member of Triple Net Properties LLC, the largest sponsor in the TIC industry. "For most people, this is a big step up." Individual investments in TIC properties typically start around $250,000 and average in the $400,000 to $500,000 range, according to Nogales. For that money, investors get Class A properties in prime locations that often draw top residents. Because these properties are in sound physical and financial shape, they're considered less risky and more likely to appreciate in value over the years.

Because the IRS places no limit on the number of TIC deals in which an investor may participate, investors are advised to diversify their TIC portfolios by selecting varied types of properties in diverse geographical regions. For example, Jongsma's properties include a mix of residential and commercial buildings spread out over Atlanta; Fort Lauderdale, Fla.; New York; Santa Cruz, Calif.; and Texas.

Although office buildings have proven to be the leading type of TIC property, apartment communities now constitute 32 percent of total TIC equity, up from an average of 10 percent in 2001-2004.

Although apartment communities usually generate less income, many investors view them as "less risky because there are more rental units, which means more diversification within a specific property," explained Joseph A. Zarlengo, a Partner at the law firm of Chuhak & Tecson P.C. Also, Rogers added, because "many investors understand how multifamily properties work, they tend to feel more comfortable owning them.

Getting Active About Getting Passive

Another important feature of the TIC is its passive ownership. Although TIC investors own the property, they aren't involved in its day-to-day management. Instead, TIC investors hire professional management companies to run their properties, a development that "has created a boon for the management industry," Murphy said. The investors' roles are limited to reviewing management contracts, approving leases and making major decisions about the property, such as whether to sell.

This passive approach is often viewed as a big plus to owners who "want to stay in real estate but don't want to manage their own properties and deal with everyday hassles," Murphy said.

For Jongsma, avoiding management headaches was key to his decision to invest in TICs. "I am not interested in getting a call that says there's a problem with the roof and asks, what are we going to do to fix it?" he said.

Chuck Gruberman, another TIC investor who bought into a residential property in North Carolina and two office buildings in Texas, agreed. "If I were to invest in my own apartment building, I would have to find someone to manage it. With the TICs, it was all put together as part of a package. For me, it was a no-brainer," he said.

As appealing as passive ownership may be to many investors, it's a deal-breaker for others who enjoy the challenges of managing their own properties and having direct communication with their residents. "There's only one kind of investor that doesn't want a TIC--those who must be in complete control over their property," Rogers said.

And Now a Word From Your Sponsor

The number of TIC sponsors--the companies that put together the deals--has climbed from around 10 in 2001 to more than 70 in 2006, and industry experts say that number will undoubtedly continue to rise as the demand for TIC properties grows.

Sponsors perform due diligence on their properties for potential investors, including property condition and environmental reports, engineering and market studies, surveys and title reports and resident and lease review. And broker/dealers, who put investors in touch with sponsors, perform an added layer of due diligence, which adds to investors' peace of mind.

Currently, investors have nearly 60 TIC properties from which to choose, according to Greg Paul, President of OMNI and Vice President of the Tenant-In-Common Association (TICA). Most of these deals are promoted as securitized transactions: To participate, investors must be "accredited," which means earning an annual income of $200,000 per year for the past two years ($300,000 if filing jointly), or having a net worth of $1 million, a sponsor's financial requirements for nonsecuritized transactions vary but are usually similar.

TIC investors who meet a sponsor's financial qualifications don't undergo a full mortgage search and qualification process and appraisal work as they normally would when purchasing real estate on their own. Instead, TIC properties offer non-recourse financing that is already in place. "Not only is this attractive to TIC investors, but new owners can assume their proportionate share of these non-recourse loans without having to qualify or pay any loan assumption fees," Murphy said.

Sponsors are also key in helping investors to comply with the IRS's strict rules for a 1031 exchange. Most notably, investors have 45 days after the sale of a property to identify in writing a replacement property for an exchange, and 180 days to close on the purchase of that property. This timetable can be tricky to accomplish on your own. "Most investors coming in are the result of a 1031 exchange and have this timeframe to deal with," Paul said. "If the exchange goes on too long, it may be jeopardized."

No Parking, Please

Real estate is not considered to be a liquid investment, and TICs are no exception. Although by law individuals have the right to sell their parts of a TIC property at any time, lender restrictions and other legal and practical considerations mean investors should expect to hold their TIC properties for at least six to eight years.

"TICs aren't a good investment for people who may want to exit early to take advantage of other real estate opportunities that come along," said Jeff Hawks, Principal of Apartment Realty Advisors.

Paul agreed, and he cautioned that potential investors should not view TICs as "parking vehicles until they find what they really wanted."

Learning Your TICs

Because of securities regulations, the TIC industry has not been able to engage in direct marketing or advertising of TIC investing. As a result, "the No. 1 way people hear about TiCs is through word of mouth," Hawks said.

But this has created some challenges when it comes to educating people about how TIC deals actually work. "Much of the information that potential investors get isn't the whole story," Hawks said. "Many people are misinformed or assume there must be a catch."

The best way to learn more about TIC investing is to talk with a financial advisor or attorney, or contact a reputable broker/dealer who worm with top TIC sponsors, recommended Gus Remppies, Triple Net's Senior Vice President of Acquisitions.

It's also wise for a potential investor to vet each sponsor himself. Zarlengo advises his clients to "understand and closely examine the track record of sponsors," and Murphy recommends looking at both the number and the size of TIC deals a sponsor has developed in the past two to three years.

What's a TIC?

A "tenancy in common" (TIC) is a standard legal way for more than one person to own the same piece of property. With a TIC, each owner holds title to a fractionalized share of a property that the owner may sell, give or bequeath.

Ron Leshnower is an attorney and freelance writer based in Syosset, N.Y. He can be reached at [e-mail].