Tenant-In-Common Investments (TICs)
What is a securitized tenant-in-common investment (TIC)? In a securitized TIC investment, an investor takes partial, undivided ownership of a property. While brokers often tout securitized TICs as passive investment vehicles, investors should take care to learn all they can about securitized TICs before taking the plunge.
Touted as supposedly low-risk opportunities with moderate returns, tenant-in-common (TIC) investments were once an enticing option for investors. In the early 1990s, entrepreneurs saw a way to meet the needs of investors with less than $500,000 cash who wanted to invest in property that could provide a stable stream of income without management hassles. These entrepreneurs, who would come to be known as TIC “sponsors,” started buying large, income-producing properties and then selling fractional interests.
2002 saw a surge in TICs with the adoption of Revenue Procedure 2002-22 in March 2002, which allowed investors to defer capital gains on TICs when switching to a new, “like-kind” property. This became known as a 1031 Exchange. An investor would seek to sell an existing piece of real estate and then enter into a TIC in order to take advantage of tax benefits. However, the period following the initial surge of these investments proved to be detrimental for those who participated in them. The real estate market downturn resulted in falling property values, and investors found it nearly impossible to exit a TIC. Meanwhile, many people began questioning their brokers’ advice to make these investments in the first place.
What exactly is a securitized TIC? Securitized Tenant-in-Common Investments are:
- a way to assume undivided partial ownership of a property
- illiquid securities
- private placements
- direct participation programs (DPPs)
For those investors looking for a way to generate passive investment income, acquiring a partial undivided ownership interest in a property investment seems like a great way to avoid the “three T’s” of property management—tenants, toilets, and trash. Since these properties are managed by a third party, the arrangements are supposed to give investors diminished management responsibilities. But prospective investors should research the characteristics of TICs before signing on the dotted line.
Illiquid securities are not suitable for investors who need easy access to the cash value of their investments. There is no secondary market for securitized TICs, so there is no way for you to resell your TIC on your own. If you want to sell a TIC interest to other accredited investors, everyone in the partnership may have to agree to the sale, which is no easy feat.
One of the hallmarks of a TIC, and why the structure is so appealing to so many investors, is because of its tax advantages. If you make capital gains on a TIC investment, you won’t have to pay taxes on those gains if you transfer them into a “like-kind” property. This is known as a 1031 Exchange. In 2002, an IRS ruling allowed investors to defer capital gains in cases where there was a “like-kind” exchange of properties, as opposed to a traditional sale or disposition. As a result, professionals in the area recognized the tax benefits of structuring pooled investments as an option for clients selling existing property. But are 1031 exchanges all they’re cracked up to be? While initially these tax deferral advantages sound great, the fees involved in TICs could easily offset the gains of the tax deferral provisions.
What makes a TIC eligible for a 1031 Exchange? It must have a structure distinct from a partnership. To be eligible for a 1031 Exchange, a TIC must meet the following 15 major criteria:
- Tenancy in Common Ownership
- Number of Co-Owners
- No Treatment of Co-Ownership as an Entity
- Co-Ownership Agreement
- Restrictions on Alienation
- Sharing Proceeds and Liabilities upon Sale of Property
- Proportionate Sharing of Profits and Losses
- Proportionate Sharing of Debt
- No Business Activities
- Management and Brokerage Agreements
- Leasing Agreements
- Loan Agreements
- Payments to Sponsor
In addition to being aware of how TICs qualify for a 1031 Exchange, it is also important to recognize that most securitized TICs are private placements. Private placements are securities exempt from registration with the SEC and state regulators. Private placements, also known as alternative investments, are only designed to be sold to so-called “accredited investors.” These investors must meet specific federal criteria, such as a net worth of $1 million or more, or an annual income of at least $200,000 for the last two years. Private placements are restricted to accredited investors because, while they carry the prospect of high returns, they also carry the potential for high risk, so they are not suitable for all investors. To that end, Regulation D (also known as “Reg D”) prohibits private placements from being advertised to the general public.
Securitized TICs are typically structured as direct participation programs (DPPs). Thus, to sell TICs, brokers need to have passed the Series 7 or Series 22 (Limited Representative – Direct Participation Program securities) exams. Additionally, most states require that brokers hold the Series 63 State Agent’s license.
What is the role of the broker when selling a securitized TIC? Before discussing the role of a broker, it is important to recognize the role of a TIC sponsor. Sponsors range from small entrepreneurs to subsidiaries of real estate investment trusts (REITs). Sponsors find suitable properties, put these properties under contact, acquire financing, do due diligence, arrange selling agreements with broker-dealers, pay out monthly disbursements to tenants-in-common, and more. Broker-dealers can also themselves be sponsors.
In its Notice to Members regarding TICs, the Financial Industry Regulatory Authority reminds brokers of their responsibilities regarding TICs. Brokers must:
- perform due diligence
- conduct a “reasonable-basis suitability analysis” to evaluate the merits of the overall offering
- conduct a “customer-specific suitability analysis” to make sure that the offering is suitable for a given client
- make sure that promotional materials used by members are accurate
- implement internal controls
- train registered representatives on proper TIC-related sales practices
One of the most important responsibilities of a broker is to conduct do diligence. What exactly does that mean? Before selling a TIC, the broker-dealer must do due diligence in order to ensure that the investment is suitable to be sold.
For example, when evaluating the merits of a shopping center, broker-dealers might ask the following questions:
- Is the property relying on balloon loans?
- Do leases expire all at the same time, so that a shopping center could become a ghost town all of a sudden?
- Do smaller businesses have an “out”? For example, if Wal-Mart is anchoring the shopping center but then shuts its doors, does the barber get to leave too?
If the answer to these questions is “yes,” then a broker-dealer doing proper due diligence may think twice about whether that property is a good investment.
If a broker-dealer does due diligence and approves an investment for sale as a security, the process has really just begun. Brokers must then conduct a customer-specific suitability analysis to ensure that the investment is right for a given client. As with any investment, brokers should consider:
- the client’s age
- the client’s risk tolerance
- the client’s long-term and short-term investment goals
- the client’s need for liquidity
One of the most common problems with securitized TICs has been the lack of due diligence performed by investment professionals when evaluating the properties involved. FINRA warns brokers that they must not solely rely on information provided by sponsors (those touting the merits of a given TIC), but must instead do their own independent analysis. A broker’s failure to adequately review financial statements, the qualifications and experience of the sponsor, and the quality of the property can result in tremendous harm to the investor.
Fortunately, TICs are typically considered securities. It is important to realize that there are certain standards that brokers must meet when dealing with these types of investments. Guidelines produced by the Securities and Exchange Commission (SEC) require them to deal fairly, recommend suitable investments, seek the most favorable terms for clients, and disclose certain information. There is always the possibility that a broker may not have fully looked into whether an opportunity was suitable for a certain client’s broader goals. It is also important to realize that these professionals whom you hope to trust are capable of earning relatively high commissions on TIC investments, which can be a huge incentive to advise individuals to sign up.
If a broker or broker-dealer does not do their due diligence, then investors can incur significant losses. Take the case of two retired California teachers who lost most of their life savings in a TIC. On May 1, 2014, a FINRA arbitration panel ordered Ameriprise Financial Services to pay $1.17 million to two retired California schoolteachers, according to InvestmentNews. FINRA found that their brokers placed them in unsuitable tenant-in-common investments, encouraging them to invest $1.03 million into three TICs in early 2008. The properties were office complexes and hotels. When one investment failed and the other two declined significantly, the couple lost most of their life savings.
The couple invested in TICs in 2008 and some might say that the 2008 financial crisis was to blame. In this case, the couple’s attorney successfully argued that the brokerage firm failed to follow supervisory procedures, which led to the couple’s losses. Still, it is important to recognize that one drawback of TICs is that they are tied to the real estate market. These days, many TICs are suburban shopping centers; while retail was once a booming business, the rise of online shopping has been a death knell for the brick and mortar stores, so these TICs may not be yielding profits.
If your broker encouraged you to invest in a securitized Tenant-in-Common (TIC) investment and you have concerns about your investments, don’t hesitate to contact the securities attorneys of Fitapelli Kurta. Call (877) 238-4175 or email firstname.lastname@example.org for your free case consultation.