Examining tenant-in-common (TIC) property transactions and the tight capital market

When the sub-prime lending problems caused ratings agencies to downgrade residential mortgage backed securities, a similar effect extended to conduit loans, and more specifically, to the commercial mortgage backed securities (CMBS) lenders. As a result, the nearly $300 billion CMBS lending market just disappeared overnight. And until this year, CMBS lending was the primary source of financing for the new securitized, tenant-in-common (TIC) industry. One of the consequences of this dry-up of capital in the commercial real estate lending market is that those real estate investors who haven't been involved in the TIC market before are now looking to the existing TIC property deals to acquire a quick replacement property for their 1031 exchange. Why? Because the existing TIC financing is already in place. Hey? Wasn't that the major benefit for which the TIC industry began in the first place? To get a quick closing on set terms within the strict 1031 guidelines? Yes, it was! And as a result, we're seeing TIC inventories in some quarters drying up a little faster than what would normally be expected because of this new dynamic. With that said, should we expect the TIC market to disappear within a few months as well? Not likely. Already TIC sponsors are looking for other sources of funds including Freddie Mac financing through lenders such as Wachovia Bank, insurance companies and other balance sheet lenders, as well as carry-back financing from large institutional sellers such as pension funds, etc. But with the cap rate UN-compressing, values lowering, spreads tightening, and lending requirements becoming more stringent, we can expect to see much more emphasis placed on due diligence and quality underwriting as it should have been in the first place. Several chief acquisitions officers in the TIC industry, as well as legal counsel operating in this market, have told me that they've been held to much higher standards by what few banks they can find who are even interested in talking to them. And they're held to a much lower number of total TIC investors in any given deal. Where one could find up to 35 investors allowed in a TIC deal just a few months ago, now we're seeing limits of as few as six to nine TIC investors allowed by either Freddie Mac, the bank, or both. The Baby Boomer generation is still there, still the largest and fastest-maturing and wealthiest demographic class in the country. And it still has a huge need for the benefits offered by the TIC industry. And the Echo Boomer generation is right behind them. So, the demand for TIC deals is assumed to continue strong into the foreseeable future. With all that we've seen so far, what can we expect in the coming months? How long can this go on? Jones Lang LaSalle suggested recently that we've seen a 75 basis point slide upward in the cap rates generally in the last few months and we can expect that to continue for a few more months. Expect the capital markets to begin to recover towards the end of the year or in 2009. This report seemed to be reiterated recently as we traveled in a due diligence trip meeting with various leading TIC sponsors located primarily on the west coast. We're still seeing new TIC deals come out on the market with beginning cash flow rates as high as 7% and minimum buy-in levels as low as $100,000. And while as a rule, we're seeing the returns go down while the minimum investments go up, we're also seeing a higher number of value-added deals projecting lower cash flow and substantially higher yields generated by the opportunities that a changing market like this can offer. We don't need to feel overwhelmed during market trends such as these. The markets correct themselves by definition. Our job is to study, watch and learn so that we can prepare and benefit our own clients and families in the investments that we participate in. And we'll do it the old fashioned way, by working with those broker-dealers, registered representatives, and investment advisors and other professionals that apply aged-old, tried and true practices of sound underwriting and investing strategies. David Rumsey is a TIC advisor and real estate attorney at Clearview Wealth Management, Rochester, N.Y.