SEC accommodates real estate brokers for TICs: Are TICs that good?

After considerable lobbying by the National Association of Realtors, the Securities and Exchange Commission (SEC) issued Release No. 34-56779, on Nov. 9, allowing commercial real estate brokers to participate in securitized, Tenants-In-Common (TIC) transactions. Specifically, the SEC will now allow commercial real estate brokers to share fees on TIC deals with securities/registered broker-dealers. What does that mean exactly? Well, let's back up. Before March, 2002, one could not be sure that a like-kind exchange under Section 1031 of the Internal Revenue Code (1031 exchange) would receive tax-deferred status if the taxpayer/investor exchanged into a partial interest in "replacement property" as defined under Section 1031. The problem had existed when the IRS found multiple owners of a single replacement property where those owners took title as tenants in common, i.e., TIC property. That usually meant the 1031 exchange would be disallowed. That problem was solved when the IRS issued revenue procedure 2002-22 indicating a willingness to allow 1031 exchanges into TIC property. The first hurdle cleared, and the new TIC industry sprang into existence with over $4 billion in equity projected to be raised this year. See, http://www.omniTICconsulting.com. The next hurdle came in the form of state and federal securities laws. In short, the issue arises when the seller provides both the TIC property and its management. Roughly stated, if an investor buys a property interest from a TIC sponsor, and relies on that TIC sponsor to manage the property, then the SEC refers to that bundle of property rights and service agreements as an "investment contract" as found under the 1946 U.S. supreme court case of SEC v. Howey. And since investment contracts are considered securities, by definition, that TIC sponsor must sell its TIC property through registered broker-dealers only. Consequently, real estate brokers have not been allowed to sell securitized TIC property unless they've had the requisite securities license. Now, back to where we started: The SEC will now allow commercial real estate brokers to participate in the sale of securitized TIC property, and share in the fees, with registered broker-dealers. They've created a narrow exemption only for experienced commercial real estate brokers so they don't need to register as broker-dealers. Notice of this exemptive relief is currently subject to a 30-day "notice-and-comment" period. Next, publication in the federal register must occur before the exemption goes into effect. That's great! But, why would savvy real estate investors want TIC property if they're already good property managers? Aren't TICs just over-priced real estate investments for people who don't want to manage? The first question asked by investors considering TIC property is: What's the cost/benefit of investing in a TIC? The best answer is found in comparison with the most likely alternative, i.e., investing in an individually-owned commercial property such as a neighborhood apartment building, retail strip mall, commercial warehouse or office building. Regardless of whether someone purchases a TIC or buys a local, self-managed,
commercial property, there are similar costs for acquiring and closing
on each. These may include a brokerage commission, a property condition report, an appraisal, an environmental study, and legal fees including those for drafting the bank's loan documents. TIC deals "layer on" additional costs for packaging and "securitizing" the deal. The
process includes the organization, offering and marketing expenses, as well as commissions paid to the broker-dealer. This "TIC load" should amount to 3 to 8% of the total purchase price over and above what one would pay for an individually-owned,commercial real estate investment. A private placement memorandum regarding the acquisition, due diligence, financing and necessary paperwork is filed by the TIC sponsor with the SEC and appropriate state securities commissions. The broker-dealer can then approve the deal which is all ready to go before it's even presented to investors in many cases. The most obvious benefit provided, therefore, is that the TIC investor may be able to identify and close on his or her 1031 exchange replacement property within weeks, ensuring the resulting tax savings, regardless of the size of the equity investment. The purchase of comparable real estate, individually, could take months to close if it can be done at all within the strict 1031 exchange timelines. Besides greater certainty of closing on schedule, there are other less obvious benefits such as the significant savings provided by the economies of scale inherent in institutional-grade TIC properties. But that's a topic for another article. For now, it's just worth noting that a tiny new segment of the real estate industry has captured the full attention of the SEC, and received an exception for it - or better stated - an exemption from it! David Rumsey is a real estate attorney and TIC advisor, Rochester, N.Y.