The TIC World - History and Opportunity
- Before the early 2000s, access to commercial real estate investments for most investors was limited to partnerships and joint ventures.
- Access to the commercial real estate investment market broadened in the early 200s with the advent of "tenant in common," or TIC investments.
- Numerous investors at the height of the last real estate boom were looking for options to allow them to cash out of existing real estate holdings - typically single family residential or small multifamily projects - and defer realizing capital gains.
- TIC investments became popular after 2002, when the IRS issued a ruling that permitted investors to complete §1031 exchanges into TIC projects. Section 1031 enables investors to take profits and accumulated depreciation from one real estate deal and put them into another project and defer paying taxes on those current and past capital gains.
- A "TIC" interest is a fractional ownership interest in real property. It is similar in concept to a joint tenancy between spouses who own property. The difference is that "tenants in common" do not have to be related in any way. There also can be potentially an unlimited amount of TIC owners in the same property.
- During the early and mid-2000s, financial sponsors marketed TIC investments for commercial real estate across the United States including retail, office, and multifamily properties. The offerings gave ordinary investors the chance to diversify their portfolio into the commercial real estate market. TIC investments offered the promise of both a steady yield, through share of rental income, and future growth as properties appreciated in value.
- The fundamental problem with TIC investments were that they were highly leveraged and thinly underwritten. Problems extended beyond underwriting including massive loads and fees to get into the deals. This combination of poor underwriting and exorbitant fees were a recipe for disaster. The outcome of many TIC deals have been foreclosure with owners losing their entire ownership interests and the strong possibility of negative tax consequences magnifying the destruction to historic levels.
- The peak of the TIC market was between 2005-2007. Many of the stronger TIC investments have survived but are nearing the end of their loan terms thus forcing many investors to make a decision on the future of their current real estate holdings.
- For investors that have low adjusted tax bases, depreciation recapture and long term capital gains can erode much of the wealth that investors have accumulated during their investment in real estate. Many investors are remiss to find replacement investments that will yield an equivalent post-tax return that is comparable to what they would earn if they could re-invest their equity into a new deal and continue to defer their capital gains and depreciation recapture.
- The basic strategy for investors that have engaged in §1031 exchanges, is to continue their tax deferral until their heirs take advantage of a stepped up basis and avoid paying the taxes altogether.
- The TIC debacle has caused many investors to shy away from re-investing in new commercial real estate opportunities but the tax implications for liquidating are causing many to analyze alternatives that maintain tax deferral.
- In the wake of the TIC meltdown, financial sponsors hoping to put together new deals with TIC investors must be transparent and not charge extraordinary fees to their clients.
- Opportunities exist for tax deferral but potential investors must ask questions and explicitly understand the risks and be comfortable with their financial sponsors moving forward.
- Commercial real estate has a place in every portfolio and with a rebounding real estate market, getting in front of the trend could allow many TIC investors recapture some of their lost wealth and enjoy modest cash flow to support a more broad investment portfolio and retirement plan.
To speak with Versant about strategies to continue tax deferral, call Derek Uldricks at 619-764-9633 for more information.