Real Estate tenant in common (TICS) vs. Securities tenant in common

Real Estate tenant in common (TICS) vs. Securities tenant in common

In addition to the different property types that are available as TICS, such as office, multifamily and retail, TIC properties also come in two different platforms or formats.

 The first type, called the real estate platform, is pure real estate property co-ownership.  This type is the essence of tenant in common co-ownership – deeded, fee simple, title insured and undivided co-ownership of investment real estate.  Buyers of these properties are not obligated to use any particular entity for property management or asset management.  The pure real estate TIC is typically sourced through a licensed real estate professional or REALTOR®.

The second type of TICS are those that are sold as securities.  These are largely the same as the first type, but they are sold only through licensed securities dealers and their Registered Investment Advisors (RIA) or Registered Representatives (Reg. Reps).  Most of the TIC industry offers their properties in this format.  In 2009, it is anticipated that these will be able to be sourced through REALTORS® also.

TICS that are sold as securities, also referred to as securitized TICS, are not more secure or safer than pure real estate TICS – that is a common misconception.  They come with essentially no more due diligence than real estate TICS, nor are the properties held to a higher standard than pure real estate TICS.  Securities broker-dealers who sell these properties perform a diligent review of the properties prior to making them available, but this review is no different than what a very experienced and expert real estate investor would do.

Why would one TIC be sold as a security and another sold as real estate?  The main reason has to do with the Securities and Exchange Commission (SEC) rules.  The rule governing TICS are at this link, then scroll down to section H:http://www.sec.gov/divisions/marketreg/bdguide.htm

“H. Real Estate Securities and Real Estate Brokers/Agents

The offer of real estate as such, without any collateral arrangements with the seller or others, does not involve the offer of a security. When the real estate is offered in conjunction with certain services, however, it may constitute an investment contract, and thus, a security.”

In plain language, TICS are regarded as a securities investment if the sponsor or an affiliate of the sponsor also manages the property, or provides asset management, or if the sponsor or its affiliates holds a master lease via a contractual agreement that is in place when the TIC property is purchased by the investor.

The reason that TICS are classified as securities when the sponsor or an affiliate of the sponsor performs these functions goes to a landmark tenants in common US Supreme Court case called SEC vs. Howey, 1946.  A good summary can be found at this link:http://en.wikipedia.org/wiki/SEC_v._W.J._Howey_Co.

In short, the court found that “an instrument qualifies as an “investment contract” for the purposes of the 1933 Securities Act which later came to be referred to as the Howey test if

•  investment of money due to an expectation of profits arising from
•  a common enterprise
•  which depends solely on the efforts of a promoter or third party

Today, modern TICS are considered securities because under the “Howey Test” when the TICS are property-managed or asset-managed by the sponsor, then they qualify as an investment contract (a security) because the sponsor is now largely responsible for the success of the enterprise.  The sponsor’s influence upon the success of the property is now greater than a simple pro-rata proportional ownership interest.

As the property or asset manager or both, the sponsor now has the ability and responsibility to ensure the property’s success.  This is in contrast to the pure real estate TIC, where the sponsor is a co-owner along with everyone else, and simply votes on the crucial issues affecting a property according to their pro rata ownership interest.

As can be seen, the determination of a real estate TIC vs. a securitized TIC is a matter of definition, not of quality.  It is based on the degree of involvement of the sponsor with the property after the close of escrow.

TICS as securities are as good as real estate platform TICS since the sponsor or its affiliated property or asset management entities may in fact be the best-qualified to manage or provide oversight and auditing for the TIC property.  This is because most TIC sponsors are experienced real estate investment companies, with expertise in every phase of real estate investment including but not limited to acquisition, management and disposition.

Regardless of whether a TIC is securitized or real estate, as always, the most important thing for the prospective investor to do is to compare the properties under consideration using tried and true traditional measures used in investment real estate.

Is the property conservatively underwritten?  Are the assumptions reasonable?  Should the property perform to pro forma calculations?  Is the net cash-on-cash return reasonable, attainable and competitive in today’s marketplace?  Are the fees reasonable?  If the answers to these questions are all yes, then it’ simply a matter of choosing which type of property and location that the investor finds most appealing.

Some investors prefer retail, others want to own multifamily residential, others want conventional office properties.  Each type has its own pros and cons.

To read a review of the various types, see the article at this site entitled Tenants-in-Common Property Comparisons at this link:

http://1031taxexchange.org/tenants-in-common-properties-overview/

I trust this has been helpful.  Feel free to contact me with questions.  Thank you.