Thursday, October 31, 2013

Conflicts of Interest in TIC Investments

By Tim Husson, PhD and Carmen Taveras, PhD

We have been discussing the value of TICs from a financial standpoint, but like most private placement investments, there are many other factors to consider than just the numbers.  TICs have a wide array of problematic features that retail investors might not think to look for.

For example, most TICs require unanimous consent of all investors for major decisions regarding refinancing or selling the property.  A TIC can be sold to up to 35 investors, making unanimous consent extremely difficult.  Short of owning a property outright, no other real estate investment is subject to this type of provision.

We have also seen TICs that involve sale-leaseback transactions on the underlying property.  Sale-leaseback agreements are common real estate transactions whereby the owner of a property sells it to an investor and then leases it back to continue using it.  After reaching a high of $6.6 billion in 2007, sale-leaseback transaction volume feel to $450.9 million in 2009. Volume has since improved reaching $1.8 billion in 2011.1

Sale-leasebacks can give investors a steady stream of income (the lease payments) and give the owner an upfront cash flow (by selling the property). Sale-leaseback transactions are marketed as a way for sellers to invest in their core business and transfer real estate risks to real estate investors. However, sale-leasebacks can also be a way for tenants to obtain financing. Since the seller and the tenant are the same entity, a sale-leaseback transaction makes it possible for sellers/tenants and TIC sponsors to agree on a sales price higher than the fair market value of the property in exchange for rent payments that are higher than market rent rates.  TIC investors may be unaware that the property that they are buying was the subject of a sale-leaseback transaction. If the purchase price of the property by the TIC is above its market value, then TIC investors have effectively loaned the seller the excess amount.  This type of arrangement can be used by tenants who cannot obtain from traditional sources, and may have a higher risk of default or vacancy.

We have seen sale-leaseback based TICs that paid above-market prices for the property.  One incentive for them to do so is that a larger purchase price means they can attract more equity seeking a 1031 exchange.  Because TIC sponsors are paid fees as a percentage of equity, they could use sale-leasebacks at below-market lease rates in order to increase their fees.

These are just a few examples of issues that plague TIC interests.  The fundamental issue, however, is that unregistered private placement investments have a tremendous degree of flexibility in what they can offer to investors.  Retail investors, even when familiar with publicly traded securities, may not be prepared for the additional complications that can have a major impact on private placement investments.

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1  Data is from Real Capital Analytics, as quoted in CBRE’s 2012 Special Report “U.S. Sale/Leasebacks: Unlocking Value” (PDF). Data includes transactions valued over $2.5 million in office, industrial, and retail property.

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