Access to affordable capital has rapidly become a difference maker in the tenant-in-common industry. TIC sponsors able to utilize an all-cash development, acquisition and offering strategy are getting a leg up on their leverage-dependent competition.
Moreover, a lack of acceptable financing is forcing some leveraged TIC sponsors to delay bringing deals to the market, or to pull them altogether.
Sales volume in the TIC industry is dwindling due to a decline in U.S. real estate sales and the corresponding slump in demand for 1031 exchange properties, which enable investors to defer capital gains taxes. TIC sponsors raised $1.1 billion during the first three quarters of 2008, down more than 50% compared with the same period in 2007.
Despite the drop in sales volume, the TIC property ownership structure remains sound for suitable 1031 exchange buyers. Prospective buyers can still find TIC offerings from which to choose, even though some TIC sponsors have scaled back. TIC buyers who are able to acquire property on an all-cash basis are best positioned to take advantage of current investment opportunities in the market.
Advantages vs. disadvantages
Benefits of an all-cash TIC transaction include no foreclosure risk, no interest rate refinancing risk, and less risk of capital calls. Added benefits include avoiding the bank application process, easier resale, and flexible 1031 exchange closing schedules.
Still, the absence of leverage makes it difficult for TIC investors to purchase larger properties such as a $100 million office tower. To keep the equity requirements within reason, all-cash TIC offerings tend to focus on institutional-grade properties priced under $10 million.
All-cash TIC properties usually generate a slightly lower rate of return — generally 6% to 6.5% initially, or about 25 basis points lower than a leveraged property that uses interest-only financing. On the other hand, the front-end fees associated with all-cash transactions will normally be less than those of TICs using debt. Hence, more investor dollars buy real estate than pay fees.
Many TIC investors are also willing to exchange a lower rate of return for less refinancing risk. Ultimately, the all-cash model provides an added layer of protection that is attractive in a market where investors are increasingly averse to risk. An added benefit for all-cash buyers is that they can move more quickly to close their TIC transactions than would be possible with a mortgage.
A financial adviser recently contacted AEI Capital Corp. to inquire about the availability of TIC properties. Two weeks later the 1031 closing was complete, and the adviser's client was earning income as a TIC co-owner of a single-tenant, retail property located on an outparcel of a major mall. The average cash investment in the property was $314,000 at an initial yield of 6% prior to any rent escalations.
Because most lenders require that all TIC buyers be signed up in advance of releasing their funding, if this TIC purchase had included a mortgage, the adviser's client would likely have not been able to complete his 1031 exchange within the prescribed IRS time limits.
In fact, 1031 deals that are leveraged to acquire the property can take several months to close. Another advantage unique to all-cash TICs is less risk of a capital call.
Leveraged deals face hurdles
Although TIC offerings requiring leverage are still offered, they are considerably more difficult to organize in today's illiquid market. Historically, TIC sponsors have relied on aggressive financing terms available from conduit or commercial mortgage-backed securities lenders. Due to the residential mortgage crisis, the CMBS market has virtually shut down, sending TIC sponsors scrambling to local and regional banks for financing.
While debt financing is still available, many regional and local banks are subjecting TIC borrowers to higher equity-to-loan ratios, full or partial recourse, and limits on the number of co-owners who may participate in the ownership.
As financing becomes more expensive and difficult to obtain, the advantages of an all-cash strategy become more meaningful for the 1031 or TIC investor. A marginally lower initial yield, in the eyes of many investors, is more than offset by the savings of fees and lower risk.
Robert Johnson is president of St. Paul, Minn.-based AEI Capital Corp., one of the nation's oldest TIC sponsors. He can be reached at [email protected]