The Securities and Exchange Commission recently issued a statement that could reshape the future of the tenant-in-common (TIC) industry. The ruling could be a blow for those sponsors that sell TICs or fractional ownership as real estate, essentially avoiding securities laws.
On January 14, the SEC issued a response to a “no action” request that supports its existing view of TIC investments as securities versus real estate. As such, sponsors are subject to securities laws related to how TIC properties are packaged, marketed and sold. TICs are a co-ownership structure that allows multiple investors to share ownership in a property such as an office building or shopping center.
What remains to be seen is whether or not this ruling will force sponsors that operate on a real estate platform to change their business model. “People that sell TICs as real estate will likely continue to fight for their position. But if you take a position contrary to the SEC, it’s a difficult road to go down,” says Darryl Steinhause, a partner and head of the real estate securities and finance group for the California law firm of Luce Forward Hamilton & Scripps LLP.
Steinhause submitted the no action request to the SEC in February 2006 on behalf of OMNI Brokerage Inc., as well as TIC sponsors Passco Cos. LLC and Argus Realty Investors, now part of Thompson National Properties.
The no action request submitted two common business models being utilized by TIC sponsors that were syndicating TIC offerings as real estate and who were compensating real estate agents. The request asked the SEC to agree to take "no action" if the companies were to syndicate offerings utilizing either the real estate model or the securities model and were to compensate licensed real estate agents, a practice prohibited for securities.
Nearly three years later, the SEC issued its brief response. Specifically, the SEC statement said that “based on the facts presented” the SEC views the sale of undivided tenant-in-common interests as securities per the Securities Act of 1933.
The intent of the no action request was to clarify the SEC position and level the playing field among TIC sponsors, notes Todd Williams, president and founder of Carlsbad, Calif.-based Todd Williams Consulting, a firm that specializes in direct investment products such as TICs, real estate investment trusts and funds. The real estate side of the business is less cumbersome because it is able to maneuver with fewer regulations and restrictions.
Yet the SEC response to the no action letter does not put an end to the securities versus real estate debate. The SEC response was a concise letter that made it clear that their decision was based only on the facts presented within the specific no action request, and may not be representative of other situations or the industry as a whole, notes Blaine Walker, president of Walker & Co. Real Estate in Salt Lake City, and chair of the Tenant-in-Common Task Force for the National Association of Realtors.
In fact, this is not the industry’s first no action request. A similar request was submitted to the SEC in 2000 that produced much the same response. As was the case in the wake of that particular letter, there will always be those real estate firms that continue to offer the co-ownership structure. Those sponsors typically argue that the SEC no action response does not apply to their unique business model.
However, the latest SEC response coupled with new litigation could force at least the larger real estate-based sponsors to change their platform. The day after the SEC letter was issued, the state of Idaho Department of Finance filed a $9.75 million civil suit against Idaho-based sponsor DBSI Inc. Although DBSI filed for Chapter 11 bankruptcy last fall, the suit claims that the defendants engaged in a scheme to defraud thousands of investors through the sale of unregistered securities by unregistered broker-dealers.
It is that fear of legal recourse or even action by the SEC that could motivate sponsors that had been selling TIC properties as real estate to change their strategy —either shifting to securities sales or perhaps adopting an alternative real estate ownership model such as a limited partnership. Even if a sponsor’s real estate TIC can stand up to SEC and legal scrutiny, the risk and cost of defending that model may not be worth it, Williams notes.