TIC investments are not risk free. Investors must consider liquidity and control risks along with market risk, management risk and economic risk. If the TIC interest is sold as a security, the risks will be specified in a Private Placement Memorandum (PPM) required by the SEC. A PPM is not required with TICs sold as real estate, although some sponsors choose to issue them anyway.
Liquidity risk (involving divestment of the TIC interest) should be a prime investment concern. A well-conceived exit strategy must consider the sale of both the individual TIC interest and the entire property.
The IRS guideline states that "each co-owner must have the right to transfer, partition and encumber the co-owner's undivided interest in the property without the agreement or approval of any person." Investors wishing to sell an individual TIC interest not as a part of the entire property may encounter problems.
The guideline goes on to say, "restrictions on the right to transfer, partition, or encumber interests in the property that are required by a lender and that are consistent with customary commercial lending practices are not prohibited." As a result, lenders may include a number of limitations designed to protect their investment when an investor anticipates selling a TIC share. For example:
- Lenders may require their prior approval before an investor transfers a TIC interest.
- Lenders may attempt to restrict a TIC investor's ability to partition the property by demanding prior approval before modifying or terminating the TIC agreement.
- Lenders may mandate a minimum holding period for any large investors, especially in the case of recourse financing, which allows an investor's personal assets to be taken in a loan default.
- Lenders may require that 100 percent of the TIC investors agree to any single investor wishing to sell their interest.
- TIC loans are now being packaged and sold in the commercial mortgage-backed security (CMBS) market. As a result, some lenders may require that a rating agency confirm the creditworthiness of new TIC investors before they are allowed to buy in to reassure CMBS investors.
- All TIC interests sold as securities must be purchased by "accredited" investors as defined by the SEC. TIC interests sold as real estate are not bound by this rule. Even so, lenders may want to ensure the creditworthiness of investors before approving the financing of a TIC property.
- Although the IRS limits the number of TIC co-owners to no more than 35, some lenders may wish to further restrict this number to reduce their underwriting costs.
Even if a TIC investor can secure permission to sell the TIC interest, locating a buyer can be difficult. No secondary market exists for the sale of TIC interests. However, TIC agreements are generally structured to give the other investors in a TIC deal the first opportunity to buy an interest before it is offered to outsiders.
TICs are so new that most investors have owned their interest for only a short time. The relative newness of TICs presents valuation challenges as well. Although an appraisal of the whole property being sold to a TIC sponsor is fairly straightforward, the valuation of an individual TIC interest may be more difficult because of lack of comparable sales data.
A TIC buyer's motivation could be another consideration in the valuation of a TIC interest. Some investors may purchase a TIC interest just to avoid capital gains taxes without adequately considering the strength of the underlying deal structure as an investment. As a result, an argument could be made that some TIC investors may be overpaying. Until more TIC interests are sold, appraisers may be reluctant to value an individual TIC interest.
In regard to control risk, a tenant-in-common relationship prevents control of the property by any one person. IRS guidelines state that "any sale, lease or re-lease of a portion or all of the property, any negotiation or renegotiation of indebtedness secured by a blanket lien, the hiring of any manager or the negotiation of any management contract (or any extension or renewal of such contract) must be by unanimous approval of the co-owners."
The practical result of this clause is the ability of any single TIC investor to veto major property decisions. Although this represents a loss of control by other individual investors, most TIC agreements employ a call option that allows a majority of TIC investors to buy out the TIC interest of any investors in opposition.