Cathy Scullin
was in a pickle.
Enticed by
high prices, the Beverly Hills, Calif., commercial real-estate
broker began selling off pieces of her small southern California
real-estate portfolio about two years ago. Only then did she realize
she couldn't use the profit to buy another property.
"Everything
I found needed an enormous amount of work and, in my opinion,
was way overpriced," says Ms. Scullin. If she didn't reinvest
in real estate quickly, she would have to pay capital gains taxes
on the proceeds.
Her solution:
a Tenant-in-Common transaction, where she joined a group of investors
who each bought a fractional share of investment property--in
this case a small retail center.
TICs--the
real-estate version of chipping in for a pizza and then grabbing
your own slice-have been around for years, but their popularity
soared in 2002 when the Internal Revenue Service said they would
be allowed for so-called 1031 Exchangers. That refers to the portion
of the U.S. tax code that allows investors to defer capital-gains
taxes if they reinvest the proceeds of an investment-property
sale in a "like kind" of property within 180 days.
Though it
is too early to know if most of these investments will pay off,
TICs are proving particularly attractive to baby boomers who invested
in real estate years ago but, upon retirement age, are looking
to shed the hassles of management, such as spending on upkeep
and negotiating with tenants. Investors can get the benefits of
property ownership-rental income and profit on any future sale--but
leave the day-to-day details to professional managers. "It's something
they can understand, it's relatively safe and it produces income
that can grow over time," says Marc Paul, president of Los Angeles-based
SCI Real Estate Investments, one of the largest TIC companies
that match properties and investors. (Graph Insert)
In 2002,
about $550 million flowed into TIC investments, according to the
research firm Real Capital Analytics, Inc., based in New York.
In 2005, TIC transactions surpassed $6.4 billion.
As the number
of investors and TIC companies increased, so have the blockbuster
deals. At least five recent TIC acquisitions topped $100 million
each, according to Real Capital Analytics.
But here
is the rub: As with all real-estate investments, TIC property
can fail to meet projected returns and investors should perform
due diligence as with any piece of property. Real-estate experts
also warn that TIC investors, focusing too narrowly on the tax
benefit, may be bidding up prices on marginal deals. Another possible
pitfall: If an investor needs to get out before a property is
sold, it may not be easy to find a buyer for the share.
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TICs
are proving particularly attractive to baby boomers who
invested in real estate years ago but, upon retirement age,
are looking to shed the hassles of management.
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Gary Gorman,
managing partner of The 1031 Exchange Experts LLC, an investment
advisory firm, says his company tracked the case of an apartment
complex bought by a TIC two years ago. He says the complex, which
he declines to name, was on the market for $15 million, but was
really worth about $12 million. A TIC company promised to pay
the $15 million, then sold individual shares to investors for
a total of $18 million. "The building is still only worth$12 million,"
Mr. Gorman says. "So that property has got to appreciate 50% before
those people are going to break even."
Mr. Paul
of SCI believes those are isolated incidents, saying his company
often finds itself outbid for properties by pension funds or publicly
traded real-estate investment trusts. "We're just paying the market
rates."
Gilbert Reese,
a retire ophthalmologist from Menlo Park, Calif., says his $750,000
investment in two TIC's in 2001 hasn't worked out. In one of those,
he says high-profile tenants emptied out of a Denver-area office
building as the tech market soured. A new tenant recently moved
in, but he says its rental rate is considerably below the original
leases, reducing the likelihood of cash disbursement to the investors
for some time. So far, he hasn't found a buyer for his share.
Tony Thompson, chief executive of Triple Net Properties LLC, the
Santa, Calif.-based TIC investment company that managed the transaction,
says that, unfortunately, the building was bought at market peak,
but he believes the Denver market is showing signs of recovery.
But Ms. Scullin,
the Beverly Hills broker, is happy with her TIC's $16.8 million
investment in a retail center in Rancho Cucamonga, Calif. "It's
something I could never dream of owning on my own," says Ms. Scullin,
who is now investing in her 12th TIC. Returns for her properties
have met projections, she adds, though none of her TIC investments
have been sold yet.
Experts say
that many investors simply won't know if their TICs will pay off
until more properties are put back on the market. Says Harold
Hunt, a research economist with the Real Estate Center at Texas
A&M University, "We're just not far enough down the line yet
to say whether this is a great idea or a bad idea." |
