Finally, cap rates in 2004 averaged 6.9 percent on apartments sold to TIC deals, versus 8 percent for offices, 8.1 percent for retail properties and 8.7 percent for industrial buildings, according to Real Capital Analytics, a New York-based research firm.
For Norm Benson, the five TIC-structured deals he’s been part of over the past several years have been matters of simple arithmetic: the tax deferrals saved him money. Benson, a 72-year-old property owner and manager living in Signal Hill, Calif., recently sold an 18-unit apartment building in Long Beach, Calif., for $1.2 million, and moved his proceeds into fractional ownerships of four buildings, including two Phoenix-area apartment complexes, priced at $38 million and $40.5 million respectively, that were sponsored by Irvine, Calif.-based Passco Real Estate Enterprises. “It’s a gamble, like anything else,” admits Benson, who makes a point of visiting each property he invests in. TIC structures have allowed Benson to get into buildings he couldn’t have touched as a sole owner. He takes comfort in the fact that Passco’s founder, Bill Passo, is credited with practically creating the TIC market in the 1990s. And Benson still thinks real estate is a better bet than the stock market, which he calls “a losing proposition.”
Market Matters
But these structures aren’t just putting their money into buildings in the highest-growth markets. As TICs (once a West Coast phenomenon) move north, sponsors seem more willing than other investment groups to consider secondary markets such as Rochester, N.Y. ,according to Dan Fasulo, a senior associate with Real Capital Analytics.
Others have observed the same thing. “REITs and pension funds are exiting secondary markets at a time when TICs are trying to achieve yield and will go where think they can get cash flow,” says Keith Harris, executive vice president of capital markets for The Laramar Group, an owner and manager based in Chicago.
That doesn’t mean, however, that investors are settling on secondary properties; in fact, the opposite seems to be the case. Passco favors Class A buildings with a minimum of 200 units, according to William Linn, the company’s president. U.S. Advisors’ Fitzgerald avoids investing in properties built before 2001 to minimize renovation costs prior to a building’s disposition. And SCI seeks properties in markets “that are starting to turn the corner,” says Scott Derrick, its vice president and director of acquisitions.
The growing popularity of this financial structure has raised questions about its impact on the market and property pricing. For their part, sponsors reject suggestions that the influx of TIC money is inflating prices. Tom Jenke, SCI’s vice president of marketing, notes that any impact TIC activity might have on prices would pale beside last year’s decision by pension funds to double their investment in real estate to $40 billion.
Some industry observers, however, think TICs and their sponsors have become hypnotized by the ever-rising prices and are downplaying, at their own peril, variables that could erode their return and reduce the properties’ resale prospects. “People are doing the analytics to see how far they can push down the yields, without taking into account the value of the property itself,” says Kevin Shields, president of Los Angeles-based broker dealer Griffin Capital, which has yet to find a multifamily property that’s priced to its liking.
The “what ifs” abound: Are tenant-in-common sponsors putting aside sufficient reserves from equity raised to cover revenue or dividend shortfalls from the property? Have they factored into their return equations the market fluctuations that could tamp down rents or cause interest rates to rise or vacancy rates to drop?
These caveats aren’t lost on the tenant-in-common sponsors or reps, who emphasize the credibility and conservatism of their research and their reputations to dispel doubts about whether the exchanges they advance are financially sound and legally bulletproof. 1031 Exchange Options touts its relationship with qualified intermediaries, third-party entities through which exchange money flows that wield considerable influence over investors’ choices. U.S. Advisors maintains a partnership with CB Richard Ellis, which handles due diligence on properties it wants to buy.
“We’re making sure our deals aren’t overloaded in a way that could be construed as abusive,” says Mike Preston, chief operating officer for the Houston-based sponsor Creekstone Partners, “because the general consensus is that this isn’t going to last forever.”