Tenants in Common Losses have Lots in Common with other Squeezed Investors

Delray Beach, FLHere we go again—yet another example of how someone may have been promised a bill of goods, only to be sold something else. In this latest example: investments of tenants in common, or Tenants in Common TIC investments. These are products tied to the commercial real estate sector. Needless to say, Tenants in Common stocks have been hammered of late, and not for quite the same reasons as an investment in the stock market might be exposed.

A TIC investment is, in reality a fractional ownership in a commercial property, such as an office tower or some other commercial, or tenant-occupied building. The investor gets the benefit of participating in a sector that, by himself, he wouldn't be able to afford. Much like the way the cottage, and vacation property industry has gone. For many, sole ownership of a waterfront property is well beyond their grasp, what with soaring prices and rates of taxation.

With fractional ownership, the investor gets all the benefit of the building and the location, without the usual headaches that go along with it. You might only use the place a couple, or three weeks out of the year for family vacations anyway. Thus, you buy just that. Suddenly, you own three weeks worth of a cottage for, say, $30,000—vs. 52 weeks with all the upkeep to boot for a million.

Tenants in Common stocks are in many ways similar, although they can—and have—been sold as either a real estate entity, or a stock product. Plus there are other benefits, such as the capacity to defer capital gains.

Here's the problem. Experts are predicting that commercial office space is going to be the next big loser in the economic downturn. Companies looking to preserve cash flow, or worse—laying off staff and facing a downsizing of operations—are moving to smaller, more efficient quarters. If employees can telecommute and work from home, who needs office space at all? Web conferencing brings people together, and you can rent a hall for a day if you need to see people face to face.

In south Florida, commercial property foreclosures are expected to represent the next wave in the recession. "We're in a market right now where there's almost no demand for large ... space," said Greg Martin of Cushman & Wakefield, the leasing agent for 500,000 square feet that Office Depot recently left behind at its former Delray Beach headquarters.

Businesses cutting jobs have led to more office, retail and industrial vacancies. Ultimately, landlords will be forced to reduce rents, which will mean a decline in property values, according to Neil Merin, head of NAI Merin Hunter Codman in West Palm Beach.

What does all this have to do with TICs?

Plenty. Tenant in common vehicles were hoarded as commercial property values steamed ahead. Brokers, who are said to have earned a healthy commission from the sale of such products, are alleged to have led their prospective clients down the garden path by suggesting that the investments were safe.

Little wonder, with stories like that of Frank Schmidt, a small business owner in San Jose who joined a TIC that purchased Heritage Corporate Center, a business park located in Santa Fe Springs, California. On his own, he wouldn't have been able to afford to finance the $57.3 million needed to undertake the complete buy. But he could manage a small piece of it.

When the property sold for $84.2 million this past spring, Schmidt cashed out and realized an annualized rate of return representing 57 percent. He more than doubled his money.

Tenants in common TICs first emerged in the late 1990s, and while there are various requirements—there can be no more than 35 partners, for example, and investors have to meet wealth requirements of $1 million in net worth or annual income of $200,000 for at least three years ($300,000 per year for a couple)—the growth of TICs have grown practically off-scale. At $167 million worth of invested capital in 2001, levels increased to $1.8 billion by 2004 and hit $3.2 last year.

According to Omni Brokerage Inc., a TIC sponsor based in Salt Lake City, that figure was expected to reach $5.4 billion in volume this year.

Yes, but now the economy is in serious trouble. The value of commercial real estate is dropping, and there have been bankruptcies within the TIC community. Investors are losing money and some have lost substantial amounts.

Were they warned? Was this risk, and potential for losses communicated to them? There are growing signs that many brokers and sales agents did not, leaving investors with the false impression that their investments were safe.

For many investors, the gravy train has come to a halt. The monthly checks have stopped. Like so many other sectors, trouble is blowing in the wind—and there could be equal trouble for brokers and sales agents who failed to disclose the various risks associated with tenants in common investments, to investors. As such they may have breached their fiduciary duties to the Tenants in common TIC investor, and could be held accountable for losses in Tenants in common stocks.