With the ever increasing competition in the commercial real estate marketplace, the broker who understands the role of TICs as it relates to his potential client will have a true advantage on his competition. Creativity in the selling process can make the difference in closing the client or losing the client to another broker. An understanding of 1031 strategies can aid the broker in closing a difficult sale.
In a normal 1031 exchange the client will sell his income producing property and will replace it with another in order to defer the capital gains indefinitely; however, because of the IRS regulations, it may be difficult to meet all requirements necessary for a successful exchange. For example, in order to qualify as an exchange, the replacement property must be identified within 45 calendar days after escrow closes. Sometimes this is easier said than done. Not being able to identify the proper property could result in the nullification of the exchange, thus resulting in a taxable event for your client.
Other problems could potentially exist, as well. For example, in a marketplace where values are rapidly rising, such as southern California, Las Vegas or Phoenix, selling a highly appreciated property could result in replacing the property with another that has also highly appreciated. This transaction would create little, if any, potential benefit for the client.
In some cases, the client would like to sell his property but would also like to retire from the real estate market. In this instance, the purchase of another property would not solve the client’s desire to no longer deal with the termites, tenants or toilets.
Additional potential problems may include the concern of finding a replacement property with the proper loan to value ratio or finding a property that would allow the client to use 100% of the replacement values in the new property. Any portion of the sale not used in the exchange may be subject to capital gains taxation.
Understanding the benefits of using a TIC in a 1031 exchange can help the broker convince a client that a TIC can be an option. Many clients may be hesitant in selling their property for the reasons mentioned above. For example, a client may worry about finding and identifying a replacement property in the 45 day period. A TIC could be an option. The market for replacement properties can change rapidly. One week there might be numerous available properties, and the next week the supply might have drastically reduced. Using a TIC as a second option in case an adequate property is not available may ease the fears of the client. It also allows the broker to make a sale that otherwise might not have been made.
Geography can be another obstacle in an exchange. In areas where most, if not all, properties have greatly appreciated, there may be little reason for a client to sell because the client would be forced to exchange for another highly appreciated property. Thus, the broker loses a sale. TICs offer geographic diversity because a TIC property can be located anywhere in the country. The due diligence and the disclosures statements give the client the opportunity of accessing all information and potential risks of the property anywhere in the country. Ideally, a replacement property would be located in a market that has been depressed in the past but is now on an upswing, which would allow for potential property appreciation. Therefore, another advantage of a TIC is that it allows for geographic diversification for a client who may not have the ability to search nationwide for a replacement property.
Another benefit to understanding TICs is that they are almost always institutional properties. These properties may range from large apartment complexes to office buildings to industrial parks anywhere in the country. They give the client an opportunity of ownership in an institutional property normally reserved for pension funds or larger corporations. The sponsor will provide professional management of the property and is responsible for all leasing, insurance, taxes and any other items associated with ownership. In addition, many properties have a master lease, which is a contractual obligation to pay the stated interest rate to the owner regardless of any circumstances concerning the property. Many clients relish the thought of ownership in these properties without having to deal with any of the potential problems associated with owning real estate.
Finally, perhaps the most important aspect in utilizing a TIC is the due diligence process. The sponsoring real estate firm, as well as the broker dealer, will spend a tremendous amount of time reviewing all aspects of each property. Properties are underwritten by the sponsoring real estate firm and diligently reviewed by independent outside firms in an attempt to fully disclose all potential risks to the client. These disclosures are made through a Private Placement Memorandum.
Every potential client has his own particular circumstances and should consider all options before deciding what is most appropriate for him. For the appropriate client, a tenant in common program offers a viable option in a 1031 exchange. The commercial broker who understands 1031 strategies utilizing tenant in common programs has a huge advantage over the competition. In today’s market it could mean the difference in making the sale or losing a client.