When the sprawling 1.2 million-square-foot Puente Hills Mall in Industry, California, sold in May for $148 million, the buyer might have been one of the usual suspects -- a real estate investment trust, pension fund or life insurance company. Instead it was an eclectic group of more than 30 investors, including 28 individuals, each of whom bought an interest in the property through an increasingly popular investment structure known as tenancy-in-common. TIC investors -- usually an alliance of small-time players who have joined forces for just one deal -- are now competing for the kind of high-quality real estate that was once the exclusive domain of institutions. The deals didn’t really get going until a favorable Internal Revenue Service ruling was published in early 2002, and since then they have become more and more popular. Although TIC investors purchased less than $1 billion worth of real estate in 2002, their holdings are expected to rise to about $2.5 billion this year, says Cary Losson, president and founder of 1031 Exchange Options, a Lafayette, Californiabased broker-dealer specializing in TIC consultancy.
“TIC investors are competing with the big boys on properties, and they are winning,” says Losson, whose firm placed about half of the $56 million of equity that helped buy Puente Hills. “It’s revolutionizing the way real estate is owned across the country.”
Adds Mike Kirby, a principal at Green Street Advisors, a Newport Beach, California, investment research boutique, “TIC investors are beating out REITs and other institutional investors.”
Under a TIC structure, unaffiliated investors buy fractional interests in a property and receive in exchange a direct ownership stake. Many TIC investors are using Internal Revenue Code section 1031, which allows them to avoid capital gains taxes (as much as 15 percent) on the sale of one property if they roll over the proceeds into a qualifying replacement property. TIC properties qualify, but partnership interests and REIT shares do not, which is one reason why investors may prefer TIC structures to partnership arrangements.
The market came to life in early 2002 when the IRS issued a procedural ruling giving new guidance on using the more favorable 1031 tax treatment for TIC investments. “It gave some clarity to the marketplace on what structure would be acceptable,” says William Winn, COO of Passco Real Estate Enterprises, the Santa Ana, California, sponsor of the Puente Hills acquisition and one of the country’s largest TIC sponsors.
Stepping up to the bidding table are large sponsor-managers like Passco and Triple Net Properties, also in Santa Ana, and smaller ones like AEI Fund Management in St. Paul, Minnesota; Argus Realty Investors of San Juan Capistrano, California; SCI Real Estate Properties in Los Angeles; and Tax Strategies Group in Chicago. At the beginning of the year, Triple Net closed on the acquisition of Congress Center in Chicago’s West Loop, a more than half-million-square-foot office asset that carried a $136 million price tag for two of its investment funds and 17 individual investors. It bid against serious competition, reportedly including Wells Real Estate Funds, an Atlanta-based firm that invests primarily through a REIT; and a German investment fund. Wells declined to comment.
Wall Street, not surprisingly, has gotten into the game as a middleman, acting as a broker-dealer along with small speciality shops like 1031 Exchange Options. ING Group, Legg Mason Wood Walker, Merrill Lynch & Co., PaineWebber and SouthTrust, among others, have all jumped in. Their fee: a percentage of the equity they place, usually between 6 and 7 percent.
“Now us folks can compete with institutional funds or public REITs,” says Anthony Thompson, chairman and CEO of Triple Net Properties. “TICs have leveled the playing field.”
