However, in order to fully realize the advantages of investing in real estate, one must be very educated and make sure that he or she is really investing in real estate, rather than speculating in real estate. Unfortunately, many of the people who most recently pulled money from the stock market to invest in real estate were not real estate educated and paid far too much for properties in a seller’s market because they hoped to make a killing as property prices continued to climb at record rates. Before the recent housing bubble burst, investors who knew what they were doing (and some who just plain lucked out) sold in time and made substantial profits. Many others were not so fortunate. Numerous so-called investors got caught at the top of the appreciation bubble and now have property that is worth far less than they paid for it, and many more that were in this situation ultimately lost those properties through foreclosure. If a person’s only plan for profits is continued real estate appreciation, he or she is speculating, not investing.

Many of the people who pulled money from stocks and bonds to invest in real estate were not looking to build a business buying and selling properties or renting properties, but were looking to invest in a vehicle that would give them all of the benefits of real estate ownership without any of the responsibility or hassles. These passive investors found a home in real estate investment trusts (REITs), real estate partnerships, and tenant-in-common (TIC) properties.

For many years, the favored way of investing in real estate for passive investors was the limited partnership. However, in recent years, educated investors have been opting for TIC and REIT-type investments as the preferred way of getting the benefits of real estate ownership without being saddled with the property management issues normally associated with real estate. REITs and TICs are both controlled by managers who make all of the day-to-day decisions, meaning the investors need not do much more than cash their monthly checks.

Real Estate Investment Trusts (REITs) – A REIT is a corporation or trust that uses pooled capital from many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT). REITs are traded on major exchanges just like stocks. REITs offer some benefits over actually owning properties. First, they are highly liquid; unlike traditional real estate, shares can be rapidly bought and sold. Second, they allow the small investor to benefit from various types of commercial real estate, from malls and hotels to large office buildings and apartment complexes. A major disadvantage of a REIT is that they do not qualify for 1031 exchange treatment, since REIT investors are not on the property title. REIT investors only own stock in a corporation. A REIT corporation must pay out 90 percent of its taxable profits in the form of dividends to the shareholders to keep its status as a REIT. The right REIT can provide a nice monthly income, but as with any real estate investment, you need to do your homework before you invest.

In recent years, some REITs were bringing in so much money that they were cash rich, and unwise managers paid too much for buildings (based on the property’s income-generating capability) just to spend the money. Some of these REITs are now in trouble with building vacancies and reduced income, resulting in reduced monthly cash flow to the investors. In fact, in some cases, cash flow to the investors has all but dried up. The lesson to be learned is that no matter what entity is used to buy real estate, the purchase price needs to be based on sound economic principles.

Tenant In Common (TIC) Investments – A TIC investment is defined as a property that is owned by a group of individuals who each have an undivided interest in the property. In other words, each individual is actually on title to the property and owns a fractional interest in the entire property based on their investment amount as compared to that of the other investors. For example, Joe might own 10 percent, Bill 15 percent, Mary 31.5 percent, Fred 7.563 percent, and so on. At one time, there were lots of questions as to how TICs should be structured and how many people could be involved in their ownership. The issuance of IRS Revenue Procedure 2002-22 gave TIC investments some rules and guidelines. The IRS procedure indicates that TICs can have up to 35 different owners and that, if structured properly, TIC investments qualify for a 1031 exchange, in which owners can turn deeded and undivided interests in their smaller apartments (or any type of real estate investment) into partial ownership of high-quality, institutional-grade properties, formerly out of the common investor’s reach and only in the purview of REITs, pension funds, and other major investors. Cash investors can also benefit from a TIC investment and 1031 exchange-out when the property is sold. The goal of most TICs is to hold the properties for five to seven years and then sell at a substantial gain. For the investor who wants a monthly cash flow without any management responsibility at all, TIC investments make great sense. And when the property is sold, they share in the profits.

All TICs are not created equal, but when you do your homework and make wise decisions, there are many advantages to investing in a TIC:

1. TIC investments are great for people who are tired of being landlords but still desire the benefits and safety of real estate ownership. Rather than selling their properties outright and paying a huge amount of money in capital gains taxes, they can 1031-exchange the entire sales proceeds into a TIC property, postpone any capital gains tax, and still reap the benefits of real estate ownership without any of the management responsibilities.

2. Any type of real estate held as an investment qualifies for a 1031 exchange into a TIC property. For example, many people have farm ground that is now surrounded by homes and new developments. The property may have been in the family for generations, have a zero basis, but is now worth two million dollars to a developer. If the property is sold without a 1031 exchange, capital gains taxes (federal and state) could take over 25 percent (>$500,000) of the proceeds. With a 1031 exchange, all $2,000,000 can be invested in a TIC property, generating a healthy monthly income with no time or management requirements.

3. Many different types of properties are available for TIC investing: apartment complexes, commercial office buildings, malls, mixed-use facilities, etc. You can exchange your raw ground for part ownership of an apartment complex, your two duplexes for a part ownership in a Class A office building, etc. TICs offer great flexibility.

4. The IRS requires 1031 exchanges to be conducted between properties that match in value, dollar for dollar. If there’s a mismatch, the owner has to come up with additional money for a new property with a higher value or pay some capital gains tax if a new property is of lesser value. This problem is eliminated with a TIC investment, since the exchange can be made for a fractional interest in the TIC that exactly matches the proceeds from the property being sold.

5. Another 1031 exchange rule requires that the debt on the new property be equal to or greater than the selling property. Again, since the TIC property has debt that is attached to it, the person doing the 1031 exchange can match the debt requirements as well. This eliminates a lot of the 1031 exchange headaches.

6. An additional 1031 exchange requirement that is solved with a TIC investment is the restrictive time requirements for a 1031 exchange. From the date of the sale of a property, the owner has 45 days to identify up to three replacement properties for the exchange and has to close on the replacement property within 180 days. Finding suitable replacement properties (within the 45-day time frame) that meet the owner’s needs can be difficult at best. Many times the properties are sold to another investor before the owner can finalize his purchase but after the 45-day identification period has ended. Ouch! The owner is stuck paying the capital gains taxes. By identifying a TIC property, the owner can be assured that the property will be available for purchase, since his portion is just a piece of the larger property.

7. TIC investments allow an investor to diversify property ownership into other areas of the country, where the real estate market and growth potential may be much stronger than in his own backyard. With no management worries, the TIC investor can own properties all across the country.

8. A TIC sponsor who is selective about the prices they pay for properties can provide an opportunity for the TIC investors to obtain a good return on their investment, even in a weak real estate market. Values of commercial investment properties are directly proportional to the net income they produce. Major factors that affect the net income are proper management, reduction in expenses, increases in rents, and increases in overall occupancy. Proper management resulting in an increase in the net income and a proper original purchase price, will result in an increased property value and profit for investors when the property is sold.

9. Most TIC investments qualify for funds that are invested in IRAs, 401Ks, etc. Many wise investors have moved some of their IRA funds into TIC investments in order to diversify their portfolio. Millions of dollars have been invested into TIC investments this past year; those who moved their retirement savings out of the stock market and into stable, safe, real-estate-backed TIC investments before this latest market crash are very happy investors today.

TIC investments can be very beneficial and offer opportunities to invest in commercial grade real estate that is normally out of reach for individual investors. However, as with all real estate investments, one needs to do the proper research before investing. Here are some tips that will help in choosing a company that will meet all of your expectations and provide you with a safe, secure, and rewarding investment experience:

• Invest with a company that has a great track record. Track record is not a guarantee of future performance, but it is a very good indicator of the management skills and ability of the company. No matter what dollar returns are projected, you really don’t want to go with the new kid on the block with little or no history.
• Do not invest with any company that does not provide audited financial statements for its investors. An independent financial auditor needs to prepare the reports. Without that overview, how do you know if the reports really reflect what is going on?
• Do not invest with a company that does not stay involved as an owner alongside the other investors. Good TIC sponsors will retain a fractional ownership of the property and also provide the property management. Part of the profits they get from the property when it is sold in five to seven years comes from their fractional ownership. This ensures that they do the best job possible managing the property, minimizing expenses, and maximizing income. Their own profits depend on good performance. Avoid TIC sponsors who only syndicate the project. Some TIC sponsors raise money from investors, then go out and find a property, mark that property up a few million above their negotiated purchase price and sell property to the investors at the inflated price. They don’t stay in as part owner with the investors. They make their profit from the sale to investors and have no vested interest in helping the project succeed from that point on, since they have already made their profit. The wise investor will invest with a sponsor who is also a part owner and manager of the property.
• Invest with a company that has owners who are very strong financially and are willing to sign on the recourse carve outs. Most commercial loans are non-recourse loans. In other words, if the property was ever foreclosed on, the bank could only take the property back and not come after the owners for a deficiency judgment (if the property was sold by the bank at a loss). But banks also want someone with deep pockets to sign what they call recourse carve outs. This means that if there were any fraud or mismanagement that caused a foreclosure and a devaluing of the property, the bank could come after the personal assets of the people who had signed the recourse carve out documents. Some TIC sponsors want the investors to sign those recourse carve out documents. Don’t do it! Find another TIC investment where the sponsors sign the recourse carve outs.
• Invest with a company that uses a cost-segregation approach to obtain accelerated depreciation benefits for the investors. A lot of the material that goes into building an apartment complex or any commercial building can be depreciated over five or 15 years (like carpeting, flooring, piping, lighting fixtures, etc.) rather than 27.5 years. A property cost-segregation study will identify the total dollar amount of materials that qualify for this accelerated depreciation treatment. Since the properties will only be owned from five to seven years, it is to the investor’s advantage to use the accelerated depreciation to create greater write-offs during this ownership time frame.
• Make sure you invest with a company who structures the TIC investment so that it meets the IRS requirements and conforms to all 15 points listed in the IRS March 2002 – Rev. Proc. 2002-22. If the IRS were to find that a TIC structure violated any of their guidelines, it could disallow the TIC structure for 1031 exchanges. This would be very costly for the investors.
• Try to find a TIC sponsor who not only has a good track record, but has not had any investor lawsuits in the past. Lawsuits usually indicate that an investor lost money. The absence of lawsuits indicates happy investors. That’s the type of company you want to deal with.
• Invest with a company that only leverages the property to 50 or 55 percent. This means that the monthly cash flow may be a little lower, but in the long run it means a safer, more secure investment.
• Avoid companies that use higher-leverage, interest-only loans just to provide a little higher monthly return. Higher loan-to-value and interest-only loans create more risk for the investors.
• Find a company that deals in newer properties – brand new is best. Newer properties mean less maintenance and fewer repairs, which produces increased net cash flow, which equals a higher property value, which results in a higher selling price, more profit, and happier investors. Plus, newer buildings are easier to lease and will bring higher rents, which also means higher returns for the investors.

TIC properties can provide you a safe and secure investment vehicle and provide very good returns. They can become an important part of your investing strategy and provide a way to maximize your profits through 1031 exchanges. Be sure to wisely choose the company you deal with and you will sleep much better at night. Then your only responsibility will be to deposit your check each month. You will love being a mailbox manager!

David Boyd is a real estate investor and owner of Wasatch Front Homes, LLC in Farmington, Utah. He is also a licensed securities agent with Regent Capital Group, specializing in 1031 Exchanges and Tenant-in-Common investments.