TIC investors don’t get much sleep these days. The recent conviction of Carlton Cabot may have put one of the most notorious TIC promoters behind bars but there is still a tremendous amount of bad behavior involving tenant in common financed real estate projects. In this post, we will discuss some of the problems faced by Tenant-in-Common investors and some of the warning signs.
First, a brief history of TIC investments.
IRS Opens the Door to TICs
A IRS revenue ruling in 2002 allowed certain investors to pool their money and invest in large real estate projects. Prior to that ruling, it was difficult for the average individual investor to purchase or build a warehouse, office building or shopping center. Those projects were reserved for the wealthiest of individuals and institutional investors. Ordinary people with a couple hundred thousand dollars to invest were suddenly allowed to pool their money and directly participate in these big projects.
Pulling these deals together requires a promoter and often stockbrokers or other investment professionals to assist in peddling these deals. The promoter finds a viable project, arranges for financing and then seeks to raise down payment and initial operating funds. The promoter does this by creating a TIC structure where up to 35 people each purchase an interest as a tenant in common.
The 2002 IRS rule (Revenue Ruling 2002-22) allowed taxpayers looking to rollover money in tax free exchanges to buy into a TIC deal instead of scrambling for another piece of property. For example, let’s say Jane sold a second home and had a $250,000 gain. Unless she finds another property in which to rollover those funds, Jane may have to pay the tax on that gain. The TIC structure allows her to invest by rolling over her funds into the project along with dozens of other people. The IRS revenue ruling lets her continue to defer taxes on the gain.
On paper, these deals make a great deal of sense. Unfortunately, the TIC deals attracted several shady characters. We have represented well over hundred TIC investors that were victims of predatory TIC schemes. Many of these folks are elderly or at least retired. While they are almost all sophisticated individuals, most don’t have commercial real estate management experience. Instead, they rely on the promoter or a professional manager.
TIC Scam Warning Signs
First, make sure that when you sign the initial TIC documents, insure that all notices go to you and not the promoter or manager. Because most of these deals require the investor to create a single purpose entity LLC to serve as the actual owner / borrower, the manager has a legitimate need to receive all notices too. If an investor lets his or her LLC to lapse, there could be a technical default under the loan. That means it is okay for both you and the manager to get notices.
In the many Carlton Cabot scams we have seen, Cabot had the notices all being sent in care of one of his companies. That let him steal rent monies for months without the investors ever seeing a default notice. The default notices were sent by the lender to each of the TICs but all were sent in care of the wrongdoer.
Second, consider forming a steering committee among the various TICs. Individual investors tend to be absentee owners and managers and others know this. If you form a committee, someone can periodically visit the property and it’s easier to organize if problems arise.
Is the property run down? Is maintenance being deferred? Do the occupancy reports match what you see? Of course, the reports sent from the management company are always going to be glowing. There is no substitute, however, for visiting the property. With a committee, there is a better chance that the investors have more involvement in their property.
Having a steering committee also makes it easier to exchange information and follow up on rumors.
Third, let’s talk more about those reports. In one of the Cabot deals, we learned from our clients that several months had lapsed since receiving a report. That is a huge red flag.
At an absolute minimum, the report must contain a current rent roll with lease expiration dates, reserve balances, cash balances, accounts receivable with aging and accounts payable. The report should also have copies of actual banks statements including a statement from the lender or loan servicer. A general ledger with all checks and transfers should also be included.
If you are just getting an executive summary and no documentation, be worried.
It is easy for us to make these recommendations, but dishonest promoters and managers will make obtaining this information difficult. One TIC group told us they weren’t allowed to see full financials.
Nonsense! The TIC deals we see have a provision in the management agreement giving investors a right to audit and inspect. If the manager tells you “no”, something dishonest is likely going on.
Something as simple as forming a steering committee can be difficult if the promoter won’t share the names of the other TICs. Once again, the management agreement usually says otherwise.
It’s easy for a manager or promoter to say no. Unless the TICs have formed a committee, they often don’t know what they can and can’t do, are afraid of taking on the manager alone and are often 1000 or more miles away.
Fourth, one of the biggest red flags are groups with no exit strategy. We have written several posts about the big bubble of TIC loans coming due in the next few months. Most of these loans were written in 2016 and 2017 and had a ten-year term. A good manager should be engaged with the owners at least a year in advance.
Bad managers don’t care, are lazy or unprepared or have more nefarious schemes in mind. It isn’t uncommon for the manager to allow the property to suffer a maturity default and then try to acquire the property for a greatly reduced price.
The closer maturity becomes, the fewer options each TIC has. That allows the manager to bring in “white knight” investors who charge huge fees and / or demand a large ownership percentage in the project in exchange for infusing enough cash to permit refinancing.
MahanyLaw and Judge, Lang & Katers – America’s TIC Lawyers
There are only a handful of law firms that represent TIC groups. Some are work out firms, some are litigation firms. The law firms of MahanyLaw and Judge, Lang & Katers are unique in that we do both. We are two national boutique law firms that combine forces when representing tenants in common. Whether it is suing a manager for mismanaging funds from the property or helping TIC groups do a roll up to secure new financing or protecting TICs from predatory loan servicers, we can help.
Midwest rates, nationwide service, and experience shared by very few.
For more information, contact attorney Chris Katers at [hidden email] or by phone at (414) 777-0778. The author of this post, attorney Brian Mahany, can be reached at [hidden email]. We also invite you to visit the TIC fraud information page on our sister Mahanylaw site and the many TIC article in their text searchable blog (use the search term "TIC fraud").