FEATURE ARTICLE, MARCH 2008

NERVOUS TICS?
Despite the wary market conditions, TICs have an overall positive outlook.
Michael Franklin

As the national capital markets continue to respond to challenging circumstances and look to move forward in 2008, the current credit environment is impacting a number of lending products. Sparked by the mid-2007 subprime lending crisis, the ripple effects from this nationwide credit crunch have been felt throughout the commercial lending marketplace. Tenant-in-common (TIC) investments, an increasingly common approach to real estate investing that has gained momentum and popularity in recent years, is certainly not immune to the difficulties.

TIC investments, where groups of individual owners each hold a deed for a percentage interest in a given property, make it possible for solo and small-group investors to get involved in some larger, generally more expensive commercial properties. By enabling a larger pool of investors to explore opportunities that would otherwise be more suited to institutional investors, TICs have proven to be an appealing alternative to sole ownership of real estate. But with 2007 projections down dramatically from past years, with an anticipated overall equity volume of approximately 3.6 billion (down from closer to 5 billion in 2006), it is clear that some would-be investors are, by necessity or by choice, re-examining their options. These are in fact the lowest numbers for securitized TICs since 2005. But how widespread is this phenomenon? How much of a short- and long-term impact is this really going to have on TIC investment strategies?

Despite the shift from the generally favorable commercial real estate market conditions that have been in place for the last several years to more of an uncertain climate, the overall outlook for TICs is a positive one. In fact, in many ways, the current challenges may prove to be a healthy development; a much-needed correction that will realize long-term benefits for the overall health of the product. The pendulum has swung from what might be characterized as an unbridled optimism bordering on greed, to something more akin to fear. While both postures represent opposite extremes, there is a definite benefit to a more cautious and thoughtful investment approach that tighter markets demand.

With the overall cost of lending going up, and quality real estate becoming less affordable, costs are rising at the same time that many investors are clamoring for higher returns. The result is a general lending slowdown. Another contributing influence is that one of the significant growth factors in the TIC industry was that people were willing to sit on non-performing properties. As that has changed, it has further contributed to an overall slowdown. More expensive debt has resulted in an overall correction, and while that correction is a necessary and healthy part of cyclical market trends, it is nonetheless having an impact. The adjustment to the cost of borrowing is putting additional pressure on TIC sponsors, who are looking to respond by reevaluating some of their core processes and refocusing on basic priorities. In general, the market is re-emphasizing the need for extensive due diligence, and there is and will continue to be a growing trend toward prioritizing deals with lower risk, rather than those with potentially high returns. It is important to keep things in perspective and understand that this cautious posture is a very natural response to the industry-wide pressures applied by rising costs, real estate concerns and uncertainty in the capital markets. Higher-quality tenants, properties in primary markets, and low acquisition costs will all take on increased value and importance in the current environment. 

Despite the overall slowing impact that the current state of the real estate and capital markets is having on TIC investing, the question remains, is such a slowdown really a bad thing? In a way, the current credit environment has only accelerated a trend that has already been noted by savvy investors and industry observers. To some in the industry, it was becoming evident that there was a glut of deals in the marketplace. Smaller and less experienced sponsors who do not have the financial resources or long-term stability to thrive in such an environment will inevitably be weeded out, and the market will continue to undergo a certain degree of consolidation. That consolidation is actually somewhat of a silver lining, both for sponsors and investors alike. As market forces thin out the opportunistic herd, the more experienced and responsible investors will be working with what will be a proportionately bigger pool of quality investments. Investors will be looking to sponsors who are pre-capitalized, who have a demonstrated history of securing stable, reliable financing relationships, and who have shown themselves to be reliable prognosticators; making thoughtful, accurate projections in the context of local, regional and national market forces.

For those experienced, knowledgeable TIC sponsors with a good track record, the outlook is generally positive. For many sponsors, the sound strategic approach looks to be a combination of continuing to offer a reliable, professional service and, to a certain degree hedging their bets by offering a more diverse range of TIC investment products. While TIC investing, like any investing, is not without risk, sound, well-thought-out TIC transactions tend to have a relatively low level of debt and generally represent a fairly stable, conservative investment. The complexities and coordination necessary for bringing together multiple parties into a single profitable investment represents the biggest logistical challenge to any successful TIC, and that has not changed.

The bottom line is that while the industry as a whole has undoubtedly faced, and will continue to face an array of evolving challenges, the overall outlook for TIC investing is still a positive one. In boom times, virtually anyone can make money, but it takes a stretch of less-than-ideal market conditions for the cream to rise to the top. As we move into 2008 and beyond, look for intelligent, thoughtful, disciplined, savvy investors and sponsors to continue to forge profitable relationships, perform responsible due diligence, and invest in the kind of projects that will deliver long-term investment results, regardless of the shifting vagaries of a fickle marketplace.

Michael Franklin is executive vice president of FORT Properties, Inc.

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