Posted by ray@lcorn on May 10, 2007 at 11:55:45:
There are significant expenses in creating a TIC.
Legal costs top of the list due to the double exposure to both real estate tax regulations and securities regulations, plus the need to be compliant in multiple states. Finance costs are higher due to the need to match individual debt amounts for 1031 investors, which necessitates a syndicated loan at the lender level. Marketing costs may include more than one layer of commissions if acquired through a financial advisor or anyone except the sponsor.
Then there are the ongoing expenses that have to be paid from the operating income of the property. These include property management, accounting and reporting to all fractional owners, and the sponsor’s fees and percentage of profits.
On the latter, many are set up similar to hedge fund and private equity managers on a 2/20 model: 2% of the total asset value as an annual asset management fee, and a 20% kicker of the profits and distributions before the investor’s distributions. (That is changing though… I saw an offering last week with a 2% management fee and zero profit kicker. The sponsor is retaining 20% ownership alongside the fractional interests and shares equally, a much better alignment of interests.)
That’s why my comment in the 2005 post likening these things to frozen food… yes, they are hands-off investments that preserve the tax advantages of real estate, but the investor pays dearly for the convenience.
In fact, after all is considered it is somewhat surprising that they can meet 7%-8% return targets. What we don’t hear much about are those that don’t. To that issue there is one more caveat?there is still no liquid market for TIC interests, which means getting out is harder than getting in.
All that said, and as I mentioned in the post above, for certain purposes, e.g. estate planning, retirement, etc., a well-constructed TIC can be an excellent investment where modest returns are sufficient for the objective of preserving wealth and tax efficiency. But they are not comparable to the returns of independent direct ownership, and do carry more risk than CTL deals. Since market valuations (remember that TIC syndicators are up against the same valuations in the market as the rest of us) and added TIC costs preclude an appropriate risk premium , the onus is on the investor to mitigate the risk exposure with thorough due diligence on two levels, sponsor and property.