How to Stay Invested in Real Estate without the Burden of Management
by Josh Slaybaugh, Trade Up 1031, Inc
Even in the face of a tumultuous debt market, the fact remains that many real estate investors are increasingly looking to capitalize on their highly appreciated property by selling. However, there is an obvious dilemma for those choosing to defer paying taxes on the sale of a property by utilizing a section 1031 like-kind exchange. That is, “What kind of property should I exchange into?” Real estate investors typically fall into two camps: those who want day-to-day management responsibility and those that don’t. If you are the latter, you have a decision to make: Should I choose between a Tenant-In-Common Investment or a Single Tenant Net-Leased property? How do I determine which investment type is the best option for me?
Firstly, let's define these two options. Single Tenant Net-Leased properties (STNLs) are usually commercial or industrial properties leased on a long term basis to tenants backed by corporate credit. These leases obligate the tenant to pay for real estate taxes, insurance, and building maintenance. Commercial properties of this type are frequently leased to regional or national retailers such as Walgreens, Rite-Aid, CVS, Wal-Mart, Home Depot, and Federal Express, to name a few. STNLs allow the owner to drive income from the property net of expenses.
Tenant-In-Common investments (TICs), on the other hand, are multi-owner investment properties with in-place professional management. Much like Single Tenant Net-Leased properties, TICs provide income net of expenses without day-to-day management responsibilities. One big difference, however, is that the Tenancy-In-Common structure can be used for virtually any property type, including multi-family, office, warehouse, hospitality, and recreational, as well as retail. (The majority of the single tenant net-lease market is retail). TIC investors are deeded, fractional owners who proportionately share in the gains and losses of the particular investment property.
So how do you determine which type of property is for you? There are three primary phases we look at to compare and contrast any given TIC to a STNL: Pre-sale, closing, and post-sale.
Pre-Sale - This is where one should evaluate the amount of time, money, and energy it takes to determine what property to buy. A Single Tenant Net-Lease property requires a traditional negotiation and contract period. Obviously, this is a variable, but one could assume this takes anywhere from a few weeks to a few months depending on the situation. With a TIC the sponsor company has already completed the negotiation and arrived at a purchase price by the time the property comes to market, thereby saving the investor a lot of time and aggravation.
The due diligence process is also vastly different. In a typical STNL transaction, the buyer bears the responsibility and cost of any third party due diligence reports, including a Property Condition Report (PCR), Environmental Survey, and Appraisal. This process can potentially add another few weeks to the timeline. Whereas in a TIC transaction, the due diligence reports have already been completed and are available to the investor for review.
Closing - If an investor desires financing on an STNL investment, they are responsible for locating a source of funds and negotiating the terms. TIC property sponsors take the responsibility of finding a lender and negotiating the terms on the investors’ behalf. Usually, a TIC property sponsor's banking relationships allow it to secure institutional-quality, non-recourse financing. This has the potential of saving the investor a substantial amount of time and money. Otherwise, closing on both types of investments is relatively easy. Attendance of the investor is typically not required.
Post-Sale - Once the sale is complete, both types of ownership require little or no active management on the part of the investor. STNLs rely on the tenant to take responsibility for the building's general maintenance. A TIC owner relies on a third-party property manager for such duties. Both TIC and STNL owners customarily receive rental income checks on a regular basis (typically monthly or quarterly). One big difference between the two is that TIC property managers are in regular communication with the investors regarding issues affecting the property, including financial data and the property's performance. Furthermore, TIC property sponsors have a built-in exit strategy before the property is marketed. This provides the investor with an estimated hold time for any given TIC investment. In addition, the sponsor acts as the broker or enlists a professional to help the investors evaluate prospective buyers' offers. Of course, STNL owners can put a similar exit strategy into place, but they are on their own in evaluating the sale.
In addition to the benefits mentioned above, TICs offer an investor the opportunity to diversify by asset type and geography more easily than a typical STNL buyer could. For example, a NNN, corporate-leased Advanced Auto Parts in Bedford, IN is selling for $1,500,000. That $1.5M could easily be diversified between 3-5 TIC investments (depending on the minimum investment requirement) into ownership of larger, more desirable assets in potentially stronger markets throughout the country. The old adage of 'Don't put all your eggs in one basket' remains as true in real estate investing as it does in your brokerage account. Creating a diversified portfolio of real estate holdings not only mitigates risk but also increases the potential greater returns.
So what's the best option? Of course, this depends on what type of investor you are. For the investor who desires complete ownership control without active management, a Single Tenant Net-Lease investment may be the answer. For the investor who seeks to diversify their investment dollars, own significantly larger institutional-quality property, and still have the freedom from management responsibilities, TICs may be a more suitable option.
What type of investor are you? You may want to reevaluate your answer to this question. The type of investor you are today may be very different from the type you were years ago. The real estate investment market has changed dramatically in the past five years. Prior to 2002, when the IRS gave guidance to real estate companies regarding TIC offerings, net-leased properties were the first choice for those wanting to remain invested in real estate without actively participating in property management. The TIC marketplace has since grown to over 60 real estate companies offering hundreds of institutional-quality properties in which to invest each year. Do yourself a favor and research the options available in the TIC market. Before jumping into that next Walgreens or Rite-Aid, seek education on how TICs work and how they differ from traditional net-leased property. You may be surprised at what you find.
For more information, we recommend the following resources:
Federation of Exchange Accomodators (FEA)
http://1031.org/about1031/faq.htm
IRS Rev. Proc. 2002-22
http://www.irs.gov/pub/irs-drop/rp-02-22.pdf
http://en.wikipedia.org/wiki/Net_lease
Investors Turn Attention To Net-Lease Properties” By Ray A. Smith
http://homes.wsj.com/columnists_com/buildingvalue/20030930-buildingvalue.html
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