Financing Focus

Lenders Talk TICs

Gain an inside perspective on how to finance these investments.

Tenancy-in-common transactions involve a number of unique features. While currently there are no clear-cut guidelines on how TIC deals must be structured, lenders that finance such projects are careful to impose certain requirements that usually are not present in single-entity transactions. Understanding how lenders scrutinize TIC deals prior to underwriting them can help commercial real estate professionals who are involved in these types of projects.

TIC transactions and single-entity deals differ in numerous ways. Specifically, each TIC investor owns an undivided interest, or share, in the property being acquired or refinanced. In situations where entities such as corporations own a property, the entity — not the shareholders — is responsible for the loan's repayment. In a TIC transaction, the lender requires that each tenant in common is a borrower. As a result, each TIC investor is jointly and severally liable for the repayment of the loan. Several consequences flow from this. Specifically, in the case of a non-recourse financing, a lender may require that one or more high-net-worth TIC investors (if not all TIC investors) execute a carve-out guaranty, making such tenants liable for the loan in the event that the tenant declares bankruptcy or commits a bad act, such as fraud.

Limiting Withdrawal

Lenders may consider one or more of the TIC investors' credit when making the loan. As a result, lenders often seek to limit TIC investors' ability to withdraw from the transaction or transfer their interest. In many cases, lenders limit the TIC investors' ability to transfer their interests in order to ensure certain investors remain in the deal and liable for the loan. Such transfers usually allow lenders to determine if they want to accelerate the loan. To protect their interests, lenders often include transfer restrictions among the loan's default provisions. In cases where TIC investors can transfer their interests, lenders require that new TIC investors assume the obligations and liabilities of the departing TIC investor under the loan document.

Lenders also often seek to eliminate TIC investors' ability to institute a partition. In a partition, the property may be proportionately divided among the TIC investors. However, in most cases, partition causes the property to be sold and the proceeds distributed proportionately to the tenants in common. Lenders prefer to reduce TIC investors' partition rights to prevent one, of what could be many, tenants from forcing the sale of the entire property by instituting a partition action.

Bankruptcy Provisions

In TIC transactions, lenders generally include clauses that permit them to accelerate the loan in the event any TIC investor becomes voluntarily or involuntarily bankrupt. Upon the bankruptcy filing, an automatic stay is imposed upon all of the bankrupt investor's assets. During the automatic stay period, the bankrupt investor cannot transfer any of its assets without the bankruptcy court's permission. In this situation, lenders require the ability to call a default and accelerate the entire indebtedness under their loan because they will not be able to seize just the bankrupt TIC investor's interest. Additionally, one TIC investor's bankruptcy can make it impossible for a lender to foreclose and sell the entire property. Specifically, it is very difficult for lenders to obtain an amount equal to the loan's value by selling only a fraction of the property's interest since the automatic stay shields the remainder of the property from foreclosure.

Lenders may attempt to limit the likelihood that a TIC investor will become bankrupt by requiring that each investor be structured as a special-purpose entity. To be considered a special-purpose entity, an investor must meet certain criteria, including owning no assets other than the asset securing the lender's loan, having no indebtedness not specifically subordinated to the lender's indebtedness, and having an independent director, general partner, or manager who is contractually bound to the lender to not allow the borrower to declare bankruptcy.

Meeting a lender's requirement that each TIC investor be a special-purpose entity can be troublesome in several situations. First, if the proposed TIC investor already is an entity, existing liabilities, loans, or assets may make it impossible for that entity to be considered special purpose. This can be avoided by having the existing entity create a special-purpose entity subsidiary. However, this is not allowed if the proposed entity is attempting to complete a tax-deferred exchange and must purchase real estate, rather than an interest in an entity, to comply with the like-kind property requirement. Second, if the proposed TIC investor is an individual investor, he or she may resist having to form an entity for cost or other reasons. Additionally, if the individual is attempting to execute a tax-deferred exchange, the like-kind property issue can be solved by setting up a disregarded entity, such as a single-member limited liability company. Because the Internal Revenue Service ignores these entities, they do not pose a like-kind property problem for an individual attempting to complete an exchange.

Subordination Agreements

In non-TIC transactions, lenders often require borrowers to collaterally assign subordinate agreements, such as property management agreements, to the owner. Lenders in TIC transactions impose similar requirements. When a lender causes a borrower to subordinate an agreement to its loan, the lender is attempting to limit borrower's ability to pay monies to third parties prior to repayment of the loan. This is particularly important if a default occurs.

For instance, in the event of a property management agreement, by subordinating the rights of the TIC investors the lender can ensure that the property manager cannot be paid prior to repayment of the loan. In this case, the lenders also obtain the right to terminate the manager upon a default in the subordination agreement. The subordination agreement also prevents the manager from exercising any remedies against the TIC investors prior to the lender fully exercising its remedies.

By causing such agreements to be collaterally assigned, the lender obtains the ability to step into the borrower's shoes upon a default. By doing this, the lender can enforce agreements the borrower has made. For instance, in regard to the previous example, this can be particularly important if the TIC investors have been unable to make loan payments due to the property manager's negligence or misconduct. In such a situation, the lender could exercise its rights under the collateral assignment to step into the borrower's shoes and institute a suit against the manager to recover funds lost by the manager's actions.

Investors should be clear on how TIC transactions differ from single-investor or entity investment transactions. Understanding this raises the likelihood that a transaction will close with a minimum of cost, time, and frustration.

Andrew H. Mittler, CCIM, JD, and Steven Korbin, JD

Andrew H. Mittler, CCIM, JD, is an associate with the Dallas office of Patton Boggs LLP. Contact him at (214) 758-3522 or amittler@pattonboggs. com. Steven Korbin, JD, is general counsel of the Healthcare Real Estate Group of CapitalSource Finance LLC in Chevy Chase, Md. Contact him at (818) 540-2196 or skorbin@capitalsource.com.

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