The like-kind exchange industry threw a party for itself in Las Vegas recently, and a number of prominent players from the Boston market were front and center during the festivities.
First, the Tenants-in-Common Association (TICA) held its biggest bash yet, a 3-day conference at the Venetian (Oct. 5 – 7) which drew the maximum 775 participants permitted under fire codes, and actually saw TICA turn away would-be attendees. This was followed (actually they overlapped) by the annual meeting of the Federation of Exchange Accommodators (FEA), held at the MGM Grand (Oct. 7 – 8) which drew an estimated 400 attendees.
Whereas TICA drew a broad spectrum of participants from all segments of the real estate industry (including the curious), almost all of the participants at FEA were exchange accommodators (i.e., qualified intermediaries in like-kind exchange parlance). Nonetheless, plenty of familiar Boston faced showed up at both venues – especially during the cocktail hours.
TICA’s raucous get-together reflected the exuberance of a still-new segment of the real estate industry rapidly coming into its own. Just a few years ago, tenancy-in-common transactions (TICs) were a small, obscure corner of the real estate world, focused on the fractionalization of real estate interests. Then, in 2002, the IRS issued Rev. Proc. 2002-22, providing for the first time substantial guidance on TIC transactions, and it does not exaggerate the facts to state that the IRS enabled this new and burgeoning industry. The surge in activity was further reinforced when the IRS issued Rev. Rul. 2004-86, which sanctioned the use of Delaware Statutory Trusts (DSTs) as an alternative fractionalizing technique.
Matching Properties
Both TICs and DSTs permit real estate ownership to be fractionalized and essentially securitized, which provides ease and flexibility to a like-kind exchange market desperate for those qualities. Basically, Code §1031 exchanges have become a standard tax-deferral strategy when selling real estate, and TICs and DSTs make such exchanges dramatically easier to complete.
Since 1991, when the IRS issued the so-called “Starker regulations” formally approving deferred like-kind exchanges, the exchange business has grown from a cottage industry to a major force in real estate. However, it has always suffered from the problem of matching exchange properties. In particular, a real estate owner selling “relinquished property” typically wants to invest the sale proceeds, no less and no more, into an eligible “replacement property.” Although an exchange does not have to be an exact match, as a practical matter most parties want the size of the properties to be as close as possible – and therein lies the rub.
Finding a right-sized replacement property within the time limits mandated by the Starker regulations (45 days to identify, and 180 days to close) has led to frantic and often desperate behavior on the part of sellers. More than one property owner at the TICA Conference ruefully acknowledged buying a “lousy” replacement property at some point, simply to complete an exchange. Fortunately, real estate markets across the country have been buoyant the last few years, and as one investor admitted, “Even the mistakes paid off.” However, this is not, needless to say, the recommended strategy.
Enter the TICs and DSTs. What this type of investment offers is the ability to take a large property and sell off fractionalized interests that exactly match the simultaneous investment objectives of numerous investors. The theory is excellent and the arithmetic compelling. The problems thus far have been: 1) a lack of overall product, 2) an even more notable lack of good product; and 3) ongoing concerns about whether these “new-fangled” products really “work” for tax purposes.
The TICA Conference suggests that these concerns are rapidly fading away. Demand for TICs and DSTs continues to outstrip supply, but meanwhile the industry is attracting both more players and more serious players, so that the overall quality of the deals is improving markedly, thanks to competition. However, the number of deals is, if anything, down right now, largely because of tough competition (from REITs and pension funds) for real property.
On the legal front, TICA showcased a growing consensus on a number of important issues, from whether a TIC is real estate or a security (answer: both) to how best to create a secondary market in TIC interests (answer: still working on it).
DSTs, the new product on the block, are off to a slow start, in part because many investors (and broker/dealers) are spooked by the fact that, if the DST-held real estate encounters problems, the structure has to “spring” into an LLC. However, there are clear advantages to a DST if one has the right property, and once the missionary work is completed most people believe the DST may be roughly equal in popularity to the TIC.
Meanwhile, TICA is developing a Best Practices Memo that is designed to provide industry-recommended standards on everything from sales practices, to offering memoranda, to a code of ethics.
Summing up the conference, one wholesaler said, “Five years ago, if you were one of the few TIC players in the market, you could offer anything you wanted because there wasn’t competition. Loads were much higher, the quality of the deals was often poor, TICA didn’t exist, NASD wasn’t addressing issues and the IRS was providing no guidance.
“In just a few years TICA has become a monster, but thus far has stayed a good group. We need to continue to develop guidelines on how to do deals properly. The best practices memo is a great development. Like many people, I object to some of it, but if everyone is following it, there is a lot of strength in numbers. It shows an increasing maturity in the industry. TICA is making real progress toward getting the industry to police itself.”
At FEA, meanwhile, the chatter beside the MGM pool on Friday night was centered on the rumor (subsequently confirmed) that Boston-based Atlantic Exchange Co. had been sold to Investment Properties of America, based in Indianapolis. The conventional (non-TIC) exchange industry is having a fabulous year, most exchange accommodators are swamped with work, and the industry created by the Starker regulations in 1991 has matured nicely. There were rumors or confirmations of various acquisitions (IPA, for example, also recently picked up another exchange company based in New York) and it appears the exchange business is going through a period of consolidation and roll up. In all events, the crowd at the MGM was looked prosperous and happy.
On a prospective note, TICs clearly remain predominantly a West Coast phenomenon, particularly popular in California but with a substantial presence in the West and Southwest, notably in Texas, and with growing beach-heads in hot real estate markets such as Florida. Although there are few TIC deals as yet in the major East Coast cities such as Washington, New York and Boston, it seems only a matter of time before the Northeast joins the festivities.
The next big conclave of the TIC industry (and the only major meeting on the east coast this year) will be the TIC Transactions Forum sponsored by Information Management Network in New York on Nov. 29-30. If you want to jump into a hot area of the real estate business, time is TICking.
