For SCI Real Estate Investments of Los Angeles, there have been two earthshaking events in its business. The first, which happened more than a decade ago, resulted in the firm's founding: SCI started out acquiring and reselling distressed properties after a devastating earthquake shook Southern California in 1994.
The “second earthquake,” according to Adam Bryan, SCI's vice president of sales and marketing, came in 2002. That year, the Internal Revenue Service issued a ruling that clarified how property owners could defer capital gains taxes on relinquished real estate by parking their cash into other properties through co-ownership agreements.
These arrangements are known as tenant-in-common, or TIC, structures. They've become a specialty for SCI, which concentrates on acquiring income-producing properties and selling them to individual property owners who invest proceeds from real estate sales to acquire fractional ownership interests in larger and usually newer and higher-quality properties such as industrial sites, shopping malls, office buildings, or garden apartments.
That IRS ruling triggered an explosion in tenant-in-common activity. SCI, which now works with a network of 350 investors, expects its portfolio to increase to $1 billion this year, from $700 million in 2004.
Bryan says his company is benefiting from a TIC market that he predicts will stay “strong and healthy,” partly because housing prices are making rental properties more attractive to buyers, but also because investors today have different goals than those who got into real estate during past boom-and-bust periods. “You have different tax structures and different [investor] motivations. TIC investors are looking more for wealth preservation than wealth accumulation.”
As anyone following the industry knows, TICs have emerged as the real estate market's latest rivulet of investment capital. Equity raised through securitized TICs is expected to exceed $4 billion in 2005, from $166.7 million in 2001, according to Deloitte & Touche and San Francisco-based Omni Brokerage, which specializes in qualifying properties for TIC investments.
And those calculations don't include what's being raised by companies like SCI that sponsor properties as real estate rather than securities (see “Exit Options,” p. 68), which could hike the total to around $7 billion, according to estimates from the Sacramento, Calif.-based Tenant-in-Common Association.
“For years, I've been wrong about the growth of 1031s and TICs, which seem to double every year,” says Adam Handler, who leads PriceWaterhouse Coopers' like-kind exchange group.
Doing the Numbers
The U.S. Tax Code, specifically Section 1031, which lets property owners defer capital gains taxes when they exchange “like-kind” properties for investment purposes, is the foundation upon which TICs are expanding. For example, SCI's portfolio includes Deer Valley Village, an 842-unit apartment complex in Phoenix that it purchased from multifamily owner and manager Archstone-Smith last September for $71 million with tenant-in-common money.
Such transactions, generally structured as 1031 exchanges, account for between 2 percent and 5 percent of all 1031 transactions. But some TIC sponsors are already predicting that these deals could someday represent one-quarter of that total. “We're seeing a substantial change in the investment community, like how mutual funds altered the way people bought stock,” observes Cary Losson, president of 1031 Exchange Options, a registered rep based in Walnut Creek, Calif., that specializes in putting investors into tenant-in-common 1031 exchanges.