As different funds jockey for distressed assets, one of the places they’ve looked is properties owned by Tenant-In-Common (TIC) groups. It’s not hard to see why. With multiple investors, it’s hard for these deals to be refinanced in the current environment.
But one TIC sponsor that specializes in multifamily properties, Cottonwood Capital, out of Salt Lake City, is trying to combat this issue head-on by shifting its investors' assets into a newly formed partnership that will have ownership in a diverse group of multifamily properties, and might eventually become a REIT.
“The TIC market may be an area where there could be more damage than other areas,” says Chad Christensen, president and a co-founder of Cottonwood Capital. “The problem is the limited refinancing options available in the current market. It’s particularly acute for TIC properties. Nobody, including Fannie Mae and Freddie Mac, will refinance TIC deals right now. The problem is further exacerbated by the ownership structure's limited ability to raise fresh equity if needed to refinance a property. That’s one of the reasons we’re encouraging investors to contribute their equity interests into our new operating partnership structure.”
But for Cottonwood’s REIT aspirations to become a reality, it needs at least a meaningful percentage of its investors in each transaction to agree to contribute their equity interests into the partnership. Doing so would not create a taxable event for the investors (though investors would face taxes upon converting their equity into shares of the REIT). Currently, Cottonwood plans to offer about 4,100 of its 5,900 units to the REIT, with more units that may follow from both its portfolio and other portfolios.
Daniel Shaeffer, CEO and co-founder of Cottonwood Capital, notes that Cottonwood has received a good initial response from the investors to whom the REIT has tendered thus far. Cottonwood says that exchanging their equity in a single asset into a diverse pool of assets makes sense because they can roll in at a favorable price, and through the diversification, they can stabilize their returns. Additionally, the potential for liquidity through the REIT is greatly enhanced, and the transaction could better position the property for refinancing.
But other people in the industry wonder if those investors who are in high-performing deals may have some qualms about moving into a REIT structure. “They’ll wonder how they’re being compensated if they have better property than the other guys,” says Bill Winn, president of Irvine, Calif.-based PASSCO Cos. “It’s fairly difficult because you have to value your property at today’s values and then they contribute ownership into the REIT. If you’re doing multiple properties, how is that determined? Nobody’s property is what it was worth when you bought it."
If Cottonwood can get its investors to sign off on the REIT, there could be other advantages down the road. “It probably frees us a little bit to buy and sell,” Christensen says. “If we feel like there’s a reason to buy or sell, it makes its easier, depending on adoption rates.”