- Feb 18, 2015
Hidden inside the mountain of commercial real estate, debt maturing over the next three years is a dirty little secret. The clock is ticking on a particular sub-set of these loans, and a not-so-widely publicized bomb is set to explode. By some estimates, more than $40 billion of commercial real estate was acquired by tenant-in-common (TIC) syndicators from 2005 to 2008, most of it at inflated prices and financed with 10-year mortgages that come due in the next 12 to 36 months.
In the pre-recession frenzy, investors rolled their capital gains on sales of small rental properties via 1031 exchanges into syndicated investments in brochure-quality shopping centers, office buildings, apartment complexes and industrial parks that were larger than they could afford to purchase on their own. TIC syndicators and broker-dealers promised the moon and pocketed millions in fees, leaving investors holding the bag.
Up to 35 TIC co-owners own each property, and they retain the right to approve the hiring of any manager, and the sale, financing or other disposition of the property. The catch is that 100 percent co-owner approval is required for any of these decisions, which can be difficult or impossible to muster. Making matters worse, these mortgages cannot be refinanced under the TIC ownership structure because lenders have gotten wise. Consequently, a conversion to an L.L.C. is necessary, requiring unanimous consent of the co-owners and costly legal and professional fees. Adding to their woes, by some estimates as many as one-third of all TIC-owned properties are currently either distressed or cannot support refinancing without significant new equity investment. In many cases, existing capital reserves have been depleted or are not sufficient to fund necessary improvements to resuscitate distressed properties.
The TIC co-owners of distressed or overleveraged properties face a grim outlook. Not only has their entire original equity investment been wiped out, but their cash distributions have ceased, with little or no hope of recovery. They typically lack the capacity or the willingness to invest additional cash in properties that are in many cases worth less than the mortgage debt. And, in the event of a foreclosure, they face potentially huge capital gains taxes, with no cash coming in to offset the liability.
TIC owner-groups that cannot act together and effectively make decisions will be steamrolled into foreclosure by special servicers who have little patience. This will likely spell a bonanza for distressed investors. Fortunately, some TIC owners have had the foresight to form steering committees, forgo monthly distributions to conserve cash, and hire professional advisors that help guide them through complex restructurings and recapitalizations with third party “White Knight” investors who can provide rescue capital. Many things have to go right all at once for these groups to be successful and live to fight another day. But, for a select few who have the courage, the patience and the capital to persevere, a recovery will be possible before the clock runs out.