TIC Corner
by D. Andrew Sirkin
Q. Has individual tenancy-in-common (TIC) financing become more easily available?
A. For the uninitiated, fractional TIC financing is an arrangement where each of the tenant-in-common owners obtains a separate loan. Each loan is represented by a note signed only by the individual borrower, and secured only by the individual borrower’s percentage interest. A default by one co-owner results in a foreclosure on only the defaulting owner’s share, and does not affect the other co-owners.
The size and sophistication of the institutional loan market for fractional TIC financing has developed significantly since the first individual TIC loan program was introduced in the spring of 2005. At that time, such loans were available from only one lender (Bank of Marin), only for buildings of five or more units and only for properties being sold by certain preferred clients of the bank. By the fall of 2005, Circle Bank and America California Bank had entered the market, each with significantly fewer restrictions and a wider range of loan programs. Sterling Bank followed in early 2006 with a product focused specifically on 2-4-unit buildings. Next, Integrated Mortgage announced a new $120 million program sponsored by two lenders who would approve individual TIC loans regardless of building size and offered throughout California. Several other lenders have agreed to fund fractional loans for specific projects on a trial basis or as an accommodation to a preferred client.
The level of interest in these products among lenders is very high. A fractional lending seminar led by this author attracted a sellout crowd of over 75 lender representatives in late June, and 4 to 5 lenders request further information from our office each week. Lender interest is not limited to California institutions or property, and we frequently receive calls from as far away as the East Coast. Perhaps most significantly, at least one well-known Wall Street brokerage is currently trying to create a fund to provide a secondary market for fractional loans.
Q. What kinds of fractional TIC loans are currently available?
A. The variety of financing products available as individual TIC loans remains limited, and the terms are generally less favorable than either apartment building loans or condominium loans. The maximum fixed-rate period seems to be 5 years and there is generally a balloon payment at 10 or 15 years. Rates tend to be 25 to 50 basis points above commercial (5-plus-unit) apartment building loans, and 100-150 basis points above residential (1-4-unit) loans. Loan-to-value allowances vary, but appear to top out at 75% to 80%, and even that figure can be misleadingly optimistic in light of appraisal difficulties (described below). Secondary financing is generally permitted, and the realities of the marketplace usually require the seller to carry financing for most buyers.
Underwriting guidelines are more strict than on residential loans, and buyers who might qualify for a condo loan sometimes cannot qualify for an individual TIC loan. Many lenders also impose additional requirements such as owner-occupancy, and/or one lender makes all of the institutional loans in the building.
Perhaps the most challenging difficulty facing fractional lenders is determining the value of the fractional interests. Most now appraise the building as a whole (using the traditional income, cost and market approaches) and then also appraise the TIC interests using a market approach. The lender then takes both of these valuations into account and chooses a middle ground on which to base its underwriting. This method is only possible in San Francisco because a significant amount of TIC sales data is available.
But, even in San Francisco, the approach leads to somewhat unpredictable results. Valuation problems are significantly more severe outside of San Francisco, where few TIC sales have occurred. Until the TIC market develops in a particular locality, and a reasonable number of sales occur and are reported in the MLS or some other accessible database, appraisers (and therefore lenders) must extrapolate from the apartment building’s value and the condominium sales data, making the result less reliable yet.
None of these difficulties seem fatal, and most will disappear as the TIC market develops and more lenders introduce fractional loan programs and compete for customers. Considering that the first fraction TIC loans closed just over a year ago, a huge amount of progress has occurred in a short time, particularly given the slowness with which lenders typically move.
Q. Does selling TIC interests create unusual liability for an apartment building seller?
A. Many apartment building owners are afraid to sell TIC interests because they feel these sales would subject them to a high level of liability. But this fear is not supported by historical data. In fact, TIC sellers do not seem to get sued any more often than non-TIC sellers of similar property, and get sued much less often than condominium developers.
The type of exposure that most concerns prospective TIC sellers is construction defect liability. The volume of construction defect litigation involving new development has diminished in recent years, but is still uncomfortably high, as is the cost of insuring for this liability—which extends for 10 years after the completion of the project. The extent to which liability exists in the condominium-conversion context is unclear, but most experts believe that it applies to any significant renovation or construction work that the condo converter undertakes. Although there is no legal authority addressing construction liability for TIC sellers, it is logical that the courts would apply this same approach.
This means that the level of concern a TIC seller should have for construction defect liability is driven by the amount of renovation work the seller undertakes. If the seller is essentially gutting the building, or replacing all of the mechanical systems as well as kitchens and baths, construction defect exposure is probably present, and the seller should take protective measures, such as forming an entity to own the property during the work and at the time of the TIC sales, and obtaining developer-specific insurance. On the other hand, a TIC seller who is doing only cosmetic work and moderate kitchen and bath remodeling is probably not subject to developer liability.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or San Francisco Apartment Magazine. The information contained in this article is general in nature. Consult the advice of an attorney for any specific problem. More detailed information on this topic is available online at www.andysirkin.com. D. Andrew Sirkin’s law practice is devoted exclusively to tenancy-in-common, equity sharing, investment partnerships and other co-ownership matters. Copyright © 2006 by San Francisco Apartment Magazine. All rights reserved.