The TIC Corner
by D. Andrew Sirkin
This “TIC Corner” will be the first in an occasional series of case studies describing certain types of tenancy-in-common (TIC) transactions in narrative form. This case study involves the sale of an apartment building to a group including the building’s existing tenants, and will be presented in three parts.
Harry Chin has owned a 6-unit building located at 2550 Hyde St. on San Francisco’s Russian Hill for 18 years. Each of the circa-1908 building’s three stories contains two units, all similar two-bedroom apartments approximately 1,200 square feet in size. Each of the two top-floor units has Golden Gate Bridge views. The lowest level of the building has three-car parking and an open storage area. There is a small rear yard and a small roof deck.
Five of the apartments are tenant-occupied with month-to-month tenancies. The tenant and unit profiles are as follows: unit 1 (first floor, left), renovated in 2005, occupied by Jane Smith and Joan Day, 20-something roommates who pay $2,200 and have lived in the building for 13 months; unit 2 (first floor, right), renovated in 1992, occupied by the Han family (oldest member William Han, age 53) who pays $1,147 and has occupied the unit since 1992; unit 3 (second floor, left), just renovated and vacant; unit 4 (second floor, right), renovated in 1996, occupied by Steven and Sarah Warsaw, who pay $1,335 and have occupied the unit since 1997; unit 5 (third floor, left), last renovation date unknown, occupied by 78-year-old Silvia Wong, who pays $772 and has occupied the unit for an unknown duration; and unit 6 (third floor, right), renovated in 1996, occupied by Miriam Levi who pays $1,882 and has occupied the unit since 2004.
Chin has decided to sell the building because he is tired of maintaining it and now lives in Belmont. He has had several realtor listing presentations, and the consensus view is that the property would sell for about $2 million as-is with the existing tenants in place, and $3-$3.6 million as vacant and renovated TIC interests.
To evaluate whether selling the building as TIC interests is worthwhile, Chin has consulted with a landlord-tenant attorney, a TIC attorney and a contractor. From the landlord-tenant attorney, Chin has learned that he could evict all of the tenants under the state’s Ellis Act, but that the process will be time-consuming and expensive. All tenants will be entitled to at least four months’ notice and substantial relocation fees. Chin has at least one “protected” tenant (Wong, due to her age) who will be entitled to stay in the building for one year after an eviction notice is served and will receive additional relocation fees. He also learned that many, if not most, tenants served Ellis Act eviction notices in the past 18 months have claimed disabilities of some type, entitling them to extended notice and additional relocation fees. These claims are difficult and expensive to disprove. In addition, eviction of a “protected” tenant will permanently disqualify the building for condominium conversion under current San Francisco law. Chin is advised to be prepared to spend $100,000 on legal fees, relocation fees and tenant settlements, and to wait 18 months for the building to be completely vacant.
From the TIC attorney, Chin has learned that he will need approval from the California Department of Real Estate prior to offering TIC interests for sale. Obtaining DRE approval will take about six months and cost Chin a total of $15,000-$20,000 for (in decreasing order of amount) surveying, homeowners association (HOA) budget preparation (including a replacement-reserve study), legal costs and application fees. Chin will also need to post a cash deposit or bond for six months of HOA dues, with all funds (other than the cost of the bond) to be released back to him when the fifth sale closes. The TIC lawyer also advised Chin to consider forming a limited liability entity of some kind to act as seller in order to protect him from liability, at an extra cost of about $3,000 in professional fees and franchise taxes over the two tax years he will still own the property.
The DRE approval will be valid for five years. Chin will need to inform the DRE how the sales will be financed, and is advised by the TIC attorney to specify individual TIC financing because it is most easily approved by the DRE and most popular with buyers. Since Chin’s current loan balance of $352,000 is less than the expected sales price of each of the shares, he will not need to worry about selling a certain number of shares simultaneously to generate enough money to pay off his existing financing, or securing partial releasing from his current lender to allow the loan to be paid off gradually.
Armed with this new information, Chin decides not to sell the building as TIC shares. He figures he will need to invest a total of $353,000 to prepare the building for TIC sales (consisting of $100,000 in tenant-related costs, $180,000 in renovation costs, $50,000 in lost investment return over the course of the project and $23,000 in regulatory compliance). Assuming a conservative sale price of $3 million and a sales commission of 6%, he would make almost $600,000 more by selling TIC shares, but the process would require a considerable amount of work over several years. Chin also finds the idea of evicting tenants distasteful in general, is concerned about where the elderly Wong would go, and is quite friendly with Levi and the Warsaws.
A few days after deciding to list the building for sale as-is for $2 million, Chin receives a telephone call from Sarah Warsaw. The appearance of realtors at the property, coupled with Chin’s comments over the years that he was fed up with building management, have suggested to Warsaw that her landlord might be preparing to sell. Was it true? Would the Warsaws and their neighbors and friends be evicted? Warsaw explains that she and her husband had been thinking about buying a home and spending weekends touring open houses. From this she had learned two things: first, that they could not afford to buy anything comparable to where they now lived, and second, that most six-unit buildings were being vacated by their owners to prepare them for TIC sales. Based on this information, she had started to dream about buying 2550 Hyde St. and had explored the idea with Levi, who was also interested. Warsaw asks if Chin would consider giving them time to put together an offer. What price would he want?
Chin has learned from experience to be careful what he says to his tenants, even those who he feels he knows and trusts. He wisely decides to have another brief conversation with both his landlord-tenant attorney and his TIC attorney before answering Warsaw’s questions, and simply tells her he will investigate and get back to her. The landlord-tenant attorney confirms that Chin should be cautious, but explains that discussion of a possible sale is okay provided he confirms, both orally and in writing, that he has not approached the tenants about a possible sale to them, and is not requesting that the tenants vacate. The TIC attorney explains that Chin cannot offer TIC shares to anyone, including his tenants, without DRE approval, but that so long as he only offers to sell the entire building to a particular buyer or preformed buyer group, no approval is required. The attorney advises Chin not to discuss a sale of a fractional interest with any of the tenants, and to only accept an offer on the entire property in a single contract. The TIC attorney also notes that it generally takes a tenant or tenant group a considerable amount of time to congeal, put together an offer, obtain financing and close the transaction, and that Chin should be prepared to wait at least three or four months to close such a sale.
Chin ultimately decides that while it might require more effort and time to sell to his tenants, it is something he would feel good about and would be worth the effort of an attempt. To partially compensate him for the delay and risk of failure, he decides not to offer the property to the tenants at a price that would reflect the absence of a sales commission, meaning that a sale to his tenants would yield him $120,000 more than a market sale using a realtor. Then, he calls Warsaw back, and explaines that he would hold the property off the market for 45 days to give her time to put together a firm offer of $2 million, taking the time to explain the caveats recommended by his attorneys. He then confirms the same information (including the caveats) in a letter, which he arranges to hand deliver the following day, obtaining Warsaw’s acknowledgement of receipt on a copy for his files.
In the next installment, I will discuss Warsaw’s attempt to assemble a group, reach group agreement on salient purchase and co-ownership terms, secure financing, obtain a DRE exemption letter and, finally, make an offer.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or SF 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 © 2007 by SF Apartment Magazine. All rights reserved.