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TIC SPONSORS JOIN THE REIT CLUB

The tenancy-in-common structure has made quite a splash in the retail real estate market over the past four years. Now a couple of TIC sponsors are set to make their biggest impression yet by forming private REITs.

One of these, Passco Real Estate Enterprises, a Santa Ana, Calif.-based real estate services firm, said at press time that it expected to raise $25 million in February as a private REIT.

The other, Chicago-based TSG Real Estate, plans to follow suit sometime in the second or third quarter. TSG founder and CEO Rob Hannah says he hopes to raise about $50 million, which the firm will use to buy properties to sell to TIC investors.

This move to private REIT status is “an evolutionary one,” according to Hannah. “It is just starting to happen,” he said. There are other TIC sponsors interested in doing the same thing, he says, though he declined to name any.

TICs sprang from the popular 1031 exchanges, under which sellers can defer capital gains taxes on property sales if they replace the sold property with a similar one within a given time frame — 45 days for identifying a replacement, 180 days for buying it. A TIC allows the seller to buy only part of a replacement property if an entire one cannot be found in time to complete the 1031.

TIC deal volume went from a negligible $32.3 million at the end of 2001, when market participants first began using them regularly, to a sizzling $3.7 billion at the end of 2004, according to New York City-based research firm Real Capital Analytics.

Passco and TSG are only the latest TIC sponsors to become private REITs, however. The Oakbrook, Ill.-based Inland Group of Real Estate Cos., owner of several private REITs, operates a TIC sponsorship called the Real Estate Exchange Corp., which it launched at the cusp of the TIC market’s takeoff in 2001.

Private REITs are registered with the Securities and Exchange Commission, though their shares do not trade publicly. (Indeed, some call them nontraded REITs.) Private REIT shares can be held in large blocks by a handful of institutional investors, or widely distributed among individual investors, which is how TSG plans to raise its money.

TIC sponsors find that a private REIT is faster and cheaper to register than a public one, given the red tape and expense associated with the Sarbanes-Oxley requirements, says Bill Winn, president of Passco Real Estate.

TSG says it prefers to be a finance- and capital-driven private REIT, citing a potential conflict with the buy-and-hold approach. The reporting requirements of a public REIT call for more manpower and expertise than running a TIC sponsorship, says Hannah, and its structure is contrary to a TIC sponsor’s normal activities.

“How do you decide what asset you want to buy [and hold] versus what you want to buy and immediately resell to the TIC group?” Hannah asked. Instead, TSG will secure bridge loans and buy properties to offer to TIC clients.

Inland Group officials insist that TIC sponsorships and REIT activities can coexist without threatening each other, because they attract different spheres of investors. The 1031 exchange market caters to accredited investors — savvy, high-net-worth individuals who understand the risks. Private REIT shares attract institutional accredited and unaccredited investors. The unaccredited investors are less sophisticated and invest smaller amounts, says Patricia A. DelRosso, president of Inland Real Estate Exchange.

In any case, a TIC sponsor is better off not mingling the businesses, says DelRosso. If the TIC sponsor exclusively sells real estate between accredited and unaccredited investors instead of offering it on the open market, it risks not getting the property’s true value.

Passco sees no conflict either, mainly because the 1031 exchange process can be so complicated that TIC investors prefer to hold a stake in a TIC-sponsored property once they have completed the deal. Further, TIC investors tend to hold projects for seven to 10 years, like many REITs.

In the end, observers agree that the move is good for the industry. First, the private REIT structure gives investors a more personal and active relationship with REIT managers. Also, private REITs tend to concentrate on a particular type of retail center and a specific region, says Winn, which means they can draw investors sharing the same focus.