Stay away from TICs

I've been browsing around some of the other real estate blogs out there and many are talking about tenants in common (TIC). Only natural, since almost everyone in the industry is talking about it. It's the latest "fad" and in a crazy market like SF I guess everyone is looking for a way to bypass City Counsel's strict property rules and try to make some money. They are also cheaper, so for some buyers it's a way to get into this market. The only advice I have for those considering buying into a TIC: stay away. For investors thinking of buying a building, emptying out the tenants, doing some remodeling, and marketing it as TIC's I would highly caution against it. I'm seeing empty buildings on the market that are being sold by contractors or LLCs. The listings are marketing them as possible TIC or condo conversions.

• TIC's are one big headache to set up with legal documents that have to be drawn between the parties and clauses in case one party defaults. And you thought reading that condo CCR agreement was a pain. There are very few sources of funding for TIC mortgages. Last I heard, only Bank of Marin and Circle Bank provide loans for TIC. A mortgage broker told me that E-loan might allocate a couple million or so to the TIC market (that's enough for maybe six SF TICs). Bank of Marin may have already ran out of money for these types of mortgages and Circle Bank has few funds left (they are at least offering individual TIC loans). The interest costs are higher due to risks as they should be: in the event of foreclosure, the bank would technically become one of the tenants in common. I don't think the bank has any interest in moving into your TIC and the market for resale is not well established. Most banks require applicants to have six months worth of PITI reserves, FICO scores above 680, personal debt ratios not exceeding 45 % of income, and a 15% down payment. The interest rates are variable with 3 or 5 fixed or adjustable and are usually one to two points above the mortgage rate for a condo or single family home. There is also a prepayment penalty the first few years.
• Once a building has been Ellis Acted (the law under which rental buildings are converted to TIC), it cannot be placed back on the rental market for ten years without some consequences. Within the first two years, you can be liable for damages to the displaced tenant. Within the first five years, you must re-rent the unit to the displaced tenant at their original rent (hence, placing a price cap). Within the first ten years, you must offer it first to the displaced tenant but, you can charge the prevailing market rent. I don't know if the city can enforce this. Good luck finding that tenant years later.
• Real estate is already an illiquid asset. The TIC market is very small and undeveloped.
• I've seen some nasty divorces and property is almost always in the middle. Can you imagine 2-4 people, some of them strangers, sharing a title and a trust deed? If one person can't pay (e.g. lose their job) or have to move out of the city, the entire mortgage would either default or have to be refinanced (note: interest rates are rising). You can draw up legal documents that state the loan can be assumable by a new buyer, but the key is finding that new buyer willing to agree to the terms. I don't know what the future legal ramifications will be, but if you are a lawyer, I'd look into this market.

Why not just buy a condo? You can more easily get a mortgage for these and the legal docs in the form of CCRs are already drawn up. Yes, the HOA fees can be steep, but TIC's have costs as well. Just wait a bit before you look into buying a condo. There is a lot of new supply being developed, particularly in the downtown/south beach area. I was surprised to find that the office building across the street from my financial district office is being converted into condos. They overbuilt office buildings downtown and now there is about a 18% vacancy rate. I guess developers saw a hot housing market and decided to jump on the condo bandwagon. Can't make money with office leasings well, turn them into condos. I'm seeing a lot of supply in new condos and whether there will be demand is another story.