For individual investors, there are a number of benefits to a commercial real estate investment. However, those same individuals can face headwinds when trying to purchase an institutional grade commercial property on their own because they are very expensive. Fortunately, there is a workaround.
In certain cases, many individual investors can come together to purchase a property using an ownership structure known as “tenancy in common,” or TIC for short. Tenancy in common allows multiple investors (“tenants”) to own a fractional share of an investment property.
In this article we will describe what the TIC structure is, how it works, and why it can be beneficial for individual investors. By the end, readers will have the information necessary to determine if this type of fractional real estate ownership model is a good fit for their individual investment objectives.
At First National Realty Partners, we occasionally utilize the TIC structure in our commercial real estate deals, particularly in transactions that involve a 1031 Exchange. To learn more about our current investment opportunities, click here.
What is Tenancy In Common in Commercial Real Estate?
“Tenancy in common” is a specialized type of commercial real estate ownership structure that allows multiple owners of the same property. The exact number of owners allowed can vary by state, but they usually can’t exceed 35. No matter the number of owners, the total ownership percentage cannot exceed 100%. For example, a TIC could have four owners of 25% each or 35 owners of 2.857% each.
Pros & Cons of Tenancy in Common in Real Estate
There are both benefits and downsides to the tenancy in common structure for real estate investors.
Pros of the TIC Structure
For individual real estate investors, the TIC ownership structure comes with a few notable benefits. They include, but aren’t limited to:
- It can be used for both residential and commercial properties.
- It can be a way for individual investors to access institutional quality assets
- The legal agreement governing the Tenants In Common arrangement can be created or modified at any time, meaning that an owner can further split his or her interest if additional individuals wish to join the ownership group.
- Because the ownership agreement can be modified at any time, the TIC structure can be particularly useful when working with 1031 exchanges. (Learn more about 1031 exchanges.)
- As part of the estate planning process, owners may designate beneficiaries, who would inherit the owner’s share upon death.
While the benefits can be significant, they must be weighed against the downsides of the TIC ownership structure.
Cons of Tenancy in Common
In general, the biggest downside to the tenancy in common structure is that it is complex and it can be difficult to get co-owners to agree on a single course of management action. For example, to finance a purchase, it is possible that the lender could require each of the co-owners to sign the mortgage. If there are 35 of them, this could be easier said than done. Other potential downsides include:
- If a tenant in common passes away and does not have a designated heir, their ownership share could go to probate court, which could cause uncertainty for the surviving owners.
- Tenants in common can sell their share to anyone. A sale to a total stranger can result in disruption to the ownership group, who may not have any legal recourse.
- Tenants in common are jointly responsible for key operating expenses like property taxes and insurance. If one of the co-tenants is unable to pay their share, the rest of the group must make up the difference.
- In certain situations, it is possible that each tenant in common could obtain a loan for their individual share of the property. If any one person defaults on their individual mortgage, the lender will attempt to foreclose on the entire property, which puts the other co-owner’s share at risk.
For these reasons, it is critically important that individual investors perform their own due diligence on both the property involved and the ownership structure with which it is purchased. Because the TIC structure can be complex, it may also be a good idea to seek the counsel of a qualified real estate attorney or CPA with expertise in this area.
What are the Tax Considerations of Tenancy In Common?
When it comes to both property taxes and income taxes, the TIC entity tends to be treated as a whole. Typically, the tax bill is divided up between each of the property owners based on their percentage of ownership interest. But, if one person is unable to pay their share, it is important to note that the ownership group usually has “joint and several” liability for taxes. This means that each person is responsible for their own share and the group is responsible as a whole. So, if one person is unable to pay their share of taxes, the rest of the group needs to cover the deficit.
It is not difficult to imagine that this sort of responsibility is ripe for disagreement. This is why the agreement that governs ownership must be explicit in addressing how such situations are handled.
Dissolving a Tenancy in Common Agreement
The TIC agreement can be dissolved in one of two ways.
First, the arrangement can be dissolved if one person buys out the ownership rights of every other individual in the group. When they do, they obtain sole ownership of the property.
Second, the TIC agreement can be dissolved upon the sale of the property. While this may seem straightforward, it can become tricky if the group is not unanimous about the decision to sell. If all tenants want to sell except one, the group may have to file a “partition action” with the courts to force the sale despite the objections of one or more members.
Tenancy in Common and Commercial Real Estate Loans
Whether seeking purchase money or refinancing an existing loan, the TIC structure offers both pros and cons when trying to obtain a loan.
On the plus side, the collective assets of the group can make qualifying a bit easier. However, it is also possible that the lender could require all co-owners to sign the mortgage note. As described above this can create additional complexity in the loan closing process and added liability should one owner not be able to make their portion of the mortgage payment.
Individual real estate investors considering a TIC property should take the time to carefully review all loan documents including the mortgage and loan agreement to ensure they understand all terms associated with the financing arrangement.
Joint Tenancy vs. Tenancy in Common
Joint tenancy is another structure with which to establish ownership of property. Its name sounds very similar to tenancy in common, but there are a few key differences:
- Joint tenancy requires that each tenant own the same amount of shares, that are given simultaneously, and listed on the same deed. Tenants in common can own differing percentages and sell their shares at any time.
- Joint tenancy often comes with a right of survivorship that passes share ownership to the surviving tenants when the owner dies, bypassing probate. This is not the case with tenants in common.
In some cases a joint tenancy arrangement can become tenants in common if a joint tenant sells their ownership interest to another individual. Again, it is important to stress that these are complex ownership arrangements and investors should seek legal advice, if necessary, to ensure they understand all aspects of them.
Summary of Tenancy in Common
Tenancy in common is an ownership structure that allows multiple investors (“tenants”) to own a fractional share of an investment property.
The major benefit to this structure is that it allows individuals to have access to high quality assets that they likely cannot afford on their own. Additional benefits include easily modifiable co-tenancy agreements and the passage of shares to designated beneficiaries upon death.
The biggest downside to the co-tenancy structure is that shares can be sold to anyone at any time, which can be disruptive for other owners. In addition, joint and several liability for key expenses can leave owners on the hook for more than their proportionate share.
Typically, tenancy in common agreements are dissolved upon sale or when one tenant buys the stake of all others.
With regard to financing, the tenants in common structure can make it a bit easier to get approved for a loan because the collective resources of the group can provide the lender with additional comfort. However, they may also require each co-tenant to sign the mortgage, which can create added complexity.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
