Over the past several years TIC's have become popular among 1031 exchange investors, and for good reason. They are among the few ways you can own institutional-quality commercial real estate, potentially earn a solid cash flow and retire from day-to-day management responsibilities. (TIC investments provide simplicity by eliminating active property management headaches. However, the owners do not have direct say over the day to day property management situations, they vote on major issues.) In addition to understanding the benefits that TIC's provide, you also need to understand what can go wrong. As specialists in TIC transactions, we get the opportunity to review literally hundreds of new offerings each year. We see what works and what doesn't. From our experiences, we have developed a list of rules to help you avoid costly mistakes.

Rule #1 — Avoid situations where one or a few large tenants can hurt performance
Ask yourself "What would happen if your largest tenant stopped paying rent?" If a tenant leases most or all of your property, the results could be disastrous. You could be left without enough income to pay your mortgage. Even big companies like; Circuit City, Mervyns, K-mart, Rite-Aid, Warehouse Records and Linen & Things have filed bankruptcy and walked away from their lease obligations. It is generally better to have multiple tenants and staggered leases.

Rule #2 — Beware of unusually high cash-flow projections
TIC Sponsors compete to attract our attention. One way they do this is by projecting high levels of cash flow. Sometimes it involves "financial engineering" to make things look better than they really are. There are several ways this can be done. One way is to over-borrow and supplement cash flow out of reserves. In essence, investors are being paid back their own money disguised to look like cash flow. Another way is to understate expenses, turnover, or vacancy rates. The devil is in the details. Make sure you spend time reviewing the pro-forma financial projections, especially the assumptions.

Rule #3 — Don't commit to a TIC offering unless the financing is locked in
With all the turmoil in today's lending environment, it is essential that financing be secured before you even consider an offering. Fixed rate financing is preferable, as variable-rate financing may expose you to an unacceptable level of risk.

Rule #4 — Invest with the best
There are roughly 65 TIC Sponsors that make up the TIC market, but the vast majority of TIC's are done by a handful of top sponsors who have the ability to obtain favorable financing terms, manage the property well, and service the investors. Many newer TIC sponsors lack the management experience and service capabilities to perform. Before investing, there are a few questions you should ask the TIC sponsor, including:

Rule # 5 — Avoid development deals
Many TIC offerings involve stabilized real estate, which is well suited to multiple owners who want predictable cash flow and long-term growth. Development deals may offer the promise of big gains, but many things need to come together to turn those gains into reality. Development deals in the TIC world face two significant challenges. First, the co-owners must approve all major decisions, which can be cumbersome. Second, active participation by TIC owners could cause the venture to be considered a partnership by the IRS, which could jeopardize its status as like-kind property and trigger capital gains taxes.

Rule #6 — Not all markets are created equal
This may seem obvious, but some markets are better than others. Remember the three rules of real estate, location, location, location. We pay close attention to demographic trends, job growth, absorption, and vacancy rates. We continue to see a major migration toward the sun-belt states which we believe may ultimately translate into healthy real estate markets in those areas. Conversely, many rust-belt states may appear to provide cheap valuations, but without job growth, it may be difficult for lease rates and property values to grow.

Rule # 7 — Never overpay
There are certain things you should check to make sure you are getting a good deal on a TIC. Compare the appraised value of the property to the offering price. If the offering price is significantly higher than the appraised value, it could take a long time to profitably sell the property. It is also an indication that the fees could be too high.

Rule # 8 — Diversify
You've heard the saying "don't put all your eggs in one basket." This definitely applies to TIC transactions. We encourage diversification* both geographically and by asset category. There are several major categories of commercial real estate including office, medical, multi-family, retail, industrial, hospitality, senior housing, and oil & gas royalties. By investing in different asset categories and geographic areas you could reduce exposure to regional market and economic fluctuations.
*Diversification does not guarantee a profit or protect against a loss.

Rule #9 — Kick the tires before you buy
We don't believe in buying real estate sight-unseen. Most real estate transactions are big-ticket items. You wouldn't buy a car before test driving it, so why buy real estate without seeing it first. We usually tour a property before recommending it to clients, and we encourage clients to tour properties before investing in them as well. There is no way you can gain a true sense of a property and a market without seeing it first-hand.

Rule #10 — Work with an experienced and trustworthy advisor
Most people have a sixth sense when it comes to knowing if someone is trustworthy, ethical and experienced. Always ask for references. A good advisor will ask a lot of questions to learn about your needs. Make sure your advisor learns what your needs are before recommending anything to you. Above all else, if that little voice in the back of your head tells you that something isn't quite right, listen to it.