Back in the early 2000s, the leading Sponsors and real estate attorneys worked together with the IRS and established guidelines that would make the then Tenant-in-Common (TIC) co-ownership structure clearly qualify for 1031 Exchange. The text of the result, IRS Revenue Procedure 2002-22, is shown in full here.
As a result of Rev. Proc. 2002-22, the industry exploded in growth. Investors and their advisors had the Revenue Procedure to rely upon. If TICs followed these guidelines, they could qualify without question as “like- kind” property in 1031 Exchange. The industry grew until its height in 2007 when almost $4 billion of equity was invested. Also in the early 2000s, the idea of the Delaware Statutory Trust (DST) gained traction. In 2004, a similar revenue letter was developed by the IRS that gave the same level of certainty to the DST structure regarding 1031 Exchange. In 2004, the IRS released Revenue Ruling 2004-86 that allowed the use of DSTs to acquire real estate where the beneficial interests in the Trust will be treated as direct interests in replacement property for purposes of 1031 Exchange. This was another milestone for the syndicated real estate industry. IRS Revenue Ruling 2004-86 is what we now rely upon for our DST 1031 Exchanges, and you may read it in full here.
Then 2008 happened. We’re sure you remember it—and probably not with a pleasant wave of nostalgia. The Great Recession affected values of real estate across the industry. All classes of real estate suffered, including TICs. As the banks became extremely conservative in their lending practices, TICs fell out of favor. In the TIC structure, the banks review and underwrite each investor’s credit worthiness, and because TICs can have up to 35 owners, the work required to establish loans on TICs was simply too much to bother with for the banks. The DST came into favor, because lenders were willing to underwrite them. In DSTs both the property itself and the Sponsor are responsible for repayment of the loan. Investors have no responsibility for the loan principal in the event of default. This is called non-recourse financing to the investor. In addition, DSTs do not require that investors be credit approved by the banks. This advantage is also unavailable when investing on your own.
A few Sponsors still occasionally use the TIC structure, and their lenders are usually regional banks with which the Sponsor has a close and long standing relationship, and the burdens involved in underwriting up to 35 investors are acceptable. The syndicated real estate industry has steadily come back since 2008. Our personal experience of real estate investors during the recession was that they were unwilling to sell property they owned, as they felt they had lost money due to the price declines. The TIC and DST industry slowed dramatically from 2008-2011, when it steadily started to pick up as investors began selling investment properties again. Each year since the Great Recession, more and more investors have come back to syndicated real estate as incremental normalcy came back to our economy. In 2015, the market has rebounded to its pre-recession levels, and our personal experience was to raise as much equity as we did in 2007.
By Leslie Pappas, Founder and CEO