TICs Blogpost (for popup)

Posted on November 14th, 2010

TIC means Tenants In Common and generally refers to fractional ownership of a multi-unit building. On first glance, TICs may appear to be Condos but they are not! In a TIC, the buyer does not own the individual unit because the units are not legally subdivided within the building. Rather, the buyer owns a percentage of the whole building and has exclusive occupancy rights to a specific unit.

An example is a four-unit building where four different people each own 25% of the building. Normally there will be a TIC agreement that functions like CC&Rs in a condominium. Another example would be two different parties who own a duplex. Because the units are not necessarily the same size, one may end up with a 55% ownership of the building while the other owns 45%. Buildings and ownership percentages do not have to be symmetrical and usually they are not.

A TIC is NOT a condominium! Technically, a TIC is not a property type at all. The terms condo or single family home denote a specific, legally-defined type of property. The actual legal property type in the case of TICs is a multi-family residential building. TIC refers to the ownership structure of that property type.

TICs are common in San Francisco for two main reasons. First, it’s cheaper to buy a duplex, triplex or other multi-unit building and then divide the living units among different owners. The per-unit cost is roughly 10% – 30% less than the equivalent condo. The price variance relative to a similar condo is driven mainly by the number of units in the building. A duplex will have the least variance compared to a similar condo, while TICs in buildings with five or more units will have the highest variance. This is driven by the byzantine rules governing condo conversion and the issues related to risk, financing and resale.

During the real estate boom of 1997 – 2007 there was a cottage industry of investors who would buy multi-unit rental properties, renovate them and sell them as TICs. There were also many private TIC groups formed by friends who found this to be a strategic way to buy and live in properties they otherwise could not afford.

The second reason TICs became popular was a simple imbalance in the supply and demand for affordable condos. While there has been strong and consistent demand, there has been almost no new supply. This is because of policy decisions by the San Francisco Board of Supervisors related to new construction, height restrictions and condo conversion laws.

There was some supply-side easing that began in the year 2000 time frame. Significant new condo construction took place around the new baseball stadium in SoMa, South Beach and Mission Bay. However, this supply increase, in these newly re-formed neighborhoods, did not satisfy the considerable demand for condos in many of the more traditional, well established and lower density neighborhoods.

Now that the real estate market is in a price recession, there is an over-supply of condos and one of the two primary drivers for new TIC formations has largely disappeared.

There are very important ramifications to owning a TIC versus a Condo. Foremost among these is how the loan is structured. If it is a group loan, then each party is JOINTLY AND SEVERALLY liable for the loan and the monthly payment. If one party cannot make their portion of the total payment, or worse, declares bankruptcy, it can have a very significant and entirely negative impact on all the other parties. In order to reduce the financial and legal risks for everyone, TIC agreements have become sophisticated contracts that normally contain provisions for default funds and have Forced Sale clauses in case things go wrong.

In addition to financial risk, group loans for TICs create problems when one party wants to sell. Selling a TIC with a group loan is much more difficult than selling a condo. This is because the sale of a fraction of the building to a new buyer will either require a new group loan (and therefore an expensive refinancing at prevailing interest rates) or a partial loan assumption. Neither of these is easy to arrange and the other owners have an effective veto if they are negatively impacted. Seller carry-backs are a frequent solution but don’t result in the seller cashing out his or her equity.

To eliminate the risk and the problems created by group loans, several boutique lenders have created Fractional Loans. These took TIC ownership a major step forward in their emulation of condo ownership. A fractional loan indemnifies the borrower from all other owners and borrowers on the property. This is a loan specifically for the fraction of the property owned by the borrower. The non-payment or bankruptcy of other fractional owners does not impact the owner with a fractional loan. In addition, the fractional loan can be independently refinanced and this means that these TICs are much easier to re-sell.

Unfortunately, there is a down-side to fractional loans, which is cost. The interest rates for a fractional loan are normally 1.5% – 2% higher than a conventional loan. They also have higher closing costs and higher down payment requirements. When considering the impact on the typical monthly payment, this eliminates the price advantage enjoyed by most TICs. In other words, the monthly carrying cost of a TIC with a fractional loan ends up being the same as the comparable condo, which puts most buyers back into the condo market.

Condo conversion is the holy grail of TIC ownership and offers the allure of real wealth creation. There is a clear and transformative value-add that can be another motivation for TICs ownership. In the early days of TIC formations, the common wisdom was that this ownership structure was not appropriate for people who did not have a 10-year ownership horizon, which was the required amount of time to get through the condo conversion process. There is an annual condo conversion lottery in San Francisco that allows the winners to convert multi-unit buildings into condominiums. The rules are different, depending on the size of the building. There are four different sets of rules for the four different building categories, summarized briefly here:

  1. 2-unit buildings - If both units have been owner occupied for one full year and there have been no disqualifying evictions, then the property can bypass the condo conversion lottery. The owners must go through a process which usually requires some infrastructure upgrades for fire safety and power metering, among other things. After completion of these upgrades and the creation of legal documents, such as CC&Rs, budgets, etc., the building can be converted without further discretionary review by the city.
  2. 3-4 unit buildings - These properties must go through the condo lottery. It will normally take ten years to achieve this but can take longer, or may never be achieved if there is not a continuous thread of qualifying owners, or if there is a disqualifying eviction on the property. In order to qualify to be in the lottery, which takes place once per year, the building must have at least one unit that has been owner-occupied for at least three years and that unit must represents a minimum ownership of 25% of the entire building.

    A building may be qualified by virtue of an owner who meets all these requirements but if that owner moves out and there were no other qualifying owners, then the building would lose eligibility and would have to start from the beginning when eligibility is reestablished.

    The chances of winning the lottery go up very significantly with each consecutive time the building is in the lottery. Buildings in the lottery for the first through third times have a nearly zero chance of winning, while buildings in the lottery for the sixth or seventh time have a high and sometimes nearly certain chance of winning.

  3. 5-6 unit buildings - The requirement is that a minimum of two units be owner occupied for a minimum of three years, along with other minimum ownership percentage requirements. The same basic rules of process apply for this category as for the 3-4 unit category.
  4. 7+ unit buildings are not eligible for condo conversion under any circumstances. This does not mean that there are no TICs in these larger buildings, as in fact there are. Fractional lending has made this a possibility and these properties tend to behave somewhat similar to condos. The lower purchase price is mostly but not entirely offset by the higher loan rates. These properties tend to be in the more exotic locations and the most in-demand, higher density neighborhoods of the city, such as Russian Hill and Nob Hill.

There are numerous types of evictions and several of these may permanently disqualify a property from being converted to condos. Ellis Act evictions, evictions of protected tenants, multiple Owner Move-In (OMI) evictions or just multiple evictions, depending on the number of units in the building, can disqualify a property’s eligibility for conversion.

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