Financing for TIC Converters, Developers and Sellers
Legal Structure of TIC Fractional Financing
For the uninitiated, fractional tenancy in common financing is an arrangement where each of the tenant in common owners obtains her own loan. Each loan is represented by a note signed only by the individual borrower, and secured only by the individual borrower’s percentage interest. A default by one co-owner results in a foreclosure on only the defaulting owner’s share, and does not affect the other co-owners.
The History of Individual TIC Lending
The size and sophistication of the institutional loan market for fractional tenant in common financing has developed significantly since the first individual TIC loan program was introduced in the Spring of 2005. At that time, such loans were available from only one lender (Bank of Marin), only for buildings of five or more units, and only for property being sold by certain preferred clients of the bank. By the fall of 2005, Circle Bank and America California Bank had entered the market, each with significantly fewer restrictions and a wider range of loan programs. Sterling Bank followed in early 2006, and by the end of 2007 there were 10 lenders offering TIC fractional mortgages, and such loans were available throughout the state.
When the banking crisis hit in the fall of 2008, many of the lenders making TIC loans found themselves short of cash to lend, in trouble with regulators, or both. The problems facing these lenders had nothing to do with their portfolios of TIC loans; these lenders uniformly reported that their TIC loans were the best performing loans in their portfolio in terms of return and lack of defaults. But many of these same lenders had been focused on construction and commercial lending, and were experiencing widespread failures with those loans.
Fortunately, Sterling Bank and National Cooperative Bank not only stayed in the market but continued to offer new, more attractive TIC loan products. Sterling also created a secondary market by purchasing portfolios of TIC loans from other lender TIC lenders who were in trouble.
Beginning in 2013, additional lenders began to show interest in entering the TIC market, drawn by the high returns, extremely low default rates, and attractive profile of the borrowers from a consumer banking standpoint. By the end of 2012, Bank of Marin had returned to the TIC lending market, and several other banks were either running pilot programs and engaging in market studies.
Is there financing for TIC conversion/development?
As this article is written, both Sterling and Bank of Marin offer financing to TIC developers for acquisition and renovation of buildings that will then be converted and sold as tenancy in common. These loan products include a partial release feature that allows them to be repaid gradually as TIC interests are sold, and ensure that the sold TIC units are not encumbered by a blanket encumbrance.
Is TIC consumer financing attractive or a marketing handicap?
The variety of financing products available as individual tenant in common loans remains limited, and the terms are generally less favorable than either apartment building loans or condominium loans. The maximum fixed-rate period seems to be seven years, and there is generally a balloon payment at 10 or 15 years. Rates tend to be 25 to 50 basis points above commercial (5+ unit) apartment building loans, and 50-100 basis points above residential (1-4 unit) loans. Loan-to-value allowances vary, but seem to top out at 75-80%, and even that figure can be misleadingly optimistic in light of the appraisal difficulties (described below). Secondary financing is generally permitted, and the realities of the marketplace usually require the seller to carry financing for most buyers. Underwriting guidelines are more strict than on residential loans, and buyers who might qualify for a condo loan sometimes cannot qualify for an individual tenancy in common loan. Many lenders also impose additional requirements such as owner-occupancy, and/or that one lender make all of the institutional loans in the building.
Perhaps the most challenging difficulty facing fractional lenders is determining the value of the fractional interests. Most now appraise the building as a whole (using the traditional income, cost, and market approaches) and then also appraise the TIC interests using a market approach. The lender then takes both of these valuations into account and chooses a middle ground on which to base its underwriting. This method is only possible in San Francisco where a significant amount of tenancy in common sales data is available. Even in San Francisco, the approach leads to somewhat unpredictable results. Valuation problems are significantly more severe outside of San Francisco, where few tenants in common sales have occurred. Until the TIC market develops in a particular locality, and a reasonable number of sales occur and are reported in the MLS or some other accessible database, appraisers (and therefore lenders) must extrapolate from the apartment building value and the condominium sales date, making the result still less reliable.
None of these difficulties seem fatal, and most will disappear as the TIC market develops and more and more lenders introduce fractional loan programs and compete for customers. Considering that the first fraction TIC loans closed just over a year ago, a huge amount of progress has occurred in a short time, particularly given the slowness with which lenders typically move.
About the Author
D. Andrew Sirkin is a recognized expert in fractional ownership and other co-ownership SirkinLaw APC was a pioneer in the area of tenants in common (TIC) arrangements involving occupancy rights assignments, which are often used as a substitute for subdividing a property when true subdivision is impossible or unduly expensive. In 1985, Andy Sirkin created the legal and transactional structure which has become the industry standard for this type of TIC. Over the succeeding years, Andy’s innovations have included being the first state-approved real estate instructor for occupancy-based TICs, being the first to obtain state approval for a large-building TIC sale, being the first to convince institutional lenders to offer individual TIC financing, and being the first to develop the loan documents and lender underwriting guidelines for fractional TIC financing. In recent years, the type of co-ownership arrangement Andy conceived nearly 25 years ago has grown to comprise approximately 1/3 of all attached-home sales in San Francisco.
SirkinLaw APC has prepared close to 3,000 occupancy-based TIC agreements for properties of every size and type, and continues to assist in the vast majority of these transactions in California. This unmatched level of experience allows us to offer time-tested approaches for the vast majority of co-ownership situations, to quickly and effectively solve problems, and to produce documents that are clear, easy to navigate and read, and efficient and cost-effective to enforce. We continue to improve our documents each month as we encounter new situations and learn more about what TIC arrangements perform best in the real world. We also share our accumulated knowledge, and support real estate professionals and the TIC community, by continuously publishing new articles on our website and offering free educational workshops.
Our tenancy in common practice involves general advice and counseling, TIC agreement preparation, loan documents, and ongoing consultation to developers, seller, Realtors and TIC owners, on either a flat fee or hourly basis. We have a well-deserved reputation for returning calls promptly and providing fast turnaround times. But more important, we are known for finding creative solutions, calming fears, and finding common ground, so that transactions and relationships work. Although our role usually begins at the time the tenancy in common is first formed or sold, we are committed to remaining available to solve problems throughout the life of each TIC. Contact us via our contact form.