It's an understatement to say that the 1031 exchange has become a driving force in commercial real estate sales transactions. On the West Coast, an estimated 80% of all deals involve exchanges, which enable investors of all sizes to defer the dreaded capital-gains tax by snapping up other pieces of property of equal or greater value. Tax specialists say that the volume of 1031 exchanges nationally has risen 25% over the last three years.

What's really catching fire is the tenant-in-common (TIC) transaction, which enables exchangers to buy into portions of an investment property. While the TIC structure has been in use since the 1990s, new IRS guidelines issued in 2002 clearly have accelerated its growth (See related story, page 49).

“There has been an overabundance of capital out there in recent years and a shortage of replacement properties because there's been a lot of asset churning,” says Guy Ponticiello, senior vice president of the capital markets group at Jones Lang LaSalle in Chicago. “TICs are filling a void.”

Growing Menu of Options

Before TICs became popular, many replacement purchases were limited to “vanilla” properties such as stand-alone fast-food restaurants, video and drug stores because these best fit the modest-sized investor's profile, says Steve Regenstreif, vice president and senior director of the national retail group for Marcus & Millichap.

But the TIC has become a problem solver. In a highly publicized deal in 2003, 31 investors bought into a TIC pool to purchase part of the $148 million Puente Hills Mall in City of Industry at $1.8 million per share, with a larger investor assuming the balance.

Soon after, the $138 million Torrance Crossroads shopping center was divvied into eight varying parcels and sold to seven private investors and one institutional investor. A lone investor would have paid about $107 million for it, says Rich Walter, president of Irvine, Calif.-based Faris Lee Investments, which brokered the deal. A similar TIC format will be used by Coventry Real Estate Partners later this year to sell the $54 million Plaza at Puente Hills center across from the mall.

“This approach allows smaller investors to get in at a much better price, plus it creates additional value, mostly through marketing technique,” Walter says. “There's a substantial amount of pent-up 1031 capital looking for this kind of investment.”

TICs also buffer owners from operational headaches because the replacement properties are usually fully occupied with triple-net leases in place. “A lot of those TIC investors are happy to get out of more management-intensive real estate and into more passive investments,” says Louis Weller, principal at Deloitte & Touche National Real Estate Tax Services Group in San Francisco. “They're happy to know that their days of fixing toilets are over.”

Aging Baby Boomers heading family real estate trusts also are looking to simplify matters for their heirs by lifting the operational burden via the TIC, says Regenstreif of Marcus & Millichap. “Some Baby Boomers view TICs like they would a bond,” adds tax and real estate attorney John Napoli, a partner in New York-based Seyfarth Shaw. “It's a stable investment with a reliable long-term yield.”

Non-TIC 1031 retail opportunities are dwindling, says Regenstreif. “Three years ago, many of the Office Depot, OfficeMax and Staples buildings were for sale, but that's slowed down. A lot of major corporations are retaining their real estate because the cost of capital has been so low.”