The tenant-in-common industry is facing a painful contraction marked by a sharp decline in deal flow and a dwindling pool of sponsors. TIC transaction volume has slowed considerably in the wake of the economic and financial crisis that has made accessing both debt and equity sources extremely difficult.

Even sponsors that are successful in securing financing to buy quality properties are stymied because far fewer TIC investors are willing to commit to new deals, a stark contrast from two years ago.

The TIC industry is fueled predominantly by investors who are pursuing replacement properties as part of a tax-deferred exchange under Section 1031 of the Internal Revenue Code. The investment vehicle enables investors to own a fractional interest in institutional-quality real estate while deferring capital gains by exchanging one property for another.

But activity in this investment niche of commercial real estate has stalled. Many property owners have opted to hold onto their real estate assets in a volatile economy. Others are opting to pay the taxes on what capital gains — if any — they are able to realize in a sale.

The TIC industry raised nearly $1.4 billion in equity last year — half the $2.8 billion raised in 2007 and less than 40% of the $3.7 billion raised in 2006, according to data from Omni Consulting & Research in Salt Lake City. Omni tracks data from sponsors that structure TICs as securities. Fourth-quarter numbers saw the biggest drop with just $256 million in new equity raised — about 25% of the quarterly volume the industry was generating in its heyday in 2006.

“The paralysis in the capital markets has caused the decline in transaction volume in the TIC industry as it has throughout the commercial real estate industry,” says Patricia DelRosso, president of Inland Real Estate Exchange (IREX), a TIC sponsor based in Oak Brook, Ill. “Once credit starts to flow again, it will have a direct impact on boosting TIC activity.”

When the capital markets will recover and what the shape of recovery will look like is anyone's guess. In the meantime, the drop in deal flow has caused some sponsors to exit the business, while the remaining firms are focused on survival in what many anticipate will be another rough year. “I would venture to say that in 2009 the equity raise could be as low as $500 million if things don't change,” says Greg Paul, CEO of Omni Brokerage, a broker-dealer firm that specializes in TIC sales.

Survival of the fittest

The field of TIC sponsors has already narrowed considerably. Among firms that sell TICs as securities, 50 sponsors reportedly raised at least $1 million in investor equity in 2008 compared with 63 sponsors who had raised at least that amount the previous year, according to Omni.

At the end of January, there were 63 available TIC properties issued by 37 sponsors. “Going forward in 2009, I expect that there won't be more than 15 to 20 sponsors that will put a deal on the street,” Paul says.

The TIC industry has traditionally been split into two sectors. On one side are sponsors that sell TICs as securities, and subsequently follow Securities and Exchange Commission (SEC) rules for the marketing and sale of those securities. On the other side are those sponsors that follow a traditional real estate model in which they package and sell TICs as fractional ownership.

Real estate-based TICs have been able to avoid SEC oversight, thereby giving them greater flexibility in marketing real estate to potential investors. But the future of real estate-based sponsors is now in doubt.

The SEC recently issued a letter that effectively reinforced its opinion that TICs are securities. That letter is giving many real estate sponsors pause because continuing to sell TICs under the real estate model could leave them vulnerable to legal action for not following SEC rules and regulations.

That letter, coupled with lawsuits filed against Idaho-based sponsor DBSI Inc. and its entities for alleged securities fraud among other charges, will likely force real estate sponsors to curb their activity — at least in the short term.

“You're going to see a lot of consolidation at many levels in terms of who is syndicating new equity, who remains in business, and who is still maintaining the asset management function over the portfolio of assets they currently have,” says Jeff Hanson, president and chief investment officer of Grubb & Ellis Realty Investors in Santa Ana, Calif. Grubb & Ellis is one of the top TIC sponsors in the industry. The firm raised $181 million in equity in 2008.

TIC sponsors will face a tough road just to survive in 2009. “Those sponsors that have the staying power are going to take whatever steps they feel are necessary to ride out the downturn in the market,” says Robert Johnson, president of St. Paul-based AEI Fund Management.

“It looks like it could be a three- to five-year situation with the national economy, and sponsors are going to do what they can so they will be around in the future,” adds Johnson.

One factor that bodes well for the staying power of the TIC industry is that a number of sponsors are not dependent on TIC sales. AEI, for example, is a net-lease investment fund manager with about $500 million in net-lease properties under management.

AEI offers TIC deals as an exit strategy for properties it is selling from its portfolio of net-lease real estate. The firm has completed some 82 TIC transactions valued at $215.8 million since 1992.