The rapid growth of the 1031 Tenant in Common Exchange (TIC) industry will likely tempt unscrupulous parties to skirt the rules by offering the tax-shelter investments without following the securities guidelines that regulators require for such investments, according to regulators who spoke at the March Tenants in Common Association (TICA) meeting in San Diego.
At the same time, officials did not predict any forthcoming change in regulations regarding the 1031 Exchanges, which allow individual investors to transfer the proceeds of a sale property into “ownership units” of institutional-grade real estate, which would otherwise be out of the reach of smaller investors.
Joe Price, vice president in charge of the finance department of the National Association of Securities Dealers (NASD), said that securities laws regarding TIC investments are nothing new — at least as far as securities investments are concerned — even if many people in the real estate industry were unfamiliar with those rules.
The SEC regards TIC investments as securities, and that means the investments cannot be publicly advertised and cannot be offered to people who do not have a prior relationship with the broker-dealer. In addition, brokers must make thorough disclosures of their roles, including their fees, to investors.
Regulators on the TICA panel had praise for organization, an industry group that has defined a set of “best practices” to keep TIC investments in compliance with securities law.
Yet “once the news gets out that there is money to be made [in TIC vehicles], you can be sure that the field will be full of people” ready to exploit the new industry,” according to Denise Voigt Crawford, a Texas state securities commissioner.
“These are the people who are going to give the industry a black eye,” she said. In 2005, investors spent about $3 billion on individual ownership units in TIC vehicles, doubling the amount they spent the previous year. In 2006, investors are expected to sink between $5.75 billion to $6 billion, according to TICA.
Price revealed, in fact, that the NASD had “recently settled” a case involving an unnamed California TIC sponsor, which ran afoul of the securities law by paying commissions to real estate brokers who were not licensed to deal in securities. Under federal law, only licensed dealers are allowed to receive fees from the sale of securities.
Martin Murphy, assistant regional director of the U.S. Securities & Exchange Commission, warned that fines for securities violations had risen steeply since the 1990s “into the $10 million, sometimes $100 million range.”
Murphy told the audience, many of whom were TIC broker-dealers, that they had an ethical responsibility to give good advice to their clients and keep the latter out of trouble.