If you’ve poked around Realized Holdings’ glossary, you already know there are many different forms of real estate ownership. There is 100% direct ownership (also known as fee-simple ownership) and the equal-percentage joint tenancy. Then there is the fractional ownership, such as that offered through the Delaware Statutory Trust (DST) or tenants-in-common (TIC) set-ups.
Sometimes called tenancy-in-common, the TIC arrangement offers property ownership rights; up to 35 entities can invest in a single TIC. Unlike a joint tenancy arrangement, in which all owners have an equal percentage of ownership, the TIC allocates ownership percentages. For instance, you might own 20% of a property, while your friend owns 15%, his sister-in-law has a 25% ownership portion, and so on.
As an investor, you could reap many rewards from a TIC investment; one such advantage is a lower initial investment. But, before racing out to sign on the dotted line of your cousin’s, or coworker’s, or best friend’s TIC, it’s a good idea to understand the potential drawbacks of such an arrangement.
So, what could go wrong?
All investments carry risks, and TICs are no different. Some of the potential issues that could arise through a tenant-in-common agreement include the following.
Beneficiary or heirship designation. One TIC advantage is the ability to sell, gift, or pass your ownership share to others, without requiring approval from other co-owners. Looking at it another way, it also means your co-owners could sell, gift, or pass their property shares to others, without your approval.
This can be a great estate-planning tool, and, it could be that the new co-owner is great, and someone you enthusiastically welcome into the fold. Or, it could be someone you don’t like. Even worse, it could be someone who wants to liquidate his or her shares, while the rest of you might not. This ornery owner could force a sale through a partition, a costly legal process that gives the court the right to sever ownership in the property, thereby paving the way for a sale.
Speaking of courts, if one of the co-owners dies without designating an heir or beneficiary, you and your surviving co-owners won’t get that share unless you are the designated heirs. In this case, the property goes through probate, and the judge decides legal ownership.
Taxation without representation. In addition to sharing property ownership benefits with your co-owners, you also share property costs, such as maintenance and taxes. With the latter issue, most municipalities will send a single tax bill, rather than separate invoices to all of you.
In most cases, you and the other co-owners will chip in to pay those taxes. Until one of your co-owners doesn’t. Regardless of the reason why, that lack of payment means you and the other co-tenants will have to take up the slack, and cover the amount for those taxes.
Who pays the mortgage? In some cases, TIC financing involves each co-owner applying for a separate loan, and securing it with his/her property interest. Under this arrangement, a mortgage default means the lender might foreclose on only that owner’s share.
But in other cases, a TIC mortgage might be secured by the total property interest. This arrangement, known as group financing, certainly benefits the lender. Such an arrangement means less paperwork, requiring only one underwriting, versus many.
However, problems can occur if one of the co-owners doesn’t kick in for his or her portion of the mortgage. Much like the situation with the property taxes, above, that lack of payment puts the onus of repayment on you and the rest of the co-owners. Failure to pay the full, monthly amount could give the lender motivation to foreclose on the entire property.
Mitigate the TIC risk
The above is not to suggest that you shouldn’t consider a TIC investment. What it does suggest is that, before shaking hands with your co-owners, you spell out expectations, in writing. One expectation might focus on property costs. Another could specify rights of first refusal in the event that one of the owners wants to sell, or approval of potential buyers. Furthermore, once an agreement has been reached, it’s important to ensure your real estate lawyer examines everything, as well.
While TICs can be a good method of property investment, they can also be costly. As such, it pays to be aware of potential pitfalls. Doing so can help mitigate possible investment risks.