Are individual TIC loans still available?
The number of banks offering fractional financing for tenants in common groups has dropped from approximately 10 a year ago to only three or four today. As of this writing, only Sterling Bank has a comprehensive TIC lending program for purchases and refinances that is available to the general public. Several other lenders, including Bank of Marin, Circle Bank, and NCB, are honoring past commitments to provide purchase money financing for particular buildings, and considering new commitments for clients with existing banking relationships or particularly attractive projects.
What are the typical terms on which individual TIC loans are offered, and how do they compare to condominium loans?
As competition among TIC lenders has diminished, the terms of individual financing have become less attractive. Generally, there are fewer loan programs offered, interest rates are 1.5-2% higher than comparable programs for condominiums, underwriting guidelines restrict availability to the strongest borrowers, and loan-to-value ratios are limited to 65-75%. Terms can be more attractive when the lender is honoring a commitment made to a developer prior to September 2008.
How are sellers and agents addressing the competitive disadvantage of individual TIC financing in their TIC marketing?
In projects that have been structured for fractional financing, or are required to use such financing under the terms of their regulatory approval, sellers and agents must find a way to attract buyers despite the non-competitive terms offered by their fractional lenders. One obvious approach is to offer lower prices than those of comparable condominiums, but many agents are finding that pricing advantage alone will not overcome either buyer resistance to adverse loan terms, or the effect of strict underwriting guidelines and high down payment requirements on the size of their qualified buyer pool. Beyond lowering prices, these agents and their sellers are finding that they must “buy down” interest rates by paying additional points to banks from sale proceeds, and offer seller financing to decrease the amount of cash needed to meet loan-to-value limits.
Do sellers and agents have an alternative to individual TIC financing?
Many people forget that, until four years ago, virtually all TICs were financed with traditional financing in the name of all the owners and secured by a single deed of trust on the entire building (a “blanket encumbrance”). In the face of the shortage of fractional financing sources, and the deteriorating terms on which these loans are offered, many sellers and agents are returning to the traditional blanket encumbrance model. While these group obligations are more risky for buyers (as discussed below), they are much more readily available than individual TIC loans, and are offered on more attractive terms. For the seller or agent creating a marketing plan for a TIC property, the decision often comes down to predicting what will attract the larger number of qualified buyers: less risky but more expensive financing for which many will be unable to qualify, or more risky but less expensive financing that will be available to many more potential buyers. In many cases, the answer depends on the type of buyers the property is likely to draw, which, in turn, is a function of property location and price.
Financing options are morel limited for larger TIC properties. Marketing buildings of five or more units as TICs requires approval from the California Department of Real Estate (the “DRE”) which, in recent years, has become increasingly reluctant to approve projects to be sold with blanket encumbrances. While it remains theoretically possible to get large blanket encumbrance TICs approved, the conditions of approval are so burdensome for the seller that most have continued to opt for approval that is conditioned upon separate loans. For these projects, converting to blanket encumbrance financing is not a viable option. When the projects cannot secure individual financing (a problem which is particularly common outside of San Francisco, in marginal neighborhoods, and where the unit mix is dominated by small units), or where terms of the individual financing is making the project impossible to sell even with rate buydowns, sellers are sometimes opting to eliminate all institutional financing in favor of seller financing.
How does TIC group financing function in practice?
Each owner’s loan payment is determined by the amount of the group loan he/she is responsible to repay. Each owner’s down payment is subtracted from his/her purchase price to determine this repayment obligation. The difference between a owner’s purchase price and down payment, often called the owner’s loan amount or loan share, is divided into the total amount of the group loan to determine the owner’s loan percentage. The owner’s loan percentage determines how much of the monthly payment on the group loan that owner must pay.
For example, imagine that Jane and Bill are buying a two unit building together for $1,000,000. Jane, who will have the right to live in the better unit, is paying $600,000 for her share, and Bill is paying $400,000 for his share. The $600,000/400,000 split of the price is based upon the relative value of the two units in the building. Bill, who has more savings than Jane but a lower salary, is making a down payment of 25% of his price ($100,000). Jane, who has little savings but a good job, is making a down payment of 10% of her price ($60,000). The TIC group loan amount will be $840,000, which is the difference between the $1,000,000 purchase price and the total down payment of $160,000 ($100,000 from Bill and $60,000 from Jane). Bill’s loan amount is $300,000 (400,000-100,000), and his loan percentage is 35.71% (300,000/840,000). Jane’s loan amount is $540,000 (600,000-60,000), and her loan percentage is 64.29% (540,000/840,000). If the monthly payment on the TIC group loan is $4,200, Bill will pay $1,500 and Jane will pay $2,700.
Assuming each owner pays his/her exact share of the loan payment each month, the loan percentages never need to be adjusted. The gradual decrease of the amount owed over time (due to loan amortization) will not affect the loan percentages. The loan shares will require adjustment only if an owner decides to pay more than his/her regular monthly payment (perhaps to pay down his/her loan amount more quickly) or if the loan is refinanced. When loan percentages differ dramatically from ownership percentages, extra documentation should be used to provide additional security to the owner with substantially greater equity.
How do sellers and agents address buyer concerns about group loans?
Most TIC buyers’ instinctive objection about group financing relates to the risk of acting as co-borrower with a group of strangers and concern that one of these others will not fulfill his/her payment obligation. The first response to this concern should be statistical. Although the risk of owner default is real, actual defaults are extremely rare, and have remained rare even during the current economic calamity. The next response should be more practical, focusing on the structural measures that can be incorporated in the TIC which minimize both the risk of default and the likely consequences if a default does occur. These measures include:
• Requiring a reasonably large down payment
• Making sure that group members carefully consider each other’s creditworthiness
• Incorporating all mortgage payments into the monthly HOA dues, so that all owners know immediately if a payment is late
• Paying ahead, so that, for example, the mortgage payment due August 1 is part of the HOA dues payment made June 1
• Keeping large default reserve funds, so that if an owner defaults, the group has adequate funds to cover six or more of that owner’s payments
• Acting very quickly (meaning within days or weeks, but never a month or more) in response to a late payment, so that there is enough time to re-sell a defaulting owner’s TIC before reserves run out
Adopting and then closely adhering to these measures is more important than ever because (i) increased unemployment makes default more likely, (ii) falling property values can mean a defaulting owner has less equity than when he/she purchased which exposes the group to more risk, and (iii) the slow market can make re-selling a defaulting owner’s share more difficult. Still, these measures have continued to be effective through the worst economy in 70 years.
Buyers’ concerns about group loans may (and should) extend beyond the risk of owner default. In fact, the most common problem with blanket encumbrance financing is that it can complicate or prevent resale of tenancy in common shares. TIC groups rarely refinance when a single owner sells. Instead, the buyer will take over the seller's percentage of the outstanding balance. To accommodate this arrangement, it is important that TIC group loans be assumable. For agents marketing TICs with blanket financing, and for buyers of these tenant in common interests, loan assumability should be considered the most important feature of the loan, more important than the interest rate or the origination fee.
What is the future of individual TIC financing?
Lenders who are or were in the individual TIC loan market continue to express satisfaction with the performance of their fractional loan portfolios and optimism about the viability of the TIC loan market. These lenders say that they have suspended or restricted their programs in response to the difficulty of obtaining funds to lend and/or an institution-wide shift toward capital preservation. Based on this information, it is reasonable to expect that individual TIC loans will become more available and more attractive as the mortgage lending industry recovers.
About the author
Sirkin & Associates 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.
Sirkin & Associates 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 email at DASirkin@earthlink.net, or by telephone at 415-738-8545.