Tuesday, June 13, 2006

I was talking to a wholesaler friend earlier this week and he told me that a broker/dealer is worried that the TIC market will collapse any day. This scared me because I know the people at the broker/dealer and they are smart. I would bet that the management at this broker/dealer knows more about investments than the managment at any other independent broker/dealer. After the fear of my due diligence review fees evaporating passed, I thought through the comment.

The TIC market will not collapse. Real estate is too varied and illiquid to collapse overnight. It is not a stock. My guess is that it will slow, as real estate in general is slowing. All TIC deals are predicated on the sale of properties so that investors can exchange into the TIC deal. If investors have a hard time selling their properties, this will slow TIC sales.

Here are the biggest trouble spots that I see:

  • Specific sponsors going under is a more likely scenario. Sponsors that are leveraged and need deal flow and the corresponding fees will be in trouble. A sponsor that runs into severe financial difficulty will be a black-eye for the industry. (It may also be an oppourtunity for a better capitalized sponsor to take over management.)
  • If credit dries up, properties that need to be refinanced when the original debt term expires may find it difficult in a tight credit market. If there are defaults on a number of TIC deals, good programs may feel the affect by finding financing difficult and expensive. Bankers are followers and credit will dry up fast if the bankers get nervous.
  • Deals that were "financially engineered" will be the first to feel any pain. Watch the deals from sponsors that put them together. Financial engineering examples include projections that have outsized growth, or have distributions paid from reserves (or any other non-operating source), or interest-only financing for an extended period of time (five years or more) that artificially inflates distributions while adding no equity accumulation.
There are other potential flash points, but rather than a full-scale retreat like the stock market saw in 2000 through 2002, the TIC market will not collapse. In talking to sponsors, the biggest concern is not the ability to raise money or access to financing, but to find affordable properties that fit in a TIC pricing model. This is not the talk of an industry about to implode.

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