Yesterday's Wall Street Journal (sorry, no link) had an article about a tenant in common arbitration that ruled that fraud had been committed at an Austin, TX office property syndicated by Triple Net, one of the large TIC sponsors. The fraud resulted from Triple Net's failure to disclose a structural flaw in the building's foundation and that Triple Net was negotiating an insurance settlement, and then spent a portion of the insurance proceeds on other properties. The article states that the structural flaw in the building has prevented it from being refinanced and the lender has filed a foreclosure notice.
The article spends a good deal of space badly trying to tie the Austin property to other high profile TIC frauds, DBSI and Sunwest. The theme of the article is that the Austin property offered a look into the sinister world of small investor access to commercial real estate. The article fails here, too. The throw away line that raised my eyebrows was that Grubb & Ellis, which is managing many of the remaining Triple Net properties due to its merger with Triple Net in 2007, disclosed in its third quarter report that "the company (Grubb) has been named in multiple civil lawsuits related to its investment management programs alleging negligence, fraud and other claims."
Triple Net's Austin deal sounds more like a property specific situation than an indictment on an industry. No commercial real estate deal, regardless of size, was immune from the drop in real estate prices. The general risks of TIC deals were disclosed to investors. TIC transactions were single property (no diversification) investments. TIC deals had limited sources for any additional capital, such as for unbudgeted leasing expenses. No deal expected to have to pay down a mortgage to allow for refinancing. Most TIC deals had financing that ended up in CMBS, which had their restrictions disclosed, but no one knew how difficult these restrictions would become when the entire CMBS market closed. Finally, the fees of a TIC transaction usually required a gross property appreciation of at least 15% to 25%, just to break even.
It is naive to think that TIC deals would be immune from the recession and credit crisis. The real estate boom was fueled by easy credit, and the TIC boom in particular benefited from the residential housing boom as rental properties were sold and proceeds rolled into TIC properties. Commercial real estate prices appear to have stabilized, and might even improve with a growing economy. The next several years will write the final chapter on the TIC industry as mortgages in CMBS mature.