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Tenancy in Common Ownership in San Francisco and Bay Communities
INTRODUCTION:
San Francisco and the Bay
Area Communities have enjoyed unprecedented increase in property values
for the past decade and the end result has been the creation of a real
estate market that may be considered the most expensive in the United States.
While this has been a boon to owners of real estate, it has made entry
into the real estate market by first time buyers particularly difficult.
It also makes purchase of apartment houses, income property and
condominiums a high cost task for anyone seeking to enter the market for
the first time.
While the remainder of the
Bay Area has seen slightly lower appreciation in values, it is safe to
state that the entire Bay Area is one of the most expensive locales to
enter the real estate market in the world. Studies bear this out, with
the percentage of homeowners in San Francisco being among the lowest of
any City in the world.
But the reverse side of this
“problem” is that once you enter the real estate market you are likely to
have an asset of increasing value, which remains an excellent investment.
When combined with the significant tax benefits that one enjoys in home
ownership, ownership of residential real estate in the Bay Area is one of
the best investments available.
The question is how to break
into that market. How does one manage the economics of buying the first
home, the first condominium in such an expensive market?
Condominiums were long seen
as the best and least expensive way for those with limited funds to enter
the market and enjoy the appreciation and tax benefits that come with
home ownership. The problem became that so many people wished to own
condominiums that various governmental agencies feared that the supply of
apartments would soon be eliminated as more and more apartment building
owners converted apartment buildings into condominiums. The local
governments such as San Francisco enacted various laws seeking to limit
condominium conversions creating long waiting lists and drastically
increasing the expense of such conversions. That resulted, in turn, in
condos becoming increasingly expensive, though still less than single
family dwellings.
A solution that arose for
those still wishing to own their own homes in this expensive market was
to create Tenancy In Common, a different form of common ownership
of apartments, instead of condominiums. Tenancy in Common (“TIC”)
allows many people to own the same building and if the correct joint
ownership agreement is created, to enjoy many if not all of the benefits
of a condominium without the long waiting list of condo conversion or the
massive expense of filing all the requisite governmental documents that
condominium conversion requires. There were drawbacks…the panoply of laws
that had been enacted to protect condo owners was not available for TIC
owners…but a well drafted TIC Agreement would solve most if not all of
those dangers.
Thus a flurry of TIC
projects and sales began and the local governments suddenly realized that
their efforts to “save” apartments were floundering on a sea of TIC
sales. They sought to enact various local regulations to classify TICs
the same as condos and to limit the number that could be created.
But it was not so easy for
local governments to do so. TICs had existed in common law for hundreds
of years and were part of State law and a very widespread and useful
method of ownership. The local governments found themselves fighting the
various State laws and have not so far been successful in effectively
restricting TIC conversions or sales. While the fight is not over, recent
court decisions have seriously eroded the ability of local governments to
restrict TIC sales and the market has revived in these types of
ownerships. While condo conversion remains expensive and restricted,
often costing hundreds of thousands of dollars in fees and requiring a
decade on a waiting list, TIC conversion and sales remain much less
expensive and an excellent way for prospective home owners to enter the
market. There is no waiting list and the total cost of conversion can be
far less than the protracted condominium conversion process.
But there are significant
issues that must be confronted if one is to own or sell a TIC and the
purpose of this article is to outline the basics of TIC ownership and the
documentation necessary to minimize risks. A good attorney, a good
realtor and a good certified public accountant are key professionals
necessary to create and maintain a workable TIC structure and should be
consulted before a TIC is
purchased or sold and certainly before what was an apartment building is
sold as numerous TICs. While the cost will still be far less than a condo
conversion, one should expect to devote many hours and thousands of
dollars in creating the ownership structure and management structure that
will hopefully make the ownership work smoothly and avoid violating local
and state law. But note that even if the cost is not minor that a single lawsuit
arising based on poor creation of documents will easily cost ten times
that amount. Prevention is the key and that requires professional
creation of the documentation required for a workable TIC.
BASIC FACTS YOU MUST KNOW:
1. DEFINITION OF TENANCY IN COMMON (TIC).
Tenancy in Common is a form of joint ownership of real
property that can be achieved in any piece of real property. All Tenants
in Common are named on the Title Deed and each owns a percentage interest
in the property as a whole.
Thus, if you and I own property as Tenants in Common, we each are
listed on the title as “Tenants in Common” owning the property and each has
ownership rights to the entire piece of property. Let us emphasize that: each of us
has rights to the entire property.
One should compare that to a condominium. In comparison, with a
condominium, the portions of the property inside the apartment walls are
owned by individuals, and everything else is owned by a group. In a TIC, a
group owns the entire property. So how does one have exclusive right to
one’s own apartment? That is accomplished by a carefully drafted written
agreement executed by all owners,
which provides each owner the right to live in or rent out a particular
apartment along with other rights and duties. In effect, the agreement
seeks to replace the legal structure that condos have written into the
law.
2. WHY CREATE A TIC RATHER THAN MERELY USE THE
CONDOMINIUM STRUCTURE?
San Francisco severely restricts both new condo
construction and conversion of older buildings to condos, keeping the
cost-per-unit of condos much higher the cost-per-unit of apartment
buildings. In addition, TICs can often be converted into condos after a
period of owner-occupancy. The conversion is voluntary with the TIC
owners at a later date. While other Bay Area communities do not restrict
condo conversion as much, it is usually much more expensive to create the
copious documentation necessary for a condo conversion than for a TIC.
3. HOW ARE TICs STRUCTURED USUALLY?
In most
TICs, a "relative value percentage" is assigned to the areas
(dwelling. parking, storage, deck etc.) that each owner will occupy. The
value is altered at times by unique factors that apply to a particular
apartment within the building. Factors that affect relative value percentage include size,
level within the building, light, views, and general condition. The
percentages are typically determined through an appraisal process
conducted by either the prospective co-owners, a real estate agent, or a
licensed appraiser. A common approach is to value each unit as if it were
a condominium. Recent sale prices for comparable condominium units can be
used as a basis for this valuation. Once the condominium values are
established, they are added together and each is divided into the total
to yield the percentages.
After purchase, as required in the TIC Agreement
created and executed by each owner, each owner occupies and maintains
his/her assigned areas. The costs of maintaining shared areas, and most
other building expenses, are divided according to relative value percentage. Each owner can
sell his/her interest at any time. If the building is later converted
into condominiums, each owner receives his/her assigned areas as a
condo.
This structure is not “required” by law, but is
normally recommended by experienced lawyers and realtors in the field. It
has worked well for thousands of TICs and avoids many of the pitfalls
inherent in TIC ownership.
At times a prospective TIC owner will only be able to
make a small down payment but has good income, or, conversely, has a
large down payment but limited income. This problem of equalizing how to
own that structure as a TIC in light of those differences can be overcome
by making each owner's percentage share of the loan different from
his/her percentage share of ownership. Provided that the total of a
particular owner's down payment and loan share equal his/her share of the
building cost, this type of arrangement still works and is
equitable.
For those times when the relative value percentage
approach may not work, a real estate attorney must be consulted to
strategize and help the co-owners develop an appropriate structure. Such
structures will be known by the usual experienced attorney and are
myriad. Above all, the final Agreement should be as simple as possible
while maintaining ways to resolve disputes that are inexpensive and
quick. Remember: when you plan to sell your TIC, the Buyer will want to
know the Agreement is a good one and has worked well: in effect, you are
“selling” the Agreement as well as the apartment.
4.
LEGAL ISSUES INVOLVING TICs.
In 2001, the San Francisco Board of Supervisors overrode
a mayoral veto to enact legislation introduced by Supervisor McGoldrick
to slow down owner-occupancy of rental housing. Since the Supervisors
could not prohibit group buying or owner occupying, they attempted to
discourage this behavior by making it more risky. Traditionally, TIC
Agreements give each owner the exclusive right to occupy his/her assigned
unit so that one owner could not "invade" another owner's home.
The new law makes these exclusive occupancy arrangements illegal and
unenforceable on the theory that the co-owner unit invasion risk will
deter group owner-occupancy.
In 2002 the State Court overruled the ability of the
Board of Supervisors to enact such Ordinances, thereby seeming to make
TICs once again fully viable. The Board of Supervisors has sought to
appeal that decision but most legal authorities think that their chances
for success are small.
The prohibition on exclusive occupancy rights that was
passed by the Board applied to all co-ownership groups (whether formed as
TICs, partnerships, corporations, LLCs or anything else). It affects any
owner who purchases after August 8, 2001, even if he/she purchases an
interest in an existing TIC. Owners who purchased before that date
retained their exclusive occupancy rights. Groups consisting entirely of
family members (including domestic partners), and groups that own
two-unit properties, are exempt.
The exclusive occupancy restrictions have been suspended for all groups pending
the outcome of the above described legal challenge. Even if by some
chance the original law is upheld, TICs in San Francisco can remain
viable if the Agreement contains provisions to discourage co-owner unit
invasion and compensate the affected co-owner in the unlikely event an
invasion occurs. It is unclear whether the lack of exclusive occupancy
rights will discourage prospective TIC buyers. Since the 2002 Court
decision, there has been a marked increase in enthusiasm for this type of
ownership of property in San Francisco.
It should be noted that this risk exists only for San Francisco;
though it is possible other jurisdictions will seek to pass such
ordinances if the Board is able to overcome the current decision of the
Court. And while that risk
is certainly there, all the indications are that TICs are going to be
allowed to continue unrestricted by the Courts and that local regulations
to avoid that will be struck down.
THE TIC
AGREEMENT: WHAT IS IT AND WHAT MUST BE INCLUDED.
Each Agreement will vary
based on the unique needs and desires of the Owners or of the person
first converting an apartment building into the TIC building, but certain
common provisions almost always exist. Among them are:
·
Provisions providing for nonjudicial resolution
of any disputes, often using mediation and private arbitration and
avoiding the high expense of legal battles in Court:
·
Appropriate separation of the property into
"individual” and "group" components relating to usage
rights and maintenance responsibilities;
·
Description of the owners' financial obligations
including initial deposits, reserve accounts, mortgages, taxes, common
area maintenance and other expenses; nomination and method of selecting
professionals to represent the owners (lawyers, accountants, etc.)
·
Formulas for determining each owner’s monthly
payment in advance and periodically adjusting the amount;
·
Management of the property,
including accounts receivable, accounts payable, regular reporting
maintenance and janitorial;
·
Rules governing usage of the
property by the owners (e.g. pets, noise, floor covering) including
enforcement provisions;
·
Meeting and decision making
procedures;
·
Provisions defining when a default
has occurred and describing remedies;
·
Policy in the event of death or
bankruptcy of an owner;
·
Sale of interests, group approval of
prospective purchasers, and rights of first refusal; and
·
Provisions to anticipate and remedy
the effect of alterations in the law.
Any good attorney will have literally dozens of
additional provisions tailored to the unique requirements of the TIC. Given the critical nature of the TIC
agreement in the operation and value of the property, it is vital for the
Agreement to be correctly drafted and attempts to use forms or “standard”
agreements often result in dispute and reduction in the value of each
owner’s apartment within the TIC.
Most TIC Agreements are kept “in reserve” by the
owners and only used in the event that normal relations among group
members break down. While it is useful to have owners' rights and duties
well defined, relying on the agreement to dictate response to actual
events is often counterproductive.
The give and take of typical ownership arrangements requires
flexibility and good will.
Even the
best agreement cannot resolve all unanticipated issues arising and the
Agreement, while vital for the future of the TIC, does not take the place
of common sense and mature compromise on issues. The goal should be to develop a
consensus that all owners can accept even though some may believe that
the agreement dictates a more personally advantageous decision. If a consensus
cannot be reached, the TIC agreement can provide a final resolution.
WHO HAS THE POWER TO DECIDE IN A TIC AGREEMENT?
In most Agreements, each owner has one vote though
certain Agreements provide for percentage ownership based on monetary
value of the interest owned (e.g. you own 50% of the value of the TIC so
you get to vote 50% of the voting shares.) Usually, routine decisions are
made by a majority. Major items such as sale or refinancing of the
building, and expensive non-emergency repairs or improvements generally
require unanimity or a supermajority (e.g. 75% approval.)
DAY-TO-DAY COSTS. HOW ARE THEY HANDLED?
It costs money to maintain and repair a building as
well as to pay taxes and the various utility costs that are associated
with both the individual units and the common areas. Building expenses
are divided into "individual expenses" and "group
expenses". Individual expenses include maintenance and improvements
to unit interiors, personal property insurance, and separately metered
utilities: they are paid directly by the individual owners. Group
expenses include mortgage payments, building insurance, property taxes,
maintenance and improvements to common areas, and shared utilities like
water and trash removal; they are paid through a TIC bank account using a
monthly assessment system. Under this system, each owner makes a single
monthly payment to the TIC account.
The monthly payment is based upon the total of the
owner's share of each of the anticipated group expenses. To allow good
budgeting and protect against default, even semi-annual and annual
expenses, like property taxes and insurance, should be included in the
owners' monthly payments. Further, such medium and long term costs that
one can predict, such as roof replacement or painting of the exterior,
can be budgeted long in advance and included in the monthly payments in
small increments.
WHO MANAGES THE DAY-TO-DAY MATTERS?
TICs usually elect a authorized manager (usually a
group member) who is responsible for the usual operations of the TIC
matters including collecting monthly payments, paying bills, keeping the
books, and arranging repair. The group meets periodically with the
manager to determine the anticipated expenses for the next quarter
including mortgage payments, taxes, insurance, utilities and
replenishment of reserves, and then establish each owner’s monthly
payment. This is a serious and often time-consuming task and it is either
spread around among the members on an annual basis or some form of
compensation is paid. The TIC can hire a professional manager and add
that cost to the monthly assessments.
HOW DOES A TIC OWNER SELL HIS/HER OWN INTEREST?
By law, TIC interests can be sold at any
time for any price the market will bear. However, a good TIC Agreement
will provide that the group
approves of the qualifications of the purchaser. This is important
since otherwise a new buyer could come in who could entirely disrupt the
smooth operation of the TIC.
Reasonable criteria should be set out in the TIC Agreement.
In San Francisco,
TICs are a well-known commodity and a vibrant market exists for them.
Their relatively low price has caused them to be in constant demand and the ability to sell them is
improved if the TIC Agreement is a good one and the TIC has a history of resolving its problems and paying
its bills. One of the first things a Buyer should look at is how well
the TIC has run and whether it can handle problems in the future. Remember, when you sell your TIC
unit, one of the things you are selling (or buying) is the Agreement that
allows it to work well.
HOW ARE TIC RE-SALES FINANCED?
Usually the TIC will not refinance the property when a
single owner sells. Instead, the buyer will join the other owners as a
borrower on the existing loan, and will assume the seller's percentage of
the outstanding loan balance under the TIC agreement. Thus, it is vitally important that
purchase money loans for TICs be assumable. It also makes sense that to minimize the fees and
inconvenience associated with loan assumption, that the TIC obtain a loan
that allows a "partial
redemption" (This means allows substitution of a buying partial
owner for a selling partial owner.) Such partial assumptions are less
expensive than full assumptions, and do not involve re-qualification by
the entire owner group.
If the TIC interest being sold has dramatically
appreciated in value, there will be a large difference between the sale
price and the seller's percentage of the outstanding loan balance. If the
buyer does not have a large down payment, the seller may chose one of the
following alternatives:
a.
Accept some of the down payment as a note payable in
the future and secured by the property, or
b.
Increase the size of the existing loan (if allowed by
the lender and the TIC agreement), or
c.
Arrange to refinance the property.
A good TIC agreement will spell out
what options are available for the owners.
HOW DOES A TIC PROVIDE THE SAME TAX BENEFITS AS OTHER
RESIDENTIAL REAL ESTATE?
Most if not all of the standard tax benefits available
to homeowners or property owners remain available in a TIC arrangement.
Owners who reside in the property can deduct their mortgage interest and
property taxes, and often may avoid capital gains tax on resale. Owner
who rent out their premises can declare their income and expenses,
including depreciation, and may undertake a tax-deferred exchange.
HOW DO RENT CONTROL LAWS AFFECT TICS?
Notwithstanding the efforts of tenant activists to ban
TIC ownership, TICs are more popular than ever. But recent changes in San
Francisco's rent control laws have further restricted the ability of TIC
owners to occupy their new homes if tenants are present.
Only one
"Owner MOVE-IN" eviction per building is allowed, and this type
of eviction is limited to situations where the tenant is not a protected
elderly, disabled or terminally ill person. The evicting owner must hold a 25% ownership interest and
meet a variety of other qualifications. Where more than one eviction is
necessary, the tenant is protected, or the owner does not qualify under "Owner
Move-In" rules, all tenants in the building can be evicted under the
"Ellis Act", but
subsequent rental of the property is severely restricted. All of these
laws are complex and anyone contemplating a TIC purchase of a
tenant-occupied building should seek legal advice before buying.
WHAT OTHER LEGAL RESTRICTIONS APPLY TO TICS?
The California Department of Real Estate (DRE) has
recently taken the position that it is illegal to form a TIC in buildings
of five or more units unless the building has received a form of DRE
approval called a "Public Report". This position conflicts with
the opinion of many attorneys who believed that a Public Report was not
required for groups of 5-10 provided two simple DRE forms were signed and
filed. Until the courts decide whether a Public Report is actually
required, it will be risky to form a TIC in buildings of five or more
units without a Public Report, and sellers should consider obtaining one.
Fortunately, the DRE has stated that a Public Report is not required for
resale of an interest in an existing TIC, even if the TIC has never had a
Public report. The DRE has also stated that it is now willing to issue
Public Reports for new TICS for the first time. Please consult an
attorney regarding the latest developments in this area.
ARE TICs SO COMPLEX OR RISKY THAT ONE SHOULD AVOID
THEM?
One reason TICs cost less than owning your own single
family dwelling or buying a traditional condominium is that the purchase
and sale is a bit more complicated and there is a higher degree of risk
in the law sometime altering or the interaction with other owners being
subject to some friction. But note that all forms of co-ownership forms
(TICs, condominiums, cooperatives, partnerships etc.) involve the risks
of sharing use of property with others and relying on them to fulfill
their obligations to you.
The level of risk depends on the portion of the
property that is co-owned, and the size of the obligations that are
shared. For example, condo owners co-own relatively little of the building
(e.g. structural elements, systems, common areas), and share few
obligations (e.g. maintenance and insurance of the co-owned areas, staff
salaries), making the risk relatively low. Thus while condo owners need
to worry about such issues as whether their neighbors will be capable of
group decision making, be considerate in their use of the common areas,
and pay their home owners' association dues, they need not worry about
whether their neighbors will make mortgage payments.
The extra risk of TIC ownership arises because the
local governments such as San Francisco are trying to limit them (without
much success) and also because the owner group is collectively
responsible for all obligations of ownership. If a TIC owner fails to
make a monthly payment and mortgage default results, the lender could
foreclose on the entire building causing all of the other owners to lose
their homes and possibly their equity.
The following steps minimize the risk of TIC
ownership:
- A
complete investigation into the background a qualification of
potential co-owners;
- An
exhaustive evaluation of the property and financing;
- Creation
of a customized TIC agreement that ever member of the group fully
understands;
- Using
a month assessment system for payment of group expenses;
- Establishment
of a default reserve fund; and
- Strong
procedures to enforce the TIC agreement, and buy out a defaulting
owner or an owner who causes needless problems within the TIC.
SO, HOW DOES ONE FORM A TIC OWNERSHIP STRUCTURE? WHAT
NEXT?
1. Group
members who are considering to join together in this form of ownership
should first evaluate each other's financial statements, and undertake
the professional building inspection and loan application processes,
which are common to all real estate purchases. Accepting the financial
statements, approving the building condition, and obtaining a
satisfactory loan should all be preconditions to a groups' obligation to
buy a building. If you are a person intending to sell to a group of
potential Buyers, you, yourself, create the TIC Agreement and make the
requisite investigation of the people buying to make sure that you are
not creating a TIC structure that will not work and will result in angry
Buyers suing you later for “getting them into” a poorly working TIC.
2. The group also has a series of formation meetings.
An attorney experienced in TIC formation should raise and explain the
many important issues associated with group ownership, and help assess
the advantages and disadvantages of various approaches. If you are the
Seller of the TIC structure to new Buyers, you arrange the meetings and
attend them with each new Buyer who comes into the process, “birthing”
the new TIC. Through this process, the group's members thoroughly develop
and test their ability to get along, solve problems, and make decisions.
They also create the framework and spirit necessary for successful
response to unforeseen future events. It is common for the person who
first creates the TIC to continue in the structure, retaining an
apartment or two but it is not necessary so long as the structure created
is well conceived with an excellent agreement executed by all the new
owners.
The attorney thus must prepare a comprehensive written
agreement that is specifically tailored to the unique needs of the
particular building and owners, including their personalities and needs.
Each participant may then have the draft agreement reviewed by their own
attorney and accountant, and bring the comments of these outside experts
before the group for discussion and further revision of the agreement.
Good CPAs and real estate professionals are often included in the discussions
to assure good tax and property advice is obtained.
It is time consuming and complicated for those not used to it, but
no more complex than the initial formation of a condominium and far, far
less complex than the turmoil that occurs if one waits until there is a
dispute and ends up fighting in court. Here, an ounce of prevention is
worth a pound of cure.
WHAT IF AN OWNER BREACHES THE AGREEMENT AND FAILS TO
MAKE A PAYMENT?
If the group determines that the non-paying owners'
situation is temporary, they may make a loan from the group reserve
account. Otherwise, depending on their agreement, the group may have a
variety of harsher options including eviction, forced sale, and
foreclosure. It is vital for these powers to be spelled out clearly in
the Agreement both to protect the group and to make sure the defaulting
owner is aware of the risk he or she runs and does not breach the
Agreement.
HOW CAN I GET INVOLVED IN A TIC GROUP?
You can either join an
existing group, or create a new one. Put simply, your first decision
will be whether to join an existing TIC group by buying a single TIC
interest that is available for sale, or to create a "new" TIC
as one of the founding members or, if you are selling your own building
you already entirely own, being the sole founding member and selling
units to new members as they buy in.
Joining an existing TIC group involves less risk
because the group will already have developed a "track record"
of successful decision-making and regular monthly payments. An existing
group may also be farther along in the process of qualifying the building
for conversion to condominiums.
If you opt for a "new" TIC, there are four
possible ways to proceed:
- Assembling
your own group of family or friends, then working with a qualified
Realtor to locate a building. After you find a building that the
whole group likes, you will need to agree on the assignment of
percentages and units
- Joining
an individual or group that is in the process of buying a building
but has an available unit. A Realtor can help you find such an
individual or group and then evaluate the qualifications and suitability
of the potential co-owner(s).
- Working
with a Realtor to find a multi-unit building, and creating ownership
structure, then locating co-owners for the other units
- If
you own a building and wish to sell parts of it as TICs, then
finding a realtor or attorney who is familiar with the methodology
and who will put together a package for entry of new TIC owners and
place the units on the market.
WHY TIC AND NOT
ANOTHER FORM OF OWNERSHIP?
It all comes down to money. Buying a TIC is far less
expensive than a single-family dwelling or a condominium and if you are
planning to sell a building, is far less expensive with a much shorter
time to fruition than condominium conversion. In a market known for its
high cost and constant appreciation, TICs may be the best…and perhaps the
only…way for many to enter the home owning market. There are
disadvantages and some higher degree of risk perhaps, but the alternative
to taking that risk and engaging in the complex ownership of property…may
be no ownership of property at all. The very popularity of this form of ownership
is evidence that thousands of people have concluded that this is an
intelligent and appropriate way to purchase that “first home” in this
market.
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