The Problem: “TICs” refers to property owned by multiple people as Tenants in Common and are an increasingly popular way for people to purchase units in a building to live in without having to convert the building to a condominium. As discussed in our articles on Tenancy in Common and the Newsletter on TIC Financing, one of the chief drawbacks in creating, buying or selling a tenancy in common ownership was the complex bank financing often required. Unlike condominiums in which each unit is separately financed, TICs were normally financed in whole, so that each owner was jointly and severally liable for the entire loan and the entire building was pledged as security for each loan.
This could lead to problems if a single owner defaulted on payments or wished to borrow on or refinance their “share” of the loan. As discussed in our previous articles, this required complex and powerful provisions in each TIC Agreement to allow for efficient and fair treatment of the financing aspects of TIC ownership. As one TIC owner commented, “This makes everything connected with a credit line or selling so much more complicated, doesn’t it?” TICs were still worth while and saved hundreds of thousands of dollars, but one had to assume that restrictions on the borrowing rights on the property and the exposure due to other TIC owners not fulfilling their obligations were issues to be carefully considered.
The New Solution: “Fractional Financing.”
The rapid growth of TIC ownership has alerted more and more banks to the potentially large market of home owners that might be interested in obtaining a type of financing that would allow them to finance their particular TIC unit rather than have to be jointly and severally liable for the entire borrowing of all the owners and, beginning in 2005, various banks in the Bay Area “experimented” with “fractional loans” that allowed such financing.
The success of these loans has led to increasing numbers of banks entering the market and those banks now exist in communities far outside the San Francisco Bay Area. With these fractional loans, there is a separate loan for each TIC unit with each loan involving a note signed only by the owner of a particular TIC interest, secured by a deed of trust covering only that owner’s TIC share. If one owner defaults on the loan, the lender can foreclose only on that owner’s particular interest. Unlike group financing, none of the other TIC owners are directly affected by the particular default.
The banks require a contractual right to foreclose on a particular TIC interest so the documentation is quite different than a typical condominium loan. The various statutory methods for foreclosure of a Deed of Trust do not automatically apply and the banks thus have to create foreclosure methods in the loan documents. The result of the need for such additional work makes the TIC loans more expensive to obtain than typical condominium loans, though it is our experience that the economic advantages of owning a TIC still far outweigh the additional financing cost and, of course, avoiding the group financing is a tremendous advantage to all the TIC owners.
Typically, a TIC loan is one to two percent higher than a condo loan and is more limited in time, usually ten to twenty years rather than thirty years. But this writer predicts that as the market broadens and banks become more comfortable with the concept, we can expect the differential to lessen over the coming years.
The Effect: A Growing Market:
While fractional loans are new to the TIC market, they are actually an old concept long used for vacation rentals and certain developments. Given the huge interest in TIC ownership in urban areas, it is likely that the banks will quickly grasp the relative ease of using this methodology in expanding their home ownership loan portfolio.
It may take some time…perhaps a few years…but it is likely that soon banks will have TIC departments well versed with the intricacies of this type of loan and able to process them as easily as the typical condo loan. Unless we experience the long touted “real estate market melt down” one can expect TIC financing and equity lines as readily available as condo financing within a decade.
Which means that those purchasing TICs in the past and those buying them now will find their investments more valuable as more and more of the buying public witness the relative ease of the financing of these types of properties. It also means that many TICs already existing with group financing are likely to alter to fractional financing to achieve the same benefits.
Those who have resisted the growing popularity of TICs as threatening availability of apartments are distraught since a good TIC agreement coupled with fractional financing will allow TIC owners to enjoy most of the benefits of condominium ownership without the cost and delay so often experienced. Indeed, some condo owners now fear that TIC popularity will undermine the condo market by making a viable alterative readily available.
But the wealth of statutes and case law involving interpretation of statutory protections created for condos and their associations will still give a definite benefit to that form of ownership, and many buyers of property, who do not hesitate to buy a condo despite hundreds of pages of condo rules and restrictions being imposed still view the typical fifty page TIC Agreement with a degree of nervousness.
In short, TICs will increase in value and popularity but are unlikely to replace condominium ownership as the preferred method of group ownership of property. People will buy TICs for the lower cost of entry into home ownership rather than preference for that style of ownership.
But, as one apartment housing activist decried, “This is the end of our efforts to stop the wholesale destruction of affordable rental house.” An exaggeration, certainly, with rents going up…but the past efforts to stop conversion by legislating against condo conversion will certainly no longer be as effective as before. The TICs will simply multiply while the condos are artificially restricted.