Smiley Bishop & Porter is pursuing claims against stock brokerage firms that made unsuitable recommendations that their clients invest in tenancy in common (TIC) properties. A TIC is a form of property ownership in which several people individually own an undivided part of an entire income producing property like an office building, warehouse or retail store. For a number of years, brokers recommended that people who were selling investment properties could defer taxes (under IRS Section 1031) on their gains by rolling the sale proceeds into replacement properties owned through TICs sponsored by companies like Inland Real Estate, NNN, Wells Real Estate Funds and DBSI. These exchanges are superficially appealing, until one appreciates that:
- the tax benefits of TICs are insignificant when compared to the tremendous costs and fees (often 15% or more) tacked onto TIC investments by sponsors and brokers:
- income projections for TICs are often wildly over-optimistic; and
- TICs are illiquid investments, meaning there is no way to sell an interest in an under-performing TIC.
FINRA, which regulates broker-dealers, classifies TICS as non-conventional investments, meaning that they are offered as alternatives to conventional equity and fixed income investments (like stocks or bonds) and often have complex features that make them difficult to understand. In Notice to Members 05-18, FINRA pointed to some of the special problems presented by TICs:
Before recommending a TIC exchange, members must have a clear understanding of the investment goals and current financial status of the investor. In many cases, a TIC interest will constitute a significant portion of an investor’s total assets. Because of the favorable tax treatment, investors often elect to invest the entire proceeds from the sale of an investment property in a TIC exchange. Concentration of an investor’s assets in a single asset class, however, is not suitable for many investors. Members must, with respect to each customer for whom they make a recommendation, consider the risks from over-concentration against the benefits of tax deferral and the investment potential of the underlying real estate asset(s).
TIC interests are illiquid securities. [FINRA] is not aware of any secondary market for TIC interests. Moreover, the tenant-in-common form of ownership may require unanimous use consent to sell a TIC interest. The subsequent sale of TIC interests may only be possible at a significant discount to the net asset value of the undivided interest in the real estate. As fees charged in connection with a TIC exchange increase, the money saved as a consequence of tax deferral will be offset. Accordingly, members should consider the effect of fees on each TIC exchange.
Brokers who sell TICs have serious obligations to look after the best interests of their clients. Simply obtaining the client’s consent to an unsuitable investment is no defense. Likewise, the duty of a broker to make a fair and balanced presentation of an investment, especially a complex one, is not satisfied by just handing the client a prospectus or private placement memorandum.
Many TIC investments have turned into financial disasters for clients. Rental payments have been cut or eliminated and properties have gone into foreclosure. Investors who wanted and needed safe income producing investments should not have been persuaded to invest significant portions of their assets in TICs. If you believe that you were not given full disclosure about the risks of TICs and/or that you were solicited to buy TIC investments that were not suitable for your investment needs and objectives, you may have a way to recover your losses through FINRA arbitration against the brokerage firm that recommended the investment.