Financing for TIC
TIC’s are primarily financed in one of two ways, a common group loan or an individual tenancy in common loan. Common group loans are the most frequently used. Individual TIC loans are more recent products and may require more effort when finding a lender and negotiating terms.
Individual TIC Loans
Individual TIC loans are those where each owner has his/her own loan. The loan is secured against that particular owner’s percentage share in the property. In this case, the TIC owners collectively are not mutually responsible for each others share of the loan. While an individual TIC loan reduces the default risk if one owner fails to pay their share, the individual TIC loan can cause problems in that, in comparison to a common group loan, all owners may not have their interest and risks aligned. In a common group loan, borrowers are bound by the same loan terms. They refinance together and basically assume equal responsibility (accept of course that each owner may have different loan percentages). If a TIC has co-owners with individual TIC loans, the borrowers are not bound by the same terms. One owner could have significantly less favorable loan terms as another, could refinance or borrow excessively against the loan, or fail to keep adequate cash reserves to ensure loan payments are met during periods of financial crisis. This could result in one owner defaulting and the other co-owners suddenly sharing ownership with the foreclosing bank or other party with even less similar interest in the property.
Common Group Loans
In a TIC, mortgage financing is generally achieved via a common group loan. This is one loan for which multiple owners are responsible to repay and which is divided proportionally among each owner by percentage of ownership. It is best explained using an example:
Common Group Loan Example:
Assume there is a three unit building for sale for $2,500,000. Each unit is not equal as one unit has three bedrooms, another two bedrooms, and the third just one bedroom. Assume then that the three bedroom unit is valued at $1,200,000, the two bedroom at $800,000, and the one bedroom at $500,000. Three people –Jim, Noah, and Terry- decide to buy the building as a TIC. To do this, they will take out one common group mortgage loan. The total loan amount will be for the amount equal to the sale price minus the sum down payment paid by the three owners. Jim decided to buy the $1,200,000 unit and will put down $400,000 as a down payment. Noah is buying the $800,000 unit and will put down $200,000 as his down payment. Terry is buying the $500,000 unit and is putting down $50,000 as her down payment.
Thus the total common group loan amount will be:
+ $2,500,000 (Sale price)
- (400,000+$200,000+$50,000) (the sum of the three down payments)
= $1,850,000 (Total Group Common Loan Amount)
Each owner then pays off their respective percentage of the outstanding loan. Jim’s unit is $1,200,000 with a down payment of $400,000 subtracted making his total loan value $800,000. Noah’s unit is $800,000 with a down payment of $200,000 subtracted making his total loan value $600,000. Terry’s unit is $500,000 with a down payment of $50,000 subtracted making her total loan value $450,000. The total loans summed together ($800,000+$600,000+$450,000) equal the total loan value of $1,850,000. Jim’s loan percentage is (the percentage of the group common loan he is to repay) is 43.2% ($800,000/$1,850,000), Noah’s is 32.4%, and Terry’s is 24.4%. These percentages are the minimum amount of the monthly mortgage payment each TIC owner is expected to pay.
These percentages do not change unless one or more of the three owners decides to pay more than their minimum payment at any point during the duration of the loan or if the loan is refinanced.
Note that while each owner has a loan percentage they are expected to pay, each owner is fully responsible for the entire loan amount in the case of default by one or more of the TIC owners. For this and other reasons, many TIC owners will document and employ contractual safeguards to mitigate their risk and spell out the process involved in situations that affect TIC ownership or the common group loan. Some common safeguards:
- To mitigate loan default risk, each TIC owner should meet minimum, mutually agreed upon standards regarding credit ratings, employment, outstanding debt, and any other pertinent info (background check, criminal record, rental history, etc).
- Opening a shared bank account for the express purpose of paying the mortgage. Requiring that reserve funds equal to x months worth of mortgage payments be kept in reserve to ensure sufficient funds for each monthly mortgage payment.
- Draft specific language addressing the process to be undertaken in the event an owner falls behind on payments. In other words, make the language exact, enforceable, and strict and follow it consistently so all owners are treated equally by the same mutually agreed upon set of rules.
- Establishing specific, mutually agreed upon standards by which any new owner will be evaluated in the event a TIC unit is sold. Topics to address include costs of refinancing, voting protocol, and any other issues that would affect the selling owner, the existing owners, or the new buyer. Ultimately the goal will be to have an agreement that balances the needs of all threes without benefiting any one party at the expense of the other.
- Define what processes will occur to pay the mortgage in the event an owner experiences a life altering event such as illness, divorce, death, or loss/change of employment.
One of the most important factors effecting common group loans is what is called assumability. Assumability comes in two forms –partial assumption and full assumption- and is essentially the ability of the borrower to transfer a loan balance to another person in the event of a transfer of ownership. In other words if one TIC owner sells their interest in the building, the new owner -if the loan has partial assumption- will “take over” the existing loan.
Partial assumption is generally preferred over full assumption as full assumption requires loan approval for the entire group while partial only requires approval of the new owner. Partial assumption is not something that automatically comes with a group common loan so it is important to check for this feature on any loan agreement under consideration. Also, loans with assumability options generally come with variable interest rates. Thus group loan borrowers should weigh the benefit of assumability options against interest expense.