Michelle Napoli is editor of TIC Monthly, from which this article is excerpted.

New York City--The beginning of a new year is always a good time to take stock of the past and ponder what might be in store for the future. In that spirit, TIC Monthly asked a number of TIC market participants to review the market's highlights in 2006 and forecast trends and developments for 2007.

Clearly, the biggest headline for the TIC market in 2006 was the one that emanated from Washington, DC in early May. That's when a proposal was floated in the behind-closed-doors Congressional budget reconciliation process--a proposal that apparently would have eliminated TIC interests as qualifying for 1031 like-kind exchanges and could have thrust the TIC industry into extinction. "It could have knocked us out in one fell swoop," says Greg Paul, president of Omni Brokerage Inc. and CEO of Orchard Securities LLC of Salt Lake City. "Of anything that happened in '06, that had to be it--that got everyone's attention."

The scare mobilized the industry, which is being more proactive in its political outreach and lobbying while keeping an eye on the new Democrat-controlled Congress and looking ahead to a 2008 Presidential election. "I think we dodged a bullet. It would have terminated the business," concludes Darryl Steinhause, partner in the San Diego office of Luce, Forward, Hamilton & Scripps LLP, adding that he is hopeful there won't be any further threats in 2007. "The biggest concern will be in two years when there's an administration change," he says.

Meanwhile, the business keeps moving along. It certainly hasn't decreased in size like a flash-in-the-pan fad, even if sponsors are having a tougher time finding product to bring to an increasingly crowded market and equity is selling out more slowly when they do.

Fourth quarter and full year data is not complete yet, but Paul estimates 2006's total securitized TIC equity raised will tally roughly $4 billion, up from the previous year's $3.2 billion. But, notes Paul, when you dig a little deeper into the numbers, on a net basis the market's growth may in fact be flat--a 180-degree turnaround from prior years' prevailing trend. "You've got a lot of TIC money recycling back into the market that's reflected in that $4 billion," says Paul. "So we might have had no growth on a net basis, if you're looking at new money coming into the market."

That slowdown marks a significant change in the dynamics of the industry, at least on its selling side, notes Michael McQuay, CEO and principal of Principle Equity Management in Houston. Earlier in the industry's short history, "properties led the marketing in that there was a lot more equity out there than there were properties." But that clearly reversed itself in 2006. He hopes that new rep and BD entrants will help relieve some pressure on the equity sales side, he adds.

Many market participants, like Kathy Heshelow, president of Seminole, FL-based Legacy Real Estate & Investments, expect the industry will continue growing but at a much calmer pace. "I think it has stabilized and will continue a slow growth, but I don't think it's going to be the explosive growth from 2003 to '04 to '05," Heshelow says.

It's just one of those rules of economics, says San Clemente, CA-based Argus Realty Investors LP president Tim Snodgrass. "Eventually you're going to reach equilibrium." As for the TIC business: "You're going to continue to see growth, but it's not going to be 100%, 200% growth. It's going to be sustainable growth."

The industry has experienced not just growth in the sheer number of properties and sheer amount of equity sold, it has experienced growth in the various kinds of companies that are involved in the business, whether it be registered reps, broker-dealers, law firms and such. The number of sponsors providing product to the marketplace seems to have grown most of all, though.

But that, too, is expected to slow down in 2007. Steinhause, for one, does not expect to see as many new entrants. "A year or two ago I was getting numerous calls per week from a lot of sponsors wanting to get in," he offers anecdotally. "The number of calls has been reduced, and the type of call now involves companies that are already established. It's not three guys getting together and saying, 'Let's form a TIC'."

Market players likewise think some more sponsors will decided to exit the business, and that could be for a number of reasons, including not liking the investor relations aspect of the business, finding it too difficult to compete and differentiate themselves in the TIC market, or simply preferring other means of raising capital for real estate deals. "The solid sponsors will continue to do well this year, and some of the smaller ones will go away," Steinhause predicts.

Indeed, a smaller number of sponsors have dropped out over the past couple of years, though the trend has, at least up till now, been overwhelming on the side of new entrants adding to the ranks of TIC sponsors. The tide may begin to shift in 2007, says Jim Shaw, president of Beverly Hills, CA-based CapHarbor LLC. "We're absolutely in 2007 going to see some sponsors who were here in the market in 2005 and 2006 leave the marketplace, and not necessarily for bad reasons," Shaw says. "Many of these companies have found that the world is so flush with capital that they can raise the capital to conduct their real estate investing activities more efficiently and effectively outside the tenant-in-common arena, so why stay in it?"

In addition, Shaw predicts that as some of these market exits are undertaken, he expects to see "for the first time in 2007 a number of sponsors who actually transfer the asset management of their offerings to other TIC sponsors."

Meanwhile, for the past several years many in the TIC market have expected consolidation to take place, but it has yet to come to fruition, and there seems to be less anticipation that 2007 will be the year for consolidation to hit. But it may be the year sponsors as a group get polarized into one of three camps, if one of Paul's predictions turns out to be true. "There's going to be some mega sponsors and then there's going to be some regional niche sponsors that are lean and mean," he suggests. "Then there's this twilight zone where I think firms are struggling--they're mid-sized and they haven't figured out who they are yet."

The increased competition and the growth of sponsors and available product that is not commensurate with the pace of equity sales may have positive implications for investors, though. "In that scenario you would hope the benefits to investors are increasing transparency, better service, lower loads--all the things competition would lead to," says Paul. "We've seen a little of that--some sponsors being willing to be more forthcoming in order to be competitive."

Other key year-in-review/forecast topics:

Sponsors will continue to add other investment platforms, diversifying their businesses in the process. While this will likely to continue to include LLCs, non-traded REITs and funds, the latest being debt offerings. These have become more and more appealing as a built-in source of mezzanine financing for the sponsor's TIC program. "The projects are taking longer to sell. You have to have a mezz type structure or sponsors who can carry that," notes Steinhause. For an increasing number of sponsors, "that will be the way that mezz piece is raised."
The "other" property type category grew considerably during 2006 and is expected to continue to account for a slice of the TIC equity market pie. "The 'other' asset type came forward in more offerings last year," notes Heshelow. "That has a lot to do with the real estate markets and the sponsors having a harder time finding the traditional office, apartment, retail deals that make sense for the TIC investors…It seems that that trend is going to continue for some time, from what I hear talking to sponsors and from what I see coming out already this year."
Geography. Some have expressed concern over an increasing number of offerings with properties in secondary and tertiary markets and caution sponsors and investors to consider their ultimate exit. Who else is buying in those geographic locations?, they say.
Hot industry topics. In 2005 it was best practices, and a set of best practices were formally adopted by the Tenant-in-Common Association in early 2006. Eventually transparency, track record, performance and the importance of adequate and timely investor communications emerged as important buzzwords later in 2006, and they are expected to continue to be key topics for the industry in 2007.
And then there's the perennial topic of regulatory review, compliance and guidance. Some have given up expecting it, but others think 2007 will indeed be the year the market hears directly from regulators, for better or worse. Steinhause, for one, thinks the latter part of the year will yield something. "You keep feeling that the pot is boiling, it just hasn't overflowed yet," he says. Adds Snodgrass: "I think it is the year that they all awaken. Whether it's the year that they actually do anything, I don't know.

Instant Insights /

As Industry Matures, Growth Levels Off

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