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(This story, in slightly different form, originally appeared in Incisive Media’s Daily Business Review.)

FORT LAUDERDALE, FL-As the commercial real estate market searches for a bottom, dozens of small buyers who pooled their money into special funds to buy office buildings during the boom years may fare even worse than institutional investors.

Known as tenants-in-common, or TIC funds, the owners of two office properties, the Wachovia Plaza in Fort Lauderdale and the Harbour Centre in Aventura, face the same problems as retirement funds and other institutional owners –– rising vacancies, lower rental rates and a frozen credit market.

But fund members have it even tougher. Already skittish lenders are leery of refinancing loans coming due on properties that involve dozens of owners who may not be willing or able to pony up more equity or to provide money to help pay for building costs, such as lease commissions and management expenses.

At the 19-story, 340,000-square-foot Wachovia Plaza at 1 E. Broward Blvd., 32 investors took control of the property earlier this year after it was released from the bankruptcy proceeding of their fund sponsor, Idaho-based DBSI. The owners are negotiating with lender Monumental Life to restructure a $43.5-million loan due in January 2015, according to newly hired asset manager Rob Cord of Kennedy Wilson in California.

The restructuring will allow the owners to pay for improvements that DBSI promised to tenants, said the investors’ attorney, Michael Linton of Gregory Kaplan PLC in Richmond, VA. Tenants in the building, formerly called the SouthTrust Tower, include law firm Holland & Knight.

Ted Bliss of Miami Beach, who paid $5.3 million to become a fund investor, claims about $7 million in reserves “disappeared” while DBSI oversaw the building. DBSI is under investigation by several state attorneys general nationwide, according to news reports and Bliss.

“We have not had any luck in getting a straight answer about what happened to the money,” Linton says. He adds that an examiner for the US Bankruptcy Court in Delaware is investigating the loss, but the Wachovia owners’ claim is one of many.

Bankruptcy Judge Peter Walsh on May 22 granted examiner Joshua Hochberg’s request to conduct a financial investigation of DBSI’s entities and subsidiaries, current and former offices, directors and employees. Hochberg is scheduled to report to the court Tuesday about his investigation’s progress, according to a court document.

At the 210,000-square-foot Harbour Centre in Aventura, loan servicer Capmark Global Servicing assigned the $51-million securitized loan to special servicer Centerline Capital Group in Texas in late April. The loan terms require interest-only payments until May 2011, then principal and interest payments of about $295,000 beginning in June 2011, with a loan maturity of May 2016.

A person familiar with the situation who spoke on condition of anonymity says the transfer signaled the loan had been removed from a pool of securitized loans. That usually means the loan is in default, which could be due to inadequate reserves or the building’s value is out of sync with the lender’s prescribed debt-coverage ratio.

Capmark spokeswoman Joyce Patterson confirmed the loan was transferred to Centerline but declined to comment on a possible default. A foreclosure notice has not been filed.

Harbour Centre’s occupancy has dropped to less than 70% now from about 90% when the $51.2-million mortgage was put into the loan pool by Morgan Stanley in early 2006. UBS is the anchor tenant.

The 33 fund investors in the building at 18851 NE 29th Ave. purchased it for about $70 million through NNN Aventura Harbour Centre, the entity created for the deal by then fund sponsor Triple NNN (Net) Realty. Dogan Uygur, a commercial real estate owner in Eatontown, NJ and a member of the Harbour Centre fund, said in an e-mail that he couldn’t comment on what the group intended to do with the building.

Both buildings are examples of long-standing concerns about the TIC industry. “In a tumultuous economy with falling rents, rising vacancies, increased pressure on landlords for tenant retention and new leasing, the TIC landlords are at a competitive disadvantage to institutionally owned assets,” says Mark Gilbert, senior director of Cushman & Wakefield’s financial services group in Miami.

TIC purchases typically don’t require investors to put up additional equity, Gilbert says. And because the dozens of investors comprising a fund must be in agreement about financial actions, reaching an accord may be tough if some owners have different goals or no other money to add, which in economic times like these is a hindrance when additional capital may be required for refinancing loans or covering operating costs such as tenant improvements and leasing commissions, he says.

The appeal of TIC funds is that they allow groups of up to 35 investors to buy into properties that they couldn’t afford as individuals. Investors also can defer capital gains taxes on properties they’ve sold by rolling the sales proceeds into another property, called a 1031 exchange.

Fund sponsors earn fees for managing the assets. Those fees are paid, regardless of how well the building performs.

TIC funds, also called TIC exchanges, were among the most aggressive buyers during South Florida’s commercial real estate boom when buildings were trading at lofty prices. But even then, critics of the investment strategy warned that fund sponsors overpaid for properties. Indeed, the Wachovia buyers paid $61 million or $180 per square foot in 2005, a price considered one of the highest at the time in Downtown Fort Lauderdale.

Lax underwriting and overly optimistic projections failed to project that lease rates would decline and occupancy levels would rise, critics said. That led investors to expect returns that proved difficult to deliver –– especially in an economic downturn that has turned a once over-priced office market to a soft one pocked by rising vacancies that diminish buildings’ cash flow.

In some cases, capital raised at the time of acquisitions was used to pay expected returns to investors before the assets were capable of paying the returns, Gilbert says. And when it came time to tap reserves for building maintenance, for example, there were none.

Promised returns, in fact, are part of the financial problems now facing fund sponsor Grubb & Ellis Realty Investors (GERI), created through the merger of parent Grubb & Ellis and Triple Net in December 2007. A year before the merger, investment fund Morgan Stanley raised concerns about Triple Net’s operations in a filing with the Securities and Exchange Commission.

Morgan Stanley pooled the Harbour Centre loan as part of a $2.5-billion commercial mortgage-backed security in 2006. The fund indicated the loan was among the 10 largest in the security offering. A description of the loan in the filing includes an advisory that Triple Net and its affiliates were under SEC investigation in November 2006 for incorrect “numerical and other information in their securities.”

Grubb & Ellis filed an amended annual report on May 28 with the SEC. The new report was made to correct accounting errors in some of Triple Net’s TIC programs prior to the merger, Grubb & Ellis says. Among the errors were promises of specific returns to fund investors, though the amended filing doesn’t identify the promised rate of the return.

Triple Net also offered investors an exchange of their investment in one TIC program for another and the right to repurchase their investment. Three offers to investors were made in letters of agreement that totaled $31.6 million in value, according to the SEC filing.

GERI did not hold real estate licenses in any of the states in which it earned fees from brokering Triple Net’s programs. That makes GERI liable for regulatory penalties, according to the filing.

Former Triple Net executives and Jeffrey Hanson, GERI’s chief investment officer, have agreed to forfeit up to 4.3 million shares in common stock at a value of $11.36 per share to satisfy any liability incurred on behalf of the company, according to the filing. Former Triple Net executive Tony Thompson agreed to indemnify GERI for an additional $9.4 million, if necessary.

“We’re seeing challenges similar to [Wachovia and Harbour Centre] across the country,” says Cord, the asset manager who represents the Wachovia investors. “At Wachovia, we’re hoping it’ll be a positive story with a happy ending.”

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