Loans to TICs: Tricks, Secrets and the Inside Scoop
Andrew H. Mittler, CCIM Arx Holdings, LLC 922 Challenger Lakeway, Texas 78734 (512) 261-7705
Criston E. Cicala Arx Holdings, LLC 101 South Pointe Drive Suite 505 Miami Beach, Florida 33139 (305) 467-6403
Anatomy of a TIC September 12 and 13, 2005
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The Lender Market. Most lenders now make loans to groups of Tenants-inCommon (“TICs”) to acquire properties. Crucial types of lenders in this market include banks, finance companies, CMBS pools and life insurance companies. Some very conservative lenders, including several life insurance companies, refuse to lend to TIC syndicates. As with all other real estate loans, each lender follows certain parameters and guidelines regarding location, property types and underwriting criteria. Special Requirements Imposed by Lenders When Making Loans to TIC Syndicates. When making loans to TIC syndicates, lenders impose certain requirements that do not exist when loans are made to more traditional investors such as limited partnerships, individuals and corporations. These TIC-specific requirements include: a. All TICs are required to be joint and several borrowers. By incurring joint and several liability, each TIC is responsible for the entirety of the loan, regardless of the portion of the property owned by the TIC. This is generally not important because most loans to TIC syndicates are non-recourse.
II.
Negotiation Tip: As a TIC purchasing an undivided interest, there is no way to avoid becoming a borrower. Make certain the loan is non-recourse to you. Look carefully at the non-recourse carveouts to see the circumstances in which you may become personally liable for the loan. Attempt to work with the syndicator to have the lender reduce the events which might cause the loan to become recourse to you. Make certain you do not inadvertently trigger the springing recourse liability you might incur under the loan by transferring your interest, amending the documents governing your single purpose entity or violating the single purpose entity rules. b. While most loans to TIC syndicates are non-recourse, most lenders require that each TIC provide a non-recourse carve-out guaranty. This will either be a separate document or a springing liability contained in the loan agreement. These guaranties cause each TIC to be liable for the full amount of the loan upon the incurrence of certain events, such as a bankruptcy filing, unapproved transfer of the TIC’s interest, environmental contamination of the property securing the loan, misappropriation and fraud. This differs from a typical loan because it would be extremely rare for a lender to require such a guaranty from a limited partner or a member of a limited liability company. c. Unless a TIC syndicate takes title as a Delaware Statutory Trust (“DST”), lenders require that each TIC form a single purpose limited liability company (except in Texas where limited partnerships are used for franchise tax purposes). A single purpose entity is an entity formed specifically for one purpose, in this case, the ownership of an undivided interest in a piece of real property. The entity should not own any assets other than the real property and should incur no liabilities, including indebtedness, other than indebtedness necessary to acquire the property. The single purpose entity has come into
common use as lenders attempt to avoid (i) having one TIC drag an entire property into bankruptcy, and (ii) serial bankruptcies as one TIC after another files bankruptcy in an attempt to stave off foreclosure. The single purpose entity is also used in securitized transaction to meet the requirements of the rating agencies. For loans over a certain amount, often $15,000,000, a lender may require the syndicate to obtain a non-consolidation opinion regarding the single purpose entities, and may require the appointment of an independent manager or general partner as a method to prevent bankruptcy filings. Negotiation Tip: Most lenders require certain provisions in the governing and formation documents of each single purpose entity. Request this information from the lender prior to forming these entities, chances are they will be happy to provide it. Doing this can prevent costly and time consuming redrafting and re-execution issues later. Early in the process discuss with your lender whether a non-consolidation opinion will be required. This can be time-consuming and expensive. Most lenders will not require these until the loan amount reaches at least $15,000,000. If your loan is less, ask if this requirement can be waived. Find out early from your lender if the lender requires the appointment of an independent manager or independent general partner. This is an additional bankruptcy safeguard lenders impose. The documents appointing the independent manager or general partner prohibit that individual from ever voting to declare or file for bankruptcy. Such an appointment increases the cost to each TIC. Oftentimes lenders will waive this requirement for loans of less than $15,000,000. If your lender requires appointment of an independent manager or general partner, it is quite easy to hire one, but should be addressed early in the process to avoid unnecessary delay. d. Lenders often restrict the ability of TICs to sell their undivided interests or interests in the single purpose limited liability companies they form. This prevents lenders from having to underwrite new investors to deals. This helps the lender avoid losing a strong borrower/ carve-out guarantor. In addition to lenders limiting the ability of TICs to withdraw or sell their interest, TICs need to be aware of security law limits on selling their interests (particularly the holding period rules under Rule 144) and holding requirements under Section 1031 of the Internal Revenue Code. Negotiation Tip: If for some reason you anticipate wanting to sell an interest in a TIC or the interest held by the TIC without paying off the loan, discuss up front with your lender what the lender will acquire to allow a new investor to join the loan. e. Lenders often require the subordination of the tenancy-in-common agreement entered into by the TICs and the master lease, if any. By requiring this, lenders can wipe these agreements out upon foreclosing on the underlying property. Failing to subordinate these agreements could lead to the odd situation where the lender has foreclosed all of the TICs ownership interests in the real property, but the master lease to an entity controlled by the TIC syndicator remains in place.
f. Lenders often limit the ability of TICs to commence partition actions by making the filing of a partition action an Event of Default, and sometimes a carve-out from the non-recourse provisions of the loan. Under common law, a tenant-in-common can file a partition action to sell its portion of the property. Lenders desire to limit this right because oftentimes the filing of a partition action forces the sale of the entirety of the real property. g. Lenders will require local counsel legal opinions if the property and the borrowers are from different states. Since almost all borrowers are Delaware limited liability companies, it is advisable to procure the services of Delaware counsel early in the process. In addition, if you end with Delaware entities as borrowers, a property in State A and loan documents governed by the laws of State B, most lenders will require opinions from each state involved. Negotiation Tip: Inform your lender early on in the process of all the states involved and determine from which states the lender will require an opinion. Engage counsel in these states early. In addition, ask your lender for form opinions required from each counsel. This will save time and cost later. III. How Loans to TIC Syndicates Differ From Loans to Traditional Borrowers. When a TIC syndicate obtains a loan, the business terms differ in certain ways from loans to traditional borrowers. a. Legal costs for loans to TIC syndicates are higher than for loans to traditional borrowers because of the lender’s need to perform diligence upon each borrower entity. The need to complete this diligence process also extends the time needed to close the loan. Negotiation Tip: Pre-clear all entity documents with your lender. Then provide the lender with a blackline of each final agreement comparing the final agreement to the preapproved form. b. Some lenders charge TIC syndicates a slightly higher interest rate to compensate the lender for the increased bankruptcy risk the lender incurs when lending to a TIC syndicate. c. Some lenders require greater reserves when making loans to TIC syndicates due to the potential difficulty in receiving money from individual TICs as needs arise. Common reserves include debt coverage, repair, taxes and insurance, and capital expenditure. d. Lenders may require the subordination or collateral assignment of certain ancillary documents. This requirement is especially prevalent when affiliates of the syndicator take on roles, including serving as the property manager or entering into a master lease.
Negotiation Tip: Provide all management documents and master lease documents to the lender as soon as possible. This will allow the lender to review these documents and figure out how to deal with them. It is also advisable to provide your lender with a chart showing all relationships between parties to the transaction. The lender will review this material to determine, in part, whether any affiliated entities will be required to give guaranties and will also use this information to determine how cash-flows are going to be distributed and to whom. The lender will attempt to gain rights over cash flows owed to affiliates of the syndicator in the event of a default. e. Lenders may require one or more cash management agreements (such as a blocked account agreement or a lockbox agreement) with a TIC syndicate in order to obtain control over the rents received from the property. This enables the lender to obtain the cash quickly in case of a default. It also prevents the making distributions and payments to the TICs, affiliates of the syndicator and third parties employed by the syndicator. Negotiation Tip: If this is required, begin this process early as it often is time consuming and if put off until the last minute may delay closing. In addition to discussing this with the lender, talk to your depository bank, if different from the lender, to determine if they offer this service. If they do not, the lender may require that you move your account. If you are going to a new depository institution or need a depository institution that offers this service, ask your lender if they have pre-negotiated lockbox and blocked account agreements with any depository institutions. IV. Due Diligence. In many cases, less sophisticated TIC investors may not be as familiar with the process required in obtaining a larger loan. Educate these investors early and make sure all information needed is available. Items that often need to be verified or obtained include whether the investor is accredited and information required by the Patriot Act. Other items it is advisable to begin obtaining early include copies of all contracts to be assigned in connection with the acquisition, evidence of zoning, copies of all permits and licenses to be assigned (if any), and third reports such as appraisals, inspections and environmental reports, if not ordered by the lender. In addition, if it is necessary for the seller to defease its current lender, let the new lender know and involve the new lender in the process. This is important as the new lender may have certain logistical requirements in connection with its funding. Finally, do not hide bad things that happened in the past. Your lender will find them, and failure to disclose is more likely to sink a deal that pro-actively telling your lender what happened and explaining the situation (this includes bankruptcies, lawsuits and criminal convictions). DST. Lenders have sought to have DST’s permitted for use in connection with TIC deals. However, the IRS has limited the actions the trustee of a DST can take. As a result, it appears that using a DST is only practical for transactions involving long-term triple net leases.
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Conclusion. It is vital that TIC investors and syndicators know what to expect when dealing with their lenders. By proactively understanding what their lenders require, legal costs can be minimized and transactions can be closed more quickly. Misunderstanding why a lender imposes certain requirements can make what should be a relatively simple transaction more complicated, expensive and time consuming. Working with an experienced syndicator and counsel that has closed TIC transactions previously can help avoid traps and limit expenditures of time and money.