WHAT ARE YOU BUYING?

Since TICs represent investments in commercial or multi-family real estate, it is important to understand the underlying real estate fundamentals of any TIC transaction. The due-diligence information gathered by the sponsoring real estate company for this purpose is normally put together for investors in the offering documents, specifically in the Private Placement Memorandum (PPM). In the PPM you will typically find a description of the property, its location, the names and lease terms of the tenants, information on the location's demographics, and a summary of the revenues and expenses for the property, as part of a pro forma cash flow analysis. Information regarding appraisals, surveys, environmental reports, market comparables, and other relevant data are also normally included in the PPM.

Though a prospective investor should analyze numerous factors in considering the purchase of a commercial real estate property, whether as a sole-owner or as a tenant-in-common, the investor should realize that he or she is actually buying a stream of income–both current income as well as future income. Specifically, a commercial real estate investor is buying a certain quantity, quality, and durability of income. It is these three variables that an investor should analyze in some detail:

Perhaps the simplest calculation of the quantity of income generated by a property is the Capitalization Rate, which is the net operating income of the property as a percentage of the property's current price. Looking beyond the Cap Rate, however, the investor should go on to calculate the cash-on-cash rate of return, which also takes into consideration the debt servicing on the property. The cash-on-cash rate of return will tell the investor what he or she is earning on their invested equity ("cash") net of all expenses and mortgage payments.

The quality of the income stream is dependent on many factors, but will primarily be a function of the quality of the tenants who are paying the investor rent each and every month. A prospective investor should carefully consider the source of the income stream in determining the overall quality of the investment under consideration.

Last, the durability of the income stream will primarily be determined by the terms and conditions of the leases on the property under consideration. Investors should ascertain the rate, length and terms of the leases, as well as the existence of any early termination clauses. And, importantly, the investor should determine what types of rent increases are part of the lease contracts. In this way an investor will be able to give proper consideration to the risks of not receiving adequate protection against the rising costs of living.

In deciding what type of property to invest in, the quantity, quality, and durability of the income stream should be of critical importance to a prospective investor. Consequently, an analysis of these three factors should be high on an investor's evaluation list when it comes to comparing the various replacement property choices in a 1031 Exchange or in any other investment real estate purchase. The property's location will also impact all three of the above mentioned criteria (see FAQs for further discussion). Tenant-in-common investments may be particularly well-positioned to satisfy all of these important criteria.