TICtalk - Transwestern · OMNI Research & Consulting F or the fourth consecutive quarter the Tenant-in-Common (TIC) industry continued to show signs of attrition. In the 1st quarter

TIC talk2nd QUARTER 2008

Q U A R T E R L Y

OMNI RESEARCH & CONSULTING, LLC © 2008 COPYRIGHT AN AFFILIATE OF OMNI BROKERAGE, INC. - MEMBER FINRA/SiPC

TM

Research &Consulting

The Ant And The Grasshopper

Manuel NogalesVice PresidentOMNI Research & Consulting

For the fourth consecutive quarter the Tenant-in-Common (TIC) industry continued to show signs of attrition. In the 1st quarter

of 2008 the TIC marketplace closed $443 million in equity from 21 different sponsors representing 40 programs. These numbers represent a decrease of almost fifty percent from the average activity level of a year ago. We continue to see sponsors leave the marketplace or downsize. Of the 21 sponsors that closed transactions in the first quarter more than half closed only one program and only 4 sponsors closed more than 4 programs. Many sponsors are finding it difficult to maintain payrolls and efficiencies with the decreased program velocity. These market consequences are not just isolated to the sponsor community but are also taking their toll on the broker/dealer and registered representative communities. The cost of doing business for all parties continues to rise and as a result many players leave the industry. This “winter” season is testing the industry players’ level of preparation for the cyclical nature of real estate. For the most part the TIC industry is made up of seasoned real estate professionals who have been in real estate long enough to have weathered multiple real estate cycles. The question is, who has learned from past experience and prepared for the inevitable change of seasons and who will be left out in the cold? The current situation is reminiscent of an Aesop fable “The Ant and the Grasshopper.” The fable tells of a grasshopper that has spent the warm months singing away while the ant worked to store up food for winter. After the winter has come, the grasshopper finds itself dying of hunger, and upon asking the ant for food is only rebuked for its idleness. This fable teaches us the importance of preparing for times of change or need.

I think we can all agree that we have departed our “warm months”

and are very much in our “winter months.” Even though both the

grasshopper and the ant knew that winter was quickly approaching how

they individually prepared for the event produced drastically different

outcomes. In the peak of the TIC industry’s “summer” in late 2005 and

early 2006 it attracted new participants, many of whom were attracted

by the warm weather without much concern for the approaching

change of seasons. We are now seeing that it also attracted sponsors,

broker/dealers, and reps that had a long term approach who are still

experiencing success (although more moderate success) even in these

difficult times. They will weather this “winter season” stronger and be

better positioned to capitalize on future opportunities. It is encouraging

to see that the number of “ants” out number the “grasshoppers”, it is a

testament of an industry that has learned from past experiences and has

anticipated the change of seasons.

Our “winter season” is not an indication of an industry that cannot

stand the test of time, or that TIC’s have been a fad that has fallen out of

public favor. It is more an indication that as an industry, we are subject

to larger economic factors that can make it more difficult to produce

programs that fit the very narrow bandwidth our investors demand.

Our “warm months” will come again and have the potential to be a

longer and more fruitful season then we have experienced in the past as

more baby boomers that own highly appreciated investment real estate

are entering retirement age in record numbers.


“Our ‘winter season’ is not an indication

of an industry that cannot stand the test of

time, or that TIC’s have been a fad that has

fallen out of public favor.”

“It is encouraging to see that the number of

“ants” out number the “grasshoppers”, it is

a testament of an industry that has learned

from past experiences and has anticipated

the change of seasons.”


One of the most pronounced indications that we have changed seasons is the manifestation of TIC programs experiencing some difficulty and the need for TIC workouts. Stephen Burr of Foley & Lardner, in “What Have We Learned From TIC Workouts?” outlines some of the obstacles involved in facilitating TIC workouts from three different recent examples. The illiquid nature of TIC programs coupled with the multiple parties involved add a level of complexity and require a level of unprecedented cooperation to successfully produce the best outcome for all parties involved.

Daniel Shaeffer and Chad Christensen of Cottonwood Capital, in “How is the housing crisis affecting the apartment rental market?” address how even through difficult times there can be opportunities


to acquire and invest in apartments. Also, how one must be aware

of potential pitfalls and stick to seasoned fundamentals of real estate

acquisition: Location, Location, and Location. I would also add to that

the importance of a quality program sponsor.

“Recourse or Non-Recourse That is the Question”, by Aaron Cook

of CORE Realty Holdings, addresses the question that more and

more people will have to ask themselves in the upcoming months.

Non-recourse loans have long been a foundational building block for

prospective TIC investors, with this foundational block becoming more

difficult to acquire is there a place for recourse loans in TIC programs?

This article emphasizes both the pros and cons of recourse financing

and what questions one should ask to better understand the long-term

ramifications of this financing structure.

Although we are in the “winter” season for the TIC industry some

encouraging indicators have been provided by both sponsors and

registered reps that the product pipeline and investor equity dollars are

improving. It looks like the stars could be aligning for a small rally in

the marketplace, only time will tell.

“It looks like the stars could be aligning for

a small rally in the marketplace...”

Apartment -7.57%

Hospitality -77.28%

Industrial -46.17%

Office 23.78%

Retail -15.87%

GRAND TOTAL -13.55%

1st Quarter 2008 Numbers

Office48.68%

Apartment20.17%

Retail19.56%

Hospitality5.30%

Industrial3.41%

Equity Closed Per Asset Type - 1st Qtr 2008 % Change in Equity Closed per Asset Type From 4th Qtr 2007 to 1st Qtr 2008

The industry continues to struggle closing deals as the credit market tightens. Equity closed for this quarter dropped by 13.55 percent from 4th quarter 2007.

Office, Apartment, and Retail made up 89% of the equity closed this quarter. Both Hospitality and Industrial decreased in equity closed from fourth quarter 2007.

TIC Industry Quarterly Statistics

$200M

$400M

$600M

$800M

$1.0B

$0

$1.2B

Q105

Q205

Q305

Q405

Q106

Q206

Q306

Q406

Q107

Q207

2005

2006

2007

2008

Oil & Gas2.36%

Q307

Q407

Q108

Office was the only asset type that increased in closed equity from fourth quarter 2007. Senior Housing was unable to close any properties during the first quarter 2008.

OMNI Research & Consulting

Statistics compiled by properties closed in Q1 2008

Statistics compiled by properties closed in Q1 2008 Statistics compiled by properties closed in Q1 2008



Asset Type Q1 2008 Q4 2007 Q3 2007 Q2 2007

Apartment 95 82 61 137

Hospitality 83 73 69 46

Industrial 37 72 97 108

Office 171 122 126 117

Oil & Gas 120 N/A 44 31

Other N/A N/A 44 198

Retail 248 215 105 101

Senior Housing N/A 18 34 51

Average Days 126 97 72 99

AEIArciterraArgusBGKBirtcher AndersonBluerockBNI EquitiesCabot 1031Capital Equity GroupChristopher PlaceColeCORECottonwood

CreekstoneDBSI DeSantoDividend Capital EliasonEquitableEvergreenExchange PointFirst GuardianFORT PropertiesGeminiGenevaGeyser Holdings

Griffin CapitalGrubb & EllisInlandKodiakMeridianMoodyNPV Direct InvestORIXOxfordPasscoPennbridge CapitalPinnacle RoyaltiesPrinciple Equity

RainierREVARedwood WestdaleResource Real EstateRK PropertiesRM Crowe PropertiesSagebrushSCISequoiaSilver OakSouthforkSovereign CapitalStratford Capital

TSGTexas EnergyThe John Hicks Co.TIC CapitalTIC PropertiesTortoiseUS AdvisorWells RE FundsWestern AmericaWhite CapWilkinson 1031Woodlark

40 Programs Closed - 1st Qtr 2008

THIS MAP DOES NOT INCLUDE PROGRAMS THAT HAD PROPERTIES IN MULTIPLE STATES

Average Days to Close - 1st Qtr 2008

The TIC industry saw its lowest equity raised since 3rd quarter of 2004. Moving into 2008, the marketplace could continue to dip in equity raised as the marketplace corrects its inefficiencies and plays survival of the fittest.

The number of sponsors who only closed one property has risen since fourth quarter 2007. There are only five sponsors that closed three or more properties this quarter.

$1.0B

$2.0B

$0

$3.0B

2001 2002 2003 2004 2005 2006 2007

$4.0B

$5.0B

TIC Industry Statistical Snapshot TIC Programs Per Sponsor - 1st Qtr 2008

87654321

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of S

pons

ors

Number of Programs Closed

21 of 64 Sponsors Surveyed Closed Deals in the 1st Qtr20 Sponsors Were Active in the 1st Qtr, but Did Not Close Offerings

Apartment -7.57%

Hospitality -77.28%

Industrial -46.17%

Office 23.78%

Retail -15.87%

GRAND TOTAL -13.55%

Statistics compiled by properties closed in Q1 2008 Statistics compiled by properties closed in Q1 2008


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Stephen BurrPartnerFoley & Lardner, LLP

In its six years of existence the Tenant in Common (“TIC”) industry has had a strong record of delivering on its promises of deal

performance. However, with the general economic slowdown and the problems in the real estate debt market, some challenged transactions are beginning to surface. These problems can be caused by many factors. Three recent examples which we have been involved in became problems for different reasons:

The bankruptcy of the single tenant of a large industrial facility;1.

The bankruptcy of the Sponsor, Master Lessee and Property 2. Manager entities; and

The failure of the Property to perform as expected due to specific 3. market conditions.

Of course, these and many other causes of distress are not unique to the TIC industry, they are common to the whole national commercial real estate industry. Commercial real estate has historically been a cyclical industry.

So what is unique about the TIC workout? The crucial distinction of the TIC workout from the typical commercial real estate workout is the number of parties involved and the IRS-designed lack of control of any particular party over the borrower/property owner. Tenant in Common investors are, by design, in a structure where none of them can control decision making. This is not a crucial problem when everything is going well, and an effective, well-capitalized master lessee or property manager is in place with the power to make day-to-day decisions. However, if the performance of the property declines, whether due to vacancy, default or bankruptcy by tenants, and/or the master lessee or property manager proves untrustworthy or is in financial distress, small problems can become big problems in a hurry.

If a property is in distress, the first indication is typically that the return to the investors, whether in the form of rent under a master lease or net operating income, declines. It is critical to take meaningful action at this initial stage, as the decline can rapidly progress from failure to pay rent to failure to pay debt service.

What should investors, broker dealers and registered representatives do

when the return to investors declines? Here are a few steps to take:

Hire Competent Counsel.1. Any workout of a TIC transaction

on behalf of investors requires the immediate engagement of counsel

with experience in TIC transactions and ideally with TIC workouts.

This is much easier said than done, as there are fewer than 10 law

firms nationally with meaningful TIC experience, and less than half

that number with meaningful workout experience. The problem is

exacerbated by the fact that the normal clients of these firms are TIC

sponsors, so conflicts are a serious problem. Once through the conflict

waivers, determining who the client is, i.e. one TIC, some of the TICs,

all of the TICs, is excruciatingly complicated and needs to be well

documented. Finally, a substantial retainer will be required, typically

requiring the first of what could turn out to be a series of capital calls.

All of this will take an inordinate amount of time at a moment when

time is precious.

What Have We Learned From TIC Workouts?

“...these and many other causes of distress

are not unique to the TIC industry, they are

common to the whole national commercial

real estate industry.”



Appoint Persons to Act.2. The first action of the TICs and their

counsel must be to empower a small number of them, ideally no more

than three, to act for all of the TICs. This can be done by the grant of

irrevocable, durable powers of attorney, or by a delegation of authority

which is less broad or more limited in time. It is optimistic to expect

unanimous consent of the TICs to anything at this point, but if such

powers of attorney or other delegations of authority can be gathered

from at least a majority in interest of the TICs, the appointed TIC

“Attorneys” can make most decisions. Competent tax counsel must

review such arrangements to insure that the powers of attorney do not

turn the TIC structure into a prohibited partnership.

Carefully Read the Tenant in Common Agreement. 3. Every TIC

offering includes a Tenant in Common Agreement, a sort of non-

partnership agreement crafted to comply with Rev. Proc. 2002-22.

This Agreement is a road map for many of the actions required of TICs

in a workout, including:

Basic decision makinga. – what decisions must be unanimous and

what decisions require a majority?

Dispute resolutionb. – is there a buy-out mechanism for recalcitrant

TICs?

Capital callsc. – are they contemplated? Are there protections for

contributing TICs against defaulting TICs? Can the master lessee,

the property manager or individual TICs make loans and receive

repayment on a priority basis?

If the provisions do not fit comfortably with the circumstances of the

TIC workout, or if there are serious differences of opinion among

the TICs, making significant decisions, particularly time-sensitive

decisions, can be difficult.

Getting the Brokers/Securities Representatives Involved.4. The

question of whether to get the brokers/securities representatives involved

is a double-edged sword. Despite problems with the investment, many

investors still look upon their representatives as crucial advisors-persons

whose advice they will still follow. However, other investors may be

furious with their representatives, or there may be suitability claims.

All of this puts the investors and their representatives in a quagmire of

real or perceived conflicts. On balance their participation is generally

valuable, but conflicts need to be carefully considered and the attorney-

client privilege carefully maintained.

Dealing With Sponsors and Affiliates.5. In some workouts the

Sponsor and its affiliates, e.g. the Master Lessee and the Property

Manager, are clearly either part of the problem or so distracted as to be

a hindrance, not a help. On the other hand, if the problem is truly one

of property under performance due to underlying market conditions,

removing the Master Lessee and/or Property Manager can do more

harm than good. In particular, most loan documents prohibit changing

Master Lessees or Property Managers without lender consent. Removal

can also disrupt relationships with vendors and tenants. Finally, such

removal may produce unintended control or tax consequences. Be

particularly wary of terminating Master Leases as opposed to simply

replacing the Master Lessee.

Finding a Replacement Master Lessee and Property Manager. 6.

Where the Sponsor and its affiliates no longer have the confidence of the investors they should be removed if possible, albeit carefully, as described in the prior section. The question then becomes one of who should the new Master Lessee and Property Manager be. You must first find a new Master Lessee, as that party will likely want to pick the Property Manager. Do not expect the new Master Lessee to contribute capital or incur liabilities. A troubled TIC transaction can not afford the incentives which would have to go to the new Master Lessee to justify it in taking those risks. Be content if the new Master Lessee is experienced in TIC transactions, in the specific property type, is acceptable to the Lender, can convince a good Property Manager to come on board and is willing and able to supervise the Property Manager, stay on top of problem issues and communicate well with the investors and the Lender.

Dealing With Other Third Parties.7. Constant communication with lenders, tenants and vendors is critical during any workout. If communication is absent, slow or incorrect, third parties will assume the worst. Most lenders including, in particular servicers of conduit loans, assume that it is inherent in TIC structures that their borrowers will not make timely, prudent decisions, and foreclosure will be required. This is one reason why it is critical to retain competent counsel and appoint properly authorized representatives at the first sign of trouble.

Explaining Tax Effects.8. Workouts will almost always have at least the potential for significant negative tax consequences for the TICs, e.g. recapture, phantom income, etc. These issues must be clearly understood and explained, at least at a conceptual level. Each TIC will have his or her own specific tax issues, so continued involvement of their personal tax advisers is crucial.

DSTs.9. The discussion above applies to traditional TIC offerings. There are of course relatively fewer DST offerings in the market place. However, if a DST offering turns into a workout it will have its own specific challenges beyond what is common in a TIC offering.

These are just a few of the lessons that those active in TIC workouts have learned, generally through challenging, frequently distressing circumstances. It is critical for the TIC industry that sponsors, broker dealers, registered representatives, investors, lenders and service providers such as law firms, rapidly improve and streamline the workout process. Failure to do this could lead to a crisis of confidence that would be damaging to the future of the TIC industry.


Number of Months # of Deals % of Total Deals

12 Months (+) 3 6.12%

11 Months 0 0.00%

10 Months 0 0.00%

9 Months 0 0.00%

8 Months 0 0.00%

7 Months 1 2.04%

6 Months 5 10.20%

5 Months 4 8.16%

4 months 5 10.20%

3 months 5 10.20%

2 months 6 12.24%

1 Month 12 24.49%

Less than 1 month 8 16.33%

TOTALS 49 100.00%

Equity Per Asset Type - 3.31.2008



Week of 3.31.2008 TIC Industry SnapshotOMNI Research & Consulting

Number of Months # of Deals % of Total Deals

12 Months (+) 3 6.12%

11 Months 0 0.00%

10 Months 0 0.00%

9 Months 0 0.00%

8 Months 0 0.00%

7 Months 1 2.04%

6 Months 5 10.20%

5 Months 4 8.16%

4 months 5 10.20%

3 months 5 10.20%

2 months 6 12.24%

1 Month 12 24.49%

Less than 1 month 8 16.33%

TOTALS 49 100.00%

Equity Per Asset Type - 3.31.2008

40.39%Office

21.92%Retail

2.36%Hospitality

5.34%Other

27.92%Apartment

2.07%Oil & Gas

Compared to last quarter’s equity available (December 28, 2007), there has not been a significant change in the percentage of equity per asset type on the market. Although the overall size of the pie has decreased, the percentage share of each asset type has remained relatively similar.

TX NYGA TN LAOHIAFLPAILWI NCSCAZ IN MA MN

ASSET TYPE BY STATE - 06.29.2007Asset Type By State - 3.31.2008

Average Days On Market 118

Average 1st Year Yield 6.10%

Average Minimum $371,740

Average Total Equity $12,746,228

Average Equity Remaining $6,935,444

Asset Type Total Equity Available Equity

Apartment $171,740,447 $95,835,565

Hospitality $33,155,000 $8,093,000

Industrial N/A N/A

Office $245,046,823 $138,610,522

Oil & Gas $13,748,976 $7,108,717

Other $18,333,573 $18,333,573

Retail $139,749,150 $75,226,156

*Weighted by Total Equity $621,773,969 $343,207,533

Shelf Life - 3.31.2008 (Number of Months on Market) Week Breakdown - 3.31.2008

Since last quarter’s shelf life numbers (December 28, 2007), the percentage of properties on the market between four and six months has increased 12.69 percent. The amount of properties between seven and nine months and ten and twelve months has decreased 1.14 and 8.17 percent respectively. The number of Properties between one and three months has decreased by 4.28 percent.

With fourteen less properties on the market since last quarter’s weekly breakdown (Decembers 28, 2007), the amount of available equity has dropped $99,558,813. Total Equity has decreased by $161,280,205. Days on market, which includes the average of all asset types, has also decreased from 129 to 118.

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Texas, Georgia, and Illinois continue to remain in the top five states. Texas still holds the majority of properties as well as the greatest diversification of asset classes.

OfficeRetailApartment

HospitalityOil & Gas OtherIndustrial

Senior Housing


Aaron CookExecutive VP & National Sales ManagerCORE Realty Holdings

It is difficult to make the argument that a recourse loan is all around better than a non-recourse loan when investing in a tenant in

common (“TIC”) offering. However, in today’s volatile capital market environment it is important for investors to explore every option and select the best and most suitable investment opportunity that will help achieve their financial goals. Recourse financing for TIC investments is becoming more common due to the lack of liquidity and the near shut down of the CMBS lending markets. It will likely continue to be prevalent in the TIC industry until the capital markets become more normalized.

While “Recourse” has evolved into a bad word in the commercial real estate industry, if structured properly, Recourse financing can potentially provide some tremendous benefits for investors in TIC programs. Since the CMBS markets have effectively shut down for TICs, sponsors are becoming more creative and searching for alternative sources of financing through regional banks, balance sheet, and portfolio lenders. In many instances a Recourse, or more likely, partial Recourse, (both “Recourse”) loan will provide both sponsor and investor some significant benefits. Often times a portfolio lender will be willing to provide more leverage on a Recourse loan than they otherwise would on a non-Recourse loan creating additional positive leverage in addition to increased cash on cash returns to investors. It is also more likely that the lender will provide better pricing on a Recourse loan than a non-Recourse loan, giving the investors the benefit of a lower interest rate.

When considering an offering with Recourse financing it is also important to understand the terms of the loan. If properly structured a Recourse loan can provide much more flexibility than a non-recourse loan. Since Recourse loans will likely be made by a portfolio lender,

shrewd sponsors will negotiate more favorable repayment terms than available with a CMBS loan. If negotiated and structured properly a Recourse loan may have no prepayment penalties, yield maintenance provisions or defeasance costs associated with an early payoff. Since the loan is not securitized and collateralizing, a bond and/or bond interest payment lenders are often times willing to make these concessions. This gives the sponsor the flexibility to continue to search for more favorable financing terms on behalf of the investors throughout the term of the loan and/or the holding period of the property. If the sponsor is able to secure more favorable financing on behalf of the investors one week or one year after the loan is funded, the investors have the flexibility to refinance and payoff the exiting Recourse loan. This flexibility and benefit can be substantial over time. As the capital markets become more liquid and if the property performs as projected, investors have the flexibility to refinance with potentially greater leverage, more favorable interest rates and a longer term loan. This strategy can provide the opportunity for TIC investors to take cash out, tax favorably, on a refinance and potentially increase the internal rate of return and current cash flow due to the more favorable loan terms. The underlying asset, the market and the ability of the sponsor to execute the business plan at the property will all play an important role in executing this strategy. If net operating income has consistently increased over time under the management of the sponsor, a lender is more likely to provide more favorable terms upon refinance.

An added benefit to Recourse financing is that most portfolio lenders

Recourse Or Non-Recourse That Is The Question

“Recourse financing for TIC investments is

becoming more common...”

“...it is conceivable that a TIC investor

could have liability greater than their cash

invested under a Recourse loan and there-

fore it is a risk that must be weighed care-

fully...”



require the sponsor to have some “skin in the game,” effectively

investing alongside the tenants in common as a tenant in common.

This more closely aligns the sponsor’s goals with the tenants in common

as the sponsor also has a vested financial interest in the performance

of the asset as well as securing the most favorable financing given the

right opportunity. When the sponsor is also a tenant in common the

sponsor will also have potential Recourse on the loan, therefore aligning

the interests of the investors and the sponsor for the holding period of

the asset.

While there can be some added benefits to Recourse financing on TIC

offerings, there are risks that investors should consider when selecting a

property with Recourse financing. To the extent the lender suffers a loss

the investors may be personally liable for their pro rata portion of that

loss. In some instances investors may be liable for said loss, both jointly

and severally in which case it would be plausible that the lender could

seek indemnification from all the TIC investors or one individually.

The extent of the potential liability could be substantial considering

the size of the many loans on TIC investment offerings. With recent

developments in the TIC industry and the emergent number of under

performing TIC investment properties, it is conceivable that a TIC

investor could have liability greater than their cash invested under a

Recourse loan and therefore it is a risk that must be weighed carefully

when investing in a TIC offering.

When considering a TIC offering with Recourse financing, investors

and their reps should understand the events that could cause potential

recourse under the loan agreement (“Agreement”) and should consider

the following questions:

What is the possibility of a catastrophic event with the property that »

could cause a default and a loss under the Agreement?

What would the value of the property have to decline to in order for »

the lender to suffer a loss?

What is the break even occupancy, required debt service coverage »

ratio, and actual debt service coverage.

How far would revenue and NOI have to decline in order to cause a »

default and a loss under the Agreement and is there an ability to cure?

What is the investor’s pro rata liability based on total or partial »

recourse?

Is the recourse joint and several? »

If so, is the sponsor investing and also providing a guarantee?•

What is the net worth of the sponsor or guarantor?•

What is the sponsor’s track record of performance and how have they »

handled past challenges?

All investment opportunities come with risk and Recourse financing

is no exception. While it can provide some benefits to investors it is

important to understand any added risk thoroughly before making

recommendation or an investment. The key principals for TIC investing

hold true whether considering Recourse or non recourse financing:

Is it good real estate? »

Is it well located in a viable market? »

Is there room to grow NOI fundamentally and add value to the »

property?

Are the assumptions reasonable? »

Can the sponsor execute the business plan? »

Is the property well capitalized? »

Is the sponsor a quality company with a track record of »

performance?

Is there a viable exit strategy? »

Understanding the risks involved with Recourse financing is important

for reps and investors. However, nothing is as important as the

underlying real estate and the quality of the sponsor. If you have great

real estate and a quality sponsor it is unlikely that Recourse or non

Recourse will ever be an issue for TIC investors.

“...if structured properly, recourse financing

can provide some tremendous benefits for

investors in TIC programs.”

“All investment opportunities come with risk

and Recourse financing is no exception...”


Daniel Shaeffer & Chad ChristensenCottonwood Capital

The answer to this question seems simple and straightforward…demand for rental units will continue to rise at an increasing rate.

Rental market demand will come from three relevant directions. First, fewer people today qualify for a home mortgage either due to the lack of a larger required down payment or because of more stringent credit guidelines, which are finally being enforced. (“You mean we need to show proof of our income??”)

Second, many qualified buyers, worried about catching the proverbial “falling knife” as housing prices continue to decline, are choosing to sit on the sidelines and rent until the housing market once again seems stable. It was recently reported on Bloomberg news that over 8.5 million homeowners owe more on their homes than their property is worth – which is almost 11 percent of all American homeowners. The same source estimated that the number of people underwater in their homes may rise to as high as 12 million, almost a 50% increase from the current level. This creates continued pricing weakness because as these homeowners seek replacement financing they may be forced to sell into a weak market, or worse, may not be able to sell at all.

Finally, people are losing their homes at an increasing rate as foreclosures and job losses continue to mount with the weakening home market, resetting ARM rates, and the general slowing down of the economy. This trend of falling homeownership can be seen in the chart below.

These factors mentioned above contribute to a continuing increase to the demand side, i.e. the number of available renters. Increased demand equates to more renters, higher rents and better profits for apartment investors, right?

Unfortunately, the story is not so simple and the answer to the above question varies dramatically by market and property. Remember also that demand is only half of the equation. Let’s consider supply.

If demand for rentals is increasing then why are collections trending down in those hot markets which have been most affected by the housing crisis? Market darlings like Phoenix, Las Vegas, the Inland Empire, Sacramento, and South Florida have all been damaged badly from an occupancy, rental income and total cash collections standpoint. This is not because of weak demand but rather because of

How Is The Housing CrisisAffecting The Apartment Rental Market?

U.S. Homeownership Rate

www.calculatedrisk.blogspot.com - Data provided by U.S. Census



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a huge increase in the available supply of rental units. Don’t blame the apartment developers this time, though.

So much of the housing boom and bust was caused by rampant speculation and the bubble chickens have finally come home to roost. In an effort to ward off true financial pain (or maybe to just put off the inevitable), many of the would-be speculators in these markets have thrown their condos, town homes and single family houses into the rental pools in these markets to try and make a dent in their ever increasing (thanks to those ARM rates) mortgage payments. (The condo converters and developers are also in this bunch of speculators, but on an even grander scale at a cost basis that in some cases is even more absurd.)

Remember, these were the housing markets that had people camping overnight to wait for lot releases from builders for new houses. We guess there was a lot of speculating gold miners camping out with the folks who just wanted a small piece of America, at whatever the cost. Many of those who weren’t speculators would have been, under historical lending practices, considered unsuitable borrowers. But due to favorable and less strict standards by aggressive lenders they pre qualified for sub-prime and Alt-A (no doc or “liar”) loans.

Speculators who have become accidental landlords have created a shadow rental market. This shadow market has become a formidable competitor to suburban apartment complexes, particularly higher-end condominium like communities in some parts of this country.

How then, do investors seize the opportunities created by increased rental demand while protecting themselves from the lurking shadow-market supply? The answer lies in that 3-pronged banal law of real estate investing: Location, Location, and Location.

Even in these troubled markets, islands of tranquility exist where infill

assets may not feel the harsh effects of increased supply because of a superior location where nothing in the immediate area was converted to condominiums or newly developed and the existing housing stock is high quality where the values have held up well.

Observe that two of the three factors causing rental demand to increase are widespread, whereas the problems created by housing supply are remarkably concentrated. Specifically, it is harder for everybody everywhere to qualify for a mortgage today than it was 2 years ago. Secondly, many people across the country are choosing to rent rather than purchase while the housing markets stabilize.

Note also that the factors that favored increase rental demand prior to the housing bubble are still pertinent. First, the gap between what it costs to rent and what it costs to own is wide, has been wide, and may continue to widen for some time even with some weakening in house prices. Secondly, construction costs have risen dramatically in the past few years. Existing apartments can still be bought at a discount to replacement cost which means that rents will have to rise before new apartment supply will enter the market in any dramatic way.

Apartment communities that stand to benefit the most from the effects of the housing bubble will be in markets where there was not a huge increase in the “shadow market.” Markets included in this category are markets like San Antonio, Austin, Seattle, Portland, Salt Lake City, and even Houston and Dallas.

Clearly, it is an exciting time to invest in apartments. Yet because of the risks, fundamentals are more important than ever. Investors should seek solid infill locations in markets where job growth is strong and supply is somewhat constrained. As the housing crisis finds its bottom and the “shadow markets” begin to improve, the fundamental economic story of the local economy and job creation in each market will be ultimately critical.

How Is The Housing CrisisAffecting The Apartment Rental Market?


“...fewer people today qualify for a home

mortgage either due to the lack of a larger

required down payment or because of more

stringent credit guidelines, which are finally

being enforced...”

“...many qualified buyers, worried about

catching the proverbial “falling knife” as

housing prices continue to decline, are

choosing to sit on the sidelines...”

Tuesday, 3 June

8-9 September

5-7 October

23-24 June

RealShare TICHyatt Regency IrvineIrvine, CA

IMNReal Estate M&AMarriott MarquisNew York, New York

TICATICA 2008 Annual ConferenceThe Wynn HotelLas Vegas, NV

IMN5th Annual Private & Non-Traded REIT Industry SymposiumNew York, New York

Calendar of Events

JUNE

September

October



$1.0B

$2.0B

$0

$3.0B

2001 2002 2003 2004 2005 2006 2007

$4.0B

$5.0B

Visit us at www.omniticconsulting.com

10542 S. Jordan Gateway, #330Salt Lake City, UT 84095

The team at OMNI Research & Consulting hopes that you find the TIC Industry’s statistics and the pertinent articles within TIC Talk helpful in your daily business activity. If you have any questions, please feel free to contact us at 866-880-1031.

Manny Nogales Vice President

TIC Industry Statistical Snapshot

TIC talk


2nd QUARTER 2008

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Documents

TICtalk - Transwestern · OMNI Research & Consulting F or the fourth consecutive quarter the Tenant-in-Common (TIC) industry continued to show signs of attrition. In the 1st quarter