TIC Real Estate Investments

Since 2002, when the IRS issued official guidance in Revenue Procedure 2002-22 on how Tenant In Common investments would qualify for replacement property under Section 1031, the TIC Industry has exploded into a multi-billion dollar a year business. However, since 2002, the vast majority of TIC investments have been sold through the securities industry by licensed securities representatives and broker-dealers, not though the traditional means of licensed real estate professionals. Needless to say, the National Association of Realtors (NAR) and the real estate community have felt left out on these transactions and on October 11, 2007, NAR issued an exemption letter to the SEC on behalf of it's 1.3 million members.

This exemption request to the SEC would grant commercial real estate professionals with "substantial experience" in commercial real estate transactions, exemption from broker-dealer registration requirements of Section 15(a)(1) of the Securities Exchange Act of 1984. This exemption, if adopted in its current form would permit the real estate professional to obtain an advisory fee from the purchaser of a Tenant In Common securities investment that would be offered and sold together with other arrangements that would cause it to be deemed a security under federal securities law.

Below is an excerpt from the Law Firm of Hirschler Fleischer that outlines the NAR exemption letter, the SECs first response to the letter and what to expect on this subject going forward. Please click here to view the draft of the NAR exemption letter in its entirety.

I. Introduction

On November 9, 2007, the Securities and Exchange Commission (the "SEC") issued a much-anticipated notice (Release No. 34-56779; File No. S7-26-07) (the "Notice") concerning an application submitted on behalf of the National Association of Realtors ("NAR") requesting an exemption from federal broker-dealer registration and reporting requirements under the Securities Exchange Act of 1934 (the "1934 Act"). The primary purpose of the request is to establish a framework for licensed real estate professionals-who meet certain criteria and satisfy certain conditions-to receive compensation for real estate advisory services rendered in connection with securitized tenant-in-common ("TIC") offerings.

The Notice will certainly be viewed as anti-climactic by those who were hoping for a definitive ruling. However, by formally requesting public comment, the SEC ultimately should benefit from the feedback and analysis certain to be forthcoming from interested parties throughout the TIC industry. Further, it is likely that new issues will be raised during the comment period that will require more consideration than previously thought. Thus, the SEC may not issue a definitive ruling before the end of 2007 as some TIC industry experts were predicting.

II. What is NAR Asking For?

Simply put, NAR is asking that licensed real estate brokers and agents be afforded the opportunity to provide certain advisory services to potential TIC investors and receive compensation for those services without risk of being deemed an unlicensed securities broker-dealer in violation of federal law. The current consensus in the TIC industry is that securities broker-dealers and registered representatives are prohibited from sharing sales commissions or paying referral fees to licensed real estate professionals for client referrals or other services rendered in connection with the offer and sale of TIC securities.

More specifically, the Notice includes a variety of restrictions and limitations, including the following:

(i) Eligibility Criteria. Not all real estate professionals would benefit from this requested exemption. The exemption would be available only to licensed real estate brokers and agents who:

(a) are predominately engaged in the sale of commercial real estate (not including TIC securities); and

(b) have "substantial experience" in the sale of commercial real estate (with the term "substantial experience" being defined as having: (i) a Certified Commercial Investment Member designation, (ii) an Accredited Land Consultant designation, (iii) participated in at least five commercial real estate transactions having an aggregate value of at least $3 million in the prior five years (or at least ten such transactions having an aggregate value of at least $10 million in the prior ten years, including at least three in the prior three years)), or meeting alternative criteria that includes relevant education and experience in the commercial real estate industry.

(ii) Documentation Requirements. The relationship between the real estate professional and investor must be memorialized in a Buyer's Agent Agreement (the "Agreement") prior to any discussions regarding a specific TIC transaction. A signed copy of the Agreement must be delivered to the securities broker-dealer acting as placement agent for the TIC offering at or prior to closing. NAR suggests that the Agreement should memorialize, among other things:

(a) a statement that the real estate professional represents solely the investor;

(b) the identity of all real estate professionals who may receive compensation in connection with services provided under the Agreement;

(c) the maximum amount of the advisory compensation to be paid by the investor to those real estate professionals listed in the Agreement;

(d) educational information concerning TIC offerings in general;

(e) statements as to information and services the real estate professional can provide either before or after introducing the investor to a securities broker-dealer;

(f) statements confirming that the securities broker-dealer is responsible for compliance with applicable federal and state securities laws; and

(g) a representation from the real estate professional that he or she has substantial experience in commercial real estate.

The real estate professional must also deliver to the placement agent at closing a written representation that he or she is not subject to any "statutory disqualification," as defined in Section 3(a)(39) of the 1934 Act, such as regulatory expulsions, suspensions, and other penalties arising from securities-related violations. In addition, the selling broker-dealer representing the investor in a TIC transaction must deliver to the placement agent at closing a written representation that it has performed an investor suitability analysis in accordance with applicable self-regulatory organization (i.e., FINRA) rules as if the selling broker-dealer had recommended the TIC transaction.

The NAR request also suggests a mechanism whereby an investor can deliver a written affirmation confirming his or her intent to proceed with a TIC transaction, notwithstanding a determination by the selling broker-dealer that the investment is not suitable for the investor. This is one of several aspects of the Notice that likely will garner significant public comment.

(iii) Compensation and Services. Eligible commercial real estate professionals would be entitled to receive a real estate advisory fee (the "Advisory Fee") for services rendered to potential TIC investors. There is no discussion concerning the permissible amount of the Advisory Fee, only that the maximum amount payable must be memorialized in the Agreement. The permissible real estate advisory services contemplated in the Notice include:

(a) locate, identify, and obtain information about potential TIC transactions (both securitized and non-securitized);

(b) coordinate tours or site visits of potential TIC properties;

(c) provide advice on comparative characteristics of alternative real estate investments that meet the investor's specifications;

(d) discuss financing alternatives;

(e) evaluate and advise the investor concerning transaction documents (e.g., TIC agreements, master leases, etc.); and

(f) provide general (but not legal) tax assistance to the investor regarding Section 1031 exchanges.

(iv) Other General Conditions . Presumably to limit the scope of its exemption request, NAR suggested a variety of additional restrictions on the permissible activities of real estate professionals in this context, including prohibitions against:

(a) TIC-related advertising as part of the real estate professional's general business and marketing activities;

(b) fee sharing with any real estate professional not otherwise eligible under the conditions of the requested exemption;

(c) handling of investor funds;

(d) negotiating TIC investment terms or otherwise acting on behalf of the investor;

(e) participating in the structuring of a TIC transaction with the sponsor, issuer, placement agent, or other parties; and

(f) assisting in obtaining or negotiating financing for a TIC transaction.

III. Potential Ramifications and Unanswered Questions

If the exemption is granted in its current form, TIC industry professionals could expect to see some of the following results:

(i) Broader Distribution Network for TIC Securities. By allowing commercial real estate brokers to participate in securitized TIC transactions, the TIC industry should benefit from a wider pool of potential purchasers of TIC securities. The new distribution channel should result in increased awareness of TIC securities and 1031 exchange opportunities among commercial real estate investors. Similarly, as commercial real estate brokers learn more about TIC sponsors and products, they could aid sponsors in identifying properties suitable for TIC syndication. These factors should result in increased TIC deal flow by increasing the number of available offerings and expediting their sale to investors.

(ii) Closer Relationships between Commercial Real Estate Brokers and Securities Broker-Dealers. As commercial real estate brokers begin to bring investors to TIC deals, real estate brokers and securities broker-dealers will need to develop fee-sharing arrangements. It is likely that these arrangements will also allocate other risks and responsibilities arising from TIC deals, such as dissemination of disclosure materials and other deal information, vetting of potential purchasers, delivery of closing documents, and other closing logistics. As securities and real estate firms grow more familiar with one another, relationships could develop into formalized strategic alliances and joint ventures among firms.

(iii) Increased Regulatory Compliance Mechanisms. As commercial real estate brokers enter the securitized TIC arena, TIC sponsors and their securities broker-dealers need to be cautious to avoid violating the general solicitation and advertisement prohibitions under Rule 502(c) of Regulation D. In addition, real estate brokers may seek to familiarize themselves with the information required to enable the securities broker-dealers to provide required suitability confirmations. Such knowledge would help real estate brokers screen potential investors to avoid receiving a suitability letter indicating that a TIC investment is not a suitable investment. Finally, commercial real estate brokers will need to examine applicable state laws to avoid prohibitions against their sale of securities and collecting advisory fees from those sales. Likewise, securities broker-dealers will need to confirm that their fee-sharing arrangements comport with state law.

(iv) Increased Regulatory Scrutiny. The proposed exemption would broaden the range of professionals involved in the marketing of TIC securities and expands the pool of potential investors in TIC syndications. This expansion in the TIC securities marketplace may invite additional review and guidance from the government agencies and self-regulatory organizations charged with regulating these industries.

(v) Clarification of Unanswered Questions. The Notice provokes a number of questions about the addition of commercial real estate brokers into the TIC securities field, including the following:

(a) The Notice states that a real estate broker may discuss the real estate characteristics of a TIC security property and arrange inspections of a TIC security property prior to introducing the prospective purchaser to the selling broker-dealer. What steps will be required to ensure these activities do not result in the real estate broker engaging in general solicitation or advertising that would jeopardize the issuer's private placement exemption under Regulation D?

(b) Is it likely that purchasers would pay the real estate advisory fee to the real estate broker directly, rather than by an allocation of some portion of the broker-dealer's commission? Will real estate brokers be willing to waive portions of their fees that exceed amounts agreed to be allocated by the securities broker-dealers?

(c) Will a real estate broker's relationship with its clients work to satisfy the securities broker-dealer's prior business relationship requirements for private placements? Will the proposed requirement that the Agreement be completed prior to discussing any specific TIC security affect the "prior business relationship" analysis?

(d) Does the proposed exemption require that a TIC securities offering be structured to include a lead placement agent to be able to include real estate brokers in the marketing process?

(e) Will the proposed requirement that a real estate broker be "predominantly engaged" preclude real estate brokers from specializing in TIC securities transactions?

V. What Happens Next?

There is a 30-day comment period during which the public may offer feedback on the request. Parties interested in submitting comments should respond before the December 17, 2007 deadline by e-mailing rule-comments@sec.gov or using the SEC's online comment form at http://www.sec.gov/rules/other.shtml. File No. S7-26-07 should be referenced in the subject line. The SEC staff will consider any such input in making its decision, which will then be presented to the full Commission for consideration. If the exemption is granted, an estimated 800 commercial real estate professionals would be expected to benefit through future participation in securitized TIC offerings, and that number should increase over time as public awareness and acceptance of TIC transactions increases.

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