How to use TIC to accept 1031 money on a deal

Question

I have a portfolio deal we are raising funds for. We had initially decided to create a holding LLC with two drop down single member LLC's. We have received a lot of interest, but have a few potentially large investors wanting to use 1031 exchange funds. I understand the only way to do this by placing them in as a TIC. Can anyone explain how then to structure and pay equity splits, prefs, and manage?

Thank you for any insight on this.

John Bennett · Answer

@Dave Foster Having been a banker in a previous life I understand the need to secure the collateral. If the 1031 TIC Investors assign there interest to the no-recourse loan then all should be in good order. One borrowing entity like normal, with 100% of the property pledged under the non-recourse loan. The assignment of ownership interest is a contingency of investing in the deal. We are also requiring a proof of available funds should their 1031 not close on time. Of course, I have also suggested they could do a reverse exchange that would also work and solve the timing problem I think.

Dave Foster · Answer

@John Bennett, Structure will be everything.  Your 1031 investors will have to take title to actual real estate (or the membership interest in a Delaware Statutory Trust).  No other options.  There are specific revenue procedures that deal with this and syndication attorneys who can help you set up such a structure.  You've just hit the big snag that prevents 1031 investors frequently from entering into syndications.  And the other side of that is that if you set something up as a tenant in common then financing becomes an issue - both in getting a lender that will carve off TIC interests or in allocated the leverage values appropriately to each investor.

Alina Trigub · Answer

@Dave Foster should be able to help

Dave Foster · Answer

@John Bennett, The landscape of lending is always changing of course.  But typically lenders making a loan on a piece of property will not want to release or subrogate pieces without significant alterations to the loan.  Imagine the difficulty of lending to one entity owning 100% compared to multiple deeded owners.  If it's non-recourse money then any asset dilution complicates the issue.  If the money is recourse then all investors have to qualify.

If you have the package put together as one transaction with prorata ownership and debt assumption structure.  But to do that you would have to have all the 1031 investors ready with compatible exchange calendars.  It's not that it can't be done.  It's just that the moving parts and necessary accommodations by the lenders make it difficult.  I'm seeing more and more work because the syndicating sponsor is flush with cash and can finance the debt internally.

He with the best attorneys always wins.  Sounds like you've cracked the code.

John Bennett · Answer

@Dave Foster , I spoke to my attorneys today and they seem to have it figured out. I am still digesting some of it.

Can you give more information on how the TIC influences the financing. The attorneys today said the 1031 TIC investors would have sign a mortgage deed to perfect any debt that was placed on the property. All part of the closing and TIC Agreement.

Thanks.

Jack Martin · Answer

@John Bennett I have ran into that many times myself.  As @Dave Foster explained, it is extremely difficult to manage all the components, not to mention hitting target closing dates with the timing required by the 1031 capital.  The best way to use 1031 exchange proceeds is to have a single partner and just don't syndicate the deal.  That will limit you as a syndicator, having to find a deal that requires the perfect amount of capital.  Even a DST is limited because of the restrictions related to modifications to the lease.  Those are best suited for long term, single tenant assets.

However, if the portfolio you are buying fits into the opportunity zone strategy, you might be able to create an opportunity fund, which is a newer alternative to the 1031 exchange.

All the best,

Jack

How to use TIC to accept 1031 money on a deal

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