Savvy Way for Seniors to Manage Their Real Estate Equity

Few would deny that real estate is a solid investment. Nationally, there hasn't been a decline in home values since the end of World War II, according to the National Association of Realtors in a report the one-million-member trade organization released in March of last year. These widespread equity gains in residential real estate, as well as monies from other sources, have led many to invest beyond their primary residence and into income-producing properties such as rental housing, apartment buildings, or small office or retail centers. Over the years, many of these investment properties have built up substantial equity.

However, many seniors now find themselves in a quandary. They have become equity rich, but are cash poor-- with increases in the value of their property far outpacing income growth. Plus, they have grown tired of the day-to-day property management headaches such as toilets, tenants and trash, and want to simplify their lifestyle and enjoy golf, grandkids and gardening.

Of course they could always sell the property and unleash that accumulated equity, but this can have disastrous tax consequences. Moreover, even if they decided to sell and take the tax hit, where do they re-invest? After all, the Dow Jones is still 1,000 points below its high water mark reached in January 2000, the NASDAQ is less than half of its March 2000 peak, money market funds are barely ahead of inflation, and saving accounts can't keep pace with inflation.

INVESTMENT PRACTICES THAT DATE BACK GENERATIONS, EVEN CENTURIES

For years, investors have been using an investment option that allows them to sell a property and defer all taxes on capital gains by using the profits to acquire another "like-kind" property. In use since the 1920s, a 1031 exchange, so named for its designation in the IRS tax code, allows you to sell your income-producing property and "exchange" it for another while deferring capital gains taxes. Of course there are rules by which investors need to abide. Among them: the exchanged property must be of the same or greater value; the seller has 45 days after closing escrow on the old property to identify a new property; the seller has 180 days from the sale of the old property to close escrow on the new property.

Meanwhile, another real estate investment opportunity, Tenant-In-Common (TIC) ownership, has been around for centuries, dating back to British Common Law. TIC ownership allows for multiple parties to own an investment property, with each fractional owner holding separate title to his portion of the property. Additionally, like any property held in sole ownership, fractional ownership in a TIC can be purchased, sold, gifted, bequeathed by will or inherited. Naturally, it is also subject to property taxes, gift tax, and estate and inheritance taxes in the same manner as a solely owned property.

TIC ownership has been gaining momentum over the last 10 years, due largely to the increasing costs of acquiring real estate. By combining their resources, multiple investors can think beyond what they could purchase on their own, including gaining access to institutional-grade properties, such as grocery and drug store anchored shopping centers, large office buildings, malls, and multifamily apartment communities.

With the increasing popularity of TIC ownership, in March 2002 the IRS issued Revenue Procedure 2002-22, which set forth formal guidelines regarding the structure of TIC investments, including the maximum number of co-owners allowed in a property (35).

COMBINING OPENS OPPORTUNITIES TO SENIORS AND BABY BOOMERS

Many seniors and Baby Boomers are now finding that investing in a Tenant-In-Common property through a 1031 exchange is an attractive-- and increasingly mainstream-- investment. Now, instead of merely exchanging a "like-kind" property as part of a 1031 exchange, an investor can sell the property and pool his proceeds with other investors. This allows the investor to swap, for example, that sole ownership in a three-unit apartment building into a fractional ownership of a class-A office building in downtown Chicago, as well as an additional fractional ownership of a 220-unit, professionally managed apartment complex in the suburbs of Los Angeles. Or the investor could swap the proceeds from the sale of a strip retail center into a regional shopping center anchored by national tenants.

Aside from freeing the investor from the obligation of property management, the investor has "traded up" into institutional-grade properties that are professionally managed and have received professional scrutiny for their continued financial performance through a comprehensive due diligence process. Also, the investor can potentially reduce investment risk through geographic diversification and investing in a spectrum of property types. The TIC investors get the same oversight that's provided for a large institutional investor, including monthly reports, while potentially increasing monthly cash flow.

RAPID GROWTH IN 1031 AS TIC INVESTMENT

Since the IRS provided guidelines for TIC investments, total equity invested in this sector has more than doubled every year, according to Barron's magazine. It went from $350 million in 2002, to $750 million in 2003, and to $1.8 billion in 2004. The total is expected to reach $4.2 billion for 2005.

But beyond the numbers, there are other factors contributing to the accelerated momentum of such TIC investments for seniors:

Demographics
Today's class of seniors is the best educated and wealthiest ever. Investment and saving have long been a part of their financial discipline. Now, they are increasingly focused on wealth preservation, which involves minimizing the amount of taxes owed. TICs can accomplish just that-- allowing a taxpayer to enjoy cash flow, potentially increase equity, while continuing to defer taxes.

Meanwhile, there are 76 million Baby Boomers (those born between 1946 and 1964) who are just beginning to retire, or preparing to do so. Perhaps no other generation has been so enriched by real estate. Consequently, they tend to be comfortable-- and eager-- to reinvest their gains right back in.

Lifestyle
Being at the beck and call of your tenants to repair an overflowing toilet, or an electrical malfunction is never fun. For a senior, the physical demands of hands-on property management can become that much harder. For busy Boomers it's hard to find the time. Investment-grade properties-- office buildings, shopping malls, apartment complexes and industrial properties, valued anywhere from $10 million to $300-plus million-- employ professional asset and property managers. They relieve investors of day-to-day maintenance and leasing headaches. That can mean more days of uninterrupted golf, travel, time with grandkids and other pursuits.

Diversification
For those worried about a local real estate "bubble," TIC investments give investors the opportunity to diversify into different real estate asset classes, upgrade their investment, and get into different markets. For example, by pooling the equity earned on a three-unit apartment building into a self-storage complex in the suburbs, a class-A office building across the country, or a 220-unit high-rise condominium tower, the investor softens potential revenue fluctuation from vacancies. He is also less beholden to the performance of a particular local market or asset class.

Estate Planning
For estate planning purposes, a TIC structured investment in inherently like any other real estate investment. Upon passing, your surviving heirs inherit the investments. They can either sell the real estate, 1031 exchange their investment into something else, or can continue the TIC process. Like it did for you, this allows your heirs to enjoy tax-deferred capital gains, cash flow, and the ease of having professional property managers deal with leases, tenants and maintenance.

AN INVESTMENT THAT'S RIGHT FOR YOU?

The benefits of investing in a property through Tenant-In-Common ownership are many:
o Ability to keep real estate in your investment portfolio
o Opportunity to diversify property holdings geographically and across property types
o Mitigation of vacancy risk with larger properties that have more tenants
o Elimination of day-to-day property management headaches inherent in sole ownership properties
o Deferral of capital gains taxes when acquired using the proceeds from a 1031 exchange

Of course, investors must remember that, TIC investments have the same material risks of their previous (indeed of all) real estate investments, including potential for property value decrease, illiquidity, change of tax status, and the possible impact of fees/expenses which may outweigh a property's tax benefits.

Lastly, it is also important that the TIC real estate investment offered to you is structured as a security. When structured as a security the bar is set much higher for due diligence, confirmation of investor suitability, broker/dealer record keeping, and licensing and training of registered representatives.

This is neither an offer to sell nor an offer to buy real estate or securities. There are material risks associated with the ownership of real estate. Securities offered through Sigma Financial Corporation, Member NASD/SIPC.

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