Risk Factors
- 1031 Exchange Strategies, Inc., through its Broker Dealer, OMNI Brokerage, Inc., offers its clients fractionalized investment real estate offerings only if they are structured as a Securitized Tenant-in-Common (TIC) offering.
- Security regulations require that risk factors related to the sale of a security be clearly disclosed and communicated to any prospective investor. The disclosure regulations associated with the sale of a security are far more comprehensive then those associated with the sale of a Non-Securitized TIC offering. Prospective investors should carefully consider this fact when evaluating an investment in a TIC.
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1031ES believes that a TIC is both real estate and a security and its principals are licensed as real estate professionals and hold
FINRA designations as security's industry professionals. See About Us for more detail on the various licenses and designations held by the 1031ES principals.
- Before making a decision to purchase any investment real estate offering, prospective investors should choose an experienced real estate professional who is also licensed as a securities professional if the investment is offered as a security, carefully read all offering materials and consult with their own tax and legal advisors.
- The following 10 items highlight some of the key risks associated with TIC investments as well as investment real estate in general.
1. The speculative nature of investment real estate and that it may involve a high degree of risk:
- Different real estate asset classes will have different degrees of speculative risk.
- Office and retail properties with significant lease roll-over and/or older properties may have higher speculative risk than stabilized apartment properties as an example.
- Investment real estate income and monthly distributions are never guaranteed and are subject to the investment property's operation performance.
- The use of interest only loans.
- The use of adjustable rate loans (interest rate risk).
- Not using the appropriate type of loan amortization schedule to meet investment objectives.
- Reinvestment risk (down market, or increased interest rates at end of investment time horizon) Prepayment penalties.
- An investor may experience “phantom income” since they only receive the cash that is available to distribute and the taxable income may be greater than what is received (re: loan principal payments, reserves funded, tenant improvements, leasing commissions and capital improvements).
- This is not a function of a fractionalized interests since these same principles would apply to direct ownership of commercial real estate with phantom income generators.
- There are several significant tax risks associated with the use of fractional interests as replacement property for a §1031 exchange.
- The guidance that creates legitimacy for the use of fractional interests in an exchange is an IRS Revenue Procedure (Rev. Proc. 2002-22) and not considered a section of the IRS tax code.
- Since Revenue Procedure are considered IRS “guidance” rather than law, there are risks that the IRS could potentially amend the guidance, or eliminate it in its entirety.
- TIC’s are unique since they are typically considered securities for security purposes and real estate for IRS purposes (under Rev Proc. 2002-22).
- Investors need to be cautious when considering fractionalized real estate offerings that do not comply with Securities laws and regulations since they will not have the benefit of the investor suitability, disclosure and due diligence regulations that apply to offerings packaged as securities.
- Due to the fact that there is currently no secondary market for Tenant-in-Common (TIC) interests, investors assume the risks associated with an illiquid investment.
- These risks include a potential sale below the market value of the offering, delays associated with finding a potential purchaser, and sales below the invested amount.
- Based on the risks generally discussed in the offering documents for a TIC, an investor may face tax penalties and interest for a failed 1031 Exchange if a TIC investment was found not to qualify as a replacement property.
- The total of fees and expenses associated with a fractional interest offering purchased as replacement property in a 1031 Exchange should be evaluated on the merits of the real estate investment and the potential aggregate tax liability of the investor.
- It may be the case that a different type of replacement property is more suitable and in some cases, the prudent choice may be to pay the tax liability and consider alternative investments outside of doing a 1031 Exchange.
- Even though the investors must have the right to replace the property manager under Rev Proc. 2002-22, in reality the investor has very little real control over the operation of the property.
- Investors must rely upon others to make sure the property is effectively and efficiently managed and to protect and enhance the underlying value of the real estate.
- When evaluating the purchase of a Non-Securitized TIC, the prospective investor should consider the lack of regulatory oversight that it has compared to a Securitized TIC offering which is subject to security regulations as well as real estate regulations.
- The investor should conduct more due diligence on, and, review of the information provided in the offering materials to validate the contents of any information provided by the sponsor or related to the financial performance and financial structure of the offering.
- In addition, the ongoing involvement of the person that sold the Non-Securitized TIC to the investor, and the sponsor that brought the Non-Securitized TIC to the market is not subject to the same level of regulatory oversight as a Securitized TIC.