New TIC Financing: A Quiet Revolution
SF Apartment Magazine, August 2005

By Jeffery P. Woo

“The revolution as we call it is not necessarily an uprising in the streets or the old business of seizing power. Though the Left has always imagined it was. The revolution is change. Not merely rearrangement, but a deep emotional type of transformation that must also take place inside us. It’s a better way to live.”
-Kate Millett (b. 1934)

With only mild fanfare, a quiet revolution began in San Francisco. Circle Bank, a small bank out of Novato, announced it would offer fractional-interest financing on individual TIC units. If San Francisco is in the middle of a landlord-tenant civil war, the beginning of the end of that war may be in sight.

To understand this revolution, you need to understand what a TIC is. A TIC, short for tenancy-in-common, is a contractual relationship created between multiple persons who share ownership of a property in which they all live. This contractual relationship seeks to create a condominium-like relationship in which each owner has an exclusive right to use a certain unit and has certain obligations to contribute to common expenses such as maintenance, repairs, property taxes, insurance and other related expenses.

The primary way that a TIC differs from a condominium is that, in the case of condominiums, each unit has its own grant deed and its own individual financing; in the case of TICs, all TIC owners share both a percentage ownership of a building and a percentage obligation for the mortgage of this building. For instance, in a four-unit TIC building, each owner may have a 25% interest in the property with a specified right to occupy a particular unit. Because there is only one grant deed, up until now, each owner was obligated for a 25% share of the single mortgage.

The existence of this single mortgage created two big problems that make owning a TIC risky. The first problem is that in sharing a mortgage with your co-TIC owners, you are at risk if they should default on their portion of the mortgage. For instance, in the four-unit TIC example, if the holder of Unit A loses his job and can’t pay his share of the mortgage, the holders of Units B, C and D will either have to make up Unit A’s share or the entire mortgage will be in default. If the bank forecloses, the owners of Units A, B, C and D will all lose their homes.

The second problem is almost worse. It arises when one of the TIC owners wishes to sell her unit. Taking again the example of the four-unit TIC building, it was purchased for $1 million with an $800,000 fully assumable mortgage. Thus, each TIC interest was purchased for $250,000, including a $200,000 share of the assumable mortgage. After ten years, the building is now worth $2 million, and the owner of Unit A wants to sell her TIC interest for $500,000. If the owner finds a buyer, this buyer will be unable to simply make a down payment and get a loan for the rest like a normal real-estate purchase, unless the other three existing TIC partners all agree. If they don’t agree, the selling TIC partner faces the dilemma of either not selling her unit or allowing the buyer to assume her share of the existing mortgage, with the owner self-financing the balance. For example, if the buyer puts down $100,000 and assumes the seller’s $200,000 share of the existing mortgage, the seller will have to finance the balance of $200,000. Although this allows the seller to complete the transaction, it does not allow her to get appreciation out of the property until the second loan is paid off.

Despite these problems with TICs, the market has flourished. In a twelve-month period, beginning June 1, 2004, the San Francisco Multiple Listing Service showed 500 individual TIC units listed and sold. During that same period of time, 2,200 individual condominium units were sold. The TIC market makes up at least 23% of the condo market, but this number is likely double because the TIC-unit figures I’ve cited do not account for all the smaller buildings sold to groups of buyers who turned their buildings into TICs. My educated guess is that if you could add in those units with the individually marketed TIC units, the percentage would be close to, or exceed, 50% of the condo market.

Why would people buy a TIC with all the problems identified above? The hope of condo conversion motivates people to suffer through these snafus. When there is a conversion of a TIC to a condo, there are separate loans that eliminate these risks. On a more practical level, people buy into TIC buildings because the price is cheaper than a comparable condo, and this may be the only way for them to buy into the market.

But at its heart, something more fundamental than the forces that drive the TIC market is the limitation on the rights of owners to move into their own properties, which tenant advocates unwittingly created in 1998. At that time, tenant-advocate attacks against owner move-ins culminated in the passage of Proposition G. One facet of Prop. G was the creation of a rule that there could only be one owner move-in (OMI) per building. One of the intents of this simple rule was to stop what tenant advocates saw as the menacing threat of multiple owners purchasing buildings to live in at the expense of tenants. As a result, this turned out to be the match that lit the fuel and created the TIC explosion.

Prior to Prop. G, a state law known as the Ellis Act allowed property owners to evict tenants in places like San Francisco if the landlord sought to get out of the business of being a landlord in a little-used building. The consequence of using the Ellis Act was that the entire building could not be used for residential rental purposes for the next 10 years (changed to five years in 2002). The Ellis Act was sometimes known as the neutron bomb of evictions because after it was used the only thing left standing was the building. Because of these severe restrictions on the use of a building, the Ellis Act was seldom used.

After Prop. G passed, property owners began to look at the Ellis Act as a means for accomplishing their goals: to buy properties that allow multiple owners to move in. In fact, Prop. G became the only way for many to achieve their dreams of homeownership— dream utterly underestimated by tenant advocates and politicians in 1998. The power of the desire for homeownership is what brings us to the doorstep of this quiet revolution.

As property owners started to use the Ellis Act to gain possession of their buildings in order to live there, this approach actually worked better for many of them than if they had been allowed to do multiple OMI evictions. Even though these buildings could not be rented for many years, owners didn’t care because they only sought to use them for their respective residences. If they needed to sell their properties, there were many buyers willing to accept this restriction because they, too, desired only to live in the building. By avoiding the use of OMIs, these property owners avoided the numerous defenses that exist to meritorious OMI evictions.

But the tenant advocates, and the politicians who seek their support, did not see this trend as the outgrowth of the innate desire for home ownership. They continued to regard this process as an attack on tenants’ rights, and in turn they created tougher and tougher laws to prevent OMIs. From 1998 through today, we see a number of changes to the Rent Ordinance and the condo-conversion rules designed to make it more difficult for owners to move in to their properties or to condo-convert them. The most recent examples include: (1) Supervisor Peskin’s amendment that expands the relocation expenses due in an Ellis Act eviction from $4,500 per household for lower income households to $4,500 per person, whether or not that household is lower income; and (2) Supervisor Daly’s amendment that prevents two-unit buildings from doing fast-track condo conversions if an elderly or disabled person has been lawfully evicted.

Their@failure to understand the strength of the desire for homeownership has paved the way for very greedy developers, whom they hate, to thrive in a vibrant TIC market. The growing market for TICs has naturally led developers to buy buildings using the Ellis Act and to sell individual units off as TICs. Had Prop. G’s one-OMI-per-building rule not pushed the first-time homebuyers into exploring the use of the Ellis Act as a way of affording a home in San Francisco, the developers would not have followed suit. And that leads us full circle. Had the TIC market not been able to show its vibrancy through all the difficulties that its owners must endure, the private-sector finance community would not have eyed this market as a place to invest and make money.

Today’s banks—generally a conservative lot—see the growing strength of the TIC market and are slowly entering that market with individual TIC-interest loans that will solve the two major problems with TICs. By eradicating these two issues, these private-sector institutions will also remove the barriers that have traditionally kept TIC buildings limited to smaller buildings. There is no reason why, in time, we will not see 10-unit, 20-unit, 50-unit or larger buildings converted to TIC units with the availability of this new financing.

Could that result in a change in the population demographics of the city to one in which the majority of citizens are homeowners? Time will tell. In the meantime, Ted Gullicksen of the Tenants Union has promised to picket any banks that offer this type of financing. What better sign that we are heading in the right direction. Let the revolution begin.
   
 From:  http://www.mypropertyrights.com/index.html     By Jeffery Woo, 415-705-6470