The Key Differences Between TICs and DSTs

Wallace:
Can you describe a tenant in common investment, then? I know there used to be a lot of those before the DSTs.

Brandon:
Yeah, so essentially a tenant in common, or a TIC investment, is another way to structure the syndication of estate for Section 1031 purposes. Each investor owns an undivided interest in the real estate as a tenant in common with the other investors. You can have up to 35 co-owners of the property. Major decisions require the unanimous consent of those owners. It really was the dominant structure of the industry leading up to the Great Recession. What we found was that in times of economic disruption, especially during that financial crisis which was primarily driven by commercial real estate, getting up to 35 investors on the same page to save the investment was often impossible to do, so many TIC properties required a cash infusion to re-tenant a property because the main tenant had blown out, but you needed all the owners to agree to that capital call. In a lot of cases, some investors weren’t willing to do that and so many deals went into foreclosure.

Brandon:
So while it still might be appropriate for certain investor groups, TICs have really fallen out of favor in our industry for syndications for investors who don’t really know each other, they might have different objectives, et cetera.

Wallace:
Well, I think the capital call aspect was really a scary thing for a lot of TIC investors knowing that they … And the fact they had a full responsibility, individually, for the liability. Everybody was on hook for the whole thing, so that was scary to them. With the DSTs, then, that’s been solved. You can’t refinance a DST and they can’t do a capital call.

Brandon:
Yeah, that’s right. So that is … I mean, that’s sort of a key difference between a TIC and a DST is that the guidance that the IRS provided on DSTs for Section 1031 purposes imposed some substantial limitations on what the trustee can do, and there’s essentially seven things. We call them the seven deadly sins in our industry. So for instance, the trust can’t enter into new property leases during the ownership period. It can’t make structural improvements to the property like expanding the footprint of the building. Like you said, can’t refinance the property, can’t accept new capital contributions from investors and if it has to do one of those things to preserve the value of the property, the trust will be converted into an LLC. Investors will receive limited liability company interests in exchange for their beneficial interest in the trust and then they can’t undertake another Section 1031 exchange once the property is eventually sold.

Wallace:
Can they go back from that springing LLC back to a 1031 or to a DST?

Brandon:
That’s an open question. I think you might have to talk to IRS’s council on that. I actually, I don’t think that there’s … I think sponsors have done it or tried to do it, but I don’t know that there’s any firm guidance one way or the other, whether that’s that’s permissible.

Wallace:
Well after the COVID and the effect on hospitality, I’m aware of several that are in that process right now. So I think we’ll see. We’ll see soon enough, right?

Brandon:
And what’s interesting, Wally, is that Congress passed … Or not Congress. I believe it was the IRS, passed some relief during COVID that relaxed some of the rules around DSTs accepting new capital and such, so I think a few DSTs availed themselves of that relief.

Wallace:
I think you’re right.