The TIC Corner
by D. Andrew Sirkin
Editor’s Note: This “TIC Corner” is the second of a three-part case study of the sale of an apartment building to a group involving the building’s existing tenants. To read the first part, check your January 2007 issue of SF Apartment Magazine.
When we left off, the owner of a San Francisco 6-unit building, Harry Chin, had decided not to evict tenants under the Ellis Act or pursue a tenancy-in-common (TIC) sale on his own. Instead, following an inquiry from Sarah Warsaw, one of his tenants, Chin agreed to hold the building off the open market to allow a group of tenants to put together a viable purchase offer.
Excited about the prospect of buying the building, Warsaw immediately
convenes a meeting of the tenants. Recognizing that there is a vacant unit in the building, she also invites two close friends, and suggests that other tenants do the same. All of the tenants attend, along with three other couples who are interested in home ownership. But as the meeting wears on, little is accomplished. No one in the group is willing to commit without more information on the pricing of the shares, space assignments and an explanation of TIC basics, yet no one seems to know how to obtain this information. Thirty-year tenant Silvia Wong cannot see how she could go through a purchase at 78 years old, and 15-year tenant William Han cannot understand why it would make sense to buy when he and his family can occupy as tenants for $1,147 a month.
Undaunted, Warsaw contacts a TIC attorney. The attorney explains that without accurate pricing, down-payment and monthly payment information, it will be impossible for anyone to meaningfully evaluate purchasing, and that work on the management and ownership structure would not be worthwhile without a viable (meaning full or almost full) group. The attorney mentions that reluctant tenants are sometimes induced to reconsider purchasing once they understand that a new owner has the legal power, and a strong financial incentive, to evict the tenants under the state’s Ellis Act.
The attorney recommends that Warsaw start by contacting several local lenders to determine the typical down-payment requirements, and other terms and conditions, associated with loans to TIC groups buying 6-unit buildings. He explains that both individual and group financing is available, and suggests that Warsaw check into both.
The attorney suggests that Warsaw convene another group meeting to see if the group can reach a consensus on the relative value of each apartment (along with any parking, storage, decks and other amenities that will go with each apartment) as a fraction of the proposed $2 million building price. Initially, he explains, the valuations should be based only on the qualities of the physical spaces: sizes, locations within the building, views and condition. Once the basic values are established, adjustments can be made for nonphysical factors, such as rents being paid by the current tenants, the fact that an apartment is vacant or financial hardship. The attorney says that most groups are able to agree on this valuation on their own, but that valuation assistance from realtors and appraisers is available for those who cannot.
In preparation for the second meeting, Warsaw tells each tenant to come up with his/her opinion of the value of each of the six apartments, making sure that the total equals $2 million. At the meeting, before allowing anyone to reveal their value opinions to the others, Warsaw explains the valuation procedure recommended by the attorney: For each apartment, there will be five valuations (one from each tenant). The highest and lowest valuation for each apartment will be discarded, and the middle three valuations will be averaged. The resulting values for each apartment will be totaled, and then each apartment’s value will be divided into the total to yield a relative value percentage. The percentages will be multiplied by the $2 million price to determine the initial valuations. Everyone in the group believes that this process is neutral and fair, and agrees to be bound by the result—whatever it turns out to be.
Following the value determination, the group applies the down-payment and monthly payment information that Warsaw has gathered from the TIC lenders. It becomes immediately clear that several of the tenants do not have the down payment and/or monthly income required for purchase without further adjustment. All the nontenants attending the meeting realize they are qualified, which has the effect of making the financially weaker tenants nervous. The group decides to adjourn and seek further outside advice. As the meeting ends, Wong explains that she cannot purchase her unit, and makes an impassioned plea to be allowed to stay on as a tenant. She explains that she has lived in the building for 30 years, and has nowhere else to go. Jane Smith and Joan Day, two students sharing a unit, agree to move voluntarily if asked.
The TIC attorney suggests a meeting to be attended by all of the building’s prospective purchasers. Only the Warsaws, relatively recent tenant Miriam Levi and the three interested nontenant purchasers come to the meeting. None of the attendees are willing to evict Wong, even if there is a legal right to do so. The attorney recommends that the group consider two alternative approaches to keeping Wong in the building as a tenant: have the buyer group as a whole jointly purchase and hold the share associated with Wong’s apartment, or have one or more (but not all) of the purchasers take the Wong share. In either case, the valuation of the Wong share should be reduced to reflect the fact that it cannot be owner-occupied and will generate little income for the foreseeable future.
The meeting then moves on to a discussion of the share associated with the Han family apartment. It is clear that the Hans cannot purchase unless the price of their share is reduced, and they are permitted to make a lower percentage down payment. The attorney notes that the Han situation will be influenced by the group decision to keep Wong in the building as a tenant. Specifically, the Hans may be angry that they are not being offered the same deal as Wong, and evicting the Hans under the Ellis Act (if they choose not to purchase) while leaving Wong as a tenant makes the eviction more complex and expensive. The attorney suggests that the Han share be reduced in price to reflect its lower rent, and also that the Hans be permitted to make a 10% down payment. Noting that several prospective group members wish to make down payments that are larger than the minimum required by the lender, the attorney suggests group, rather than individual, TIC financing, so that the extra down-payment funds and loan qualification strength of some buyers can offset the Hans’ lower down payment and weaker financials.
The last part of the attorney meeting goes particularly well. Two nontenant purchasers, who are friends of the Warsaws, agree that they will jointly purchase the Wong share if the price is reduced 25% below its valuation, and also agree on which apartment each of them would occupy. After adjusting the values of the other five shares upward to compensate for the discount, the Warsaws and Levi agree to this proposal, and the third prospective nontenant purchaser is disappointed, but understanding. A detailed pricing and down-payment proposal for the Hans is then prepared, and it is agreed that Sarah Warsaw will meet privately with them to present it.
Warsaw’s meeting with the Hans is tense and inconclusive, but eventually William Han agrees to the proposed terms. The group will be composed of five purchasers: three existing tenants and two nontenant couples. One nonpurchasing tenant will remain as a tenant, and the other will vacate. The purchase will be financed with a 75% loan-to-value TIC group loan with partial assumption features to allow resales without refinancing. All of this, along with the space assignments, pricing and down payments, is captured in a short-form memorandum of understanding signed by each prospective group member. With these pieces in place, the group, assisted by a TIC attorney and mortgage broker, is ready to write an offer on the building.
In the next installment, the group proceeds through the inspection, loan application and TIC agreement preparation process, and gets a California Department of Real Estate exemption letter.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. The information contained in this article is general in nature. Consult the advice of an attorney for any specific problem. D. Andrew Sirkin’s law practice is devoted exclusively to TICs, vacation-home sharing and condo conversions. Copyright © 2007 by SF Apartment Magazine. All rights reserved.