Lenders who finance real estate owned by borrowers as tenants in common should be aware of the partition risk inherent in this ownership structure. However there are various ways a lender can protect itself.
The current reluctance of U.S. banks to provide capital for commercial real estate financings has created an opportunity for well-capitalized foreign lenders to dip their toes into the U.S. market. While many U.S. commercial real estate financings are similar to their Canadian counterparts, a tenancy-in-common ("TIC") borrower structure, prevalent in the U.S., can expose lenders to certain risks.
In 2002, the Internal Revenue Service clarified when the acquisition of a TIC interest in real estate qualifies as like-kind exchange replacement real estate under the Internal Revenue Code. This spurred the growth of parties holding direct, undivided ownership interests in real property as TICs.
While the TIC structure provides a tax vehicle for borrowers, it presents certain risks for lenders, including risks posed by partition of the real property by the various TICs, and by passive owners having limited equity in the property. Fortunately, lenders have a number of tools at their disposal to limit these risks. Among other things, prudent lenders should insist that TICs either include a provision in their tenancy in common agreement ("TIC Agreement") waiving their right to partition the mortgaged property, or covenant in the loan documents that they will not commence a partition action. The TIC Agreement should state that it cannot be modified without the lender’s consent. In addition, the TIC Agreement should be filed in the appropriate real property records office and reflected on the lender’s title insurance policy as an interest subordinate to the lender’s mortgage. An opinion of borrower’s counsel to the lender should address the enforceability of the TIC Agreement and, in particular, the partition waiver contained in it.
The above are just a few examples of precautions lenders should take when financing TIC-owned commercial real estate in the U.S.
While this article discusses the interests of lenders, potential U.S. real estate investors should also be aware of the requirements that lenders may place on them to complete financing for TIC-owned real estate.