Thursday, November 09, 2006

The Pros and Cons of Fractional TIC Financing

There are a lot of factors to consider when purchasing or selling a Tenancy in Common (TIC). How many units are in the building, whether or not there have been evictions on the property, and how long the current TIC partners have been in place, all determine how long it will take for the property to convert to condominiums. Another dynamic that is becoming more important for both buyers and sellers in this niche, is whether to consider traditional TIC financing or fractional TIC financing.

TICs in general are a more risky purchase than condominiums, in more than just their financial scenario (in which, all unit owners have a single, combined mortgage for the entire property). They are also subject to changes in legislation that, at any point in time, could offer a negative blow or downturning trend to this niche of the market (or uplifting trend, let's not forget). So, is it better to purchase a fractional (or individual) TIC over the traditional TIC? Let’s look at the possible pros and cons.

A fractional TIC loan is a recently new development in home financing. The product allows for portions of an entire building to be individually financed rather than financed by a group of all participating purchasing parties. One benefit of fractional loans is that each owner is only financially tied to the percentage of the building which he or she is purchasing. Therefore, if a residing neighbor is unable to pay his mortgage, the remaining owners are unaffected.

Another benefit of fractional TIC financing is that it deems the condominium conversion process unnecessary for existing multi-unit properties. The fractional TIC gives owners the financial independence that has been associated with condominiums, so there is no real need to wait for condominium conversion, a process which can take anywhere from 2 to 10 years depending on the scenario of the building. Additionally, the legislative changes that focus on restricting TIC conversions have little significance, since no condominium conversion is taking place.

Finally, each fractional owner is also then free to utilize his or her unit as an income property. Since the owner-occupier requirement usually mandated to TICs wanting condo conversion is no longer an issue, the purchased unit can be used as a rental instead of a primary residence.

There are a couple of negatives in the fractional loan scenario. First of all, and most important: they are not as affordable as traditional TIC financing tools. Fractional loans are more risky for banks, since the bank now only has pieces of notes on a building, rather than a note for an entire building. This means that the bank cannot foreclose on the entire building if one individual owner is defaulting on his or her loan. So banks require a) higher down payments (usually not less than 20%), b) higher credit scores from borrowers, c) and more points on the loans to eliminate risk. Additionally, the bank financing the loans may have restrictions on assumability on this type of loan, or higher pre-payment penalties than traditional financing tools.

If the property is on the market for the first time and is being offered with fractional TIC financing, although the listing price for each unit may appear affordable to buyers, often times the down payment requirements associated with fractional TICs are not. By offering units with fractional TIC financing, a seller is limiting his buyer pool to only those that can afford a 20% down payment and a higher than average interest rate. This ultimately may lengthen the amount of time it takes to sell all of the units.

If the property is already being operated as a traditional TIC and would prefer to individualize the loans, everyone in the building must know about, understand the concept of, and agree to re-finance into fractional loans. In the event everyone agrees, each individual will probably have to be re-approved, and there is a chance that for some reason one party may not. There goes the plan. If everyone does get approved, the rates on fractional loans are higher (as are down payment requirements or ltv ratios), so most likely there will be some adjustment to the amount of equity the building still holds.

Fractional loans are a fantastic product, but it's not all roses. If you are thinking of purchasing a TIC that offers individual TIC financing, make sure you have discussed the finite details of the loan with the mortgage broker offering the loan. Current Bay Area banks offering fractional loan scenarios are:
Sterling Bank
Circle Bank
Bank of Marin

Have questions about buying or selling real estate? Ready to sell or buy your home? Contact me today for honest, experienced answers.

Amy Blakeley
ablakeley at
(415)296-2173 Direct

1 comment:

Anonymous said...

Great article Amy. From a TIC owner, you may never know what will happen.

Even if they were a very good friend.

TIC agreements helps with legal matters and fees, but doesn't secure your loan.