Tenant In Common Property Type Comparisons

TIC properties are generally available in the five major types of real estate investments - Residential, retail, office, industrial and land.  This is a brief overview and comparison of the four most prevalent income property types - Residential, retail, office and industrial.

CLASS & MARKETS

When comparing tenants-in-common property types it’s important to consider the classification of the property.  Properties are classified as A, B or C for both build-quality and location.

The market classification in which the property is located is also important.  The market will likely be a primary market, a secondary market or a tertiary market.

Income properties are like bonds - The higher the quality, the lower the return.  For example, US Treasuries pay the least, while corporate junk bonds pay the most.  A very large, newer, class A property in a primary market will be the safest property overall, but it will have a relatively lower cash-on-cash return.  A small, older, class C property in a tertiary market will be the riskiest property overall, but it will have a relatively higher cash-on-cash return.

PROPERTY SIZE

The larger the property, the safer it is, mainly due to the reduction of a key risk - vacancy risk.  The greater the number of tenants, the lower is the risk of vacancy.  The smaller the number of tenants, the higher is the risk of vacancy.  For example, with one tenant, vacancy risk is highest since that property is either 100% occupied or 100% vacant.  Thus, all things being equal, a 400 unit multifamily property has less vacancy risk than a 40 unit apartment complex, which has less risk that a single tenant condominium or single family residence.  The same idea holds true for retail properties.  All things being equal, a stand-alone retail store is riskier than a multi-tenant retail center, which is riskier than a credit tenant or credit anchor tenant retail center.

QUALITY OF TENANTS

Tenant quality is based primarily on the financial ability of the tenant to pay the rent.  The highest quality of tenant has the lowest risk of vacancy.  The lowest quality of tenant has the highest risk of vacancy.  For residential tenants, the quality is reflected in FICO scores and the background check.  Retail tenants are separated into credit and non-credit.  Credit tenants have an actual corporate or company rating by the credit ratings agencies such as Standard and Poor’s or Moody’s.

Also, high quality tenants require less management time, trouble and expense, while low quality tenants require more time, trouble and expense.

VACANCY LOSS AND TENANT IMPROVEMENT COSTS

A concern of any property owner is the cost or loss due to vacancy and the cost required to re-lease the space.  Multifamily properties generally have the lowest costs, since all that is required once a unit is vacant is to clean and repair it to make it ready for a new tenant.  While competing properties may be available, concessions or incentives can be offered to incentivize the tenant to sign the lease.  Residential tenants tend to stay in place for a number of years, even with annual rent increases.  Shorter term leases, such as 12 and 24 months, enable the owners to raise the rents, increasing the cash-on-cash return.

Light industrial and light assembly space is probably the next more expensive space to re-tenant, due to the particular needs of different businesses.  Like residential, once businesses take occupancy, they tend to stay in place.  Light industrial parks tend to offer uniform unit sizes, and the spaces tend to be useful to a large variety of tenants.  Leases tend to be longer than residential, such as three to five years.

Retail space is probably the next more expensive space to re-tenant, due to the particular needs of different businesses, but retail tenants tend to stay in place a very long time because in retail sales, location and the customers’ familiarity is extremely important.  Retailers are loath to move their place of business for fear of loss of business.  Retailers have great loyalty to a location once their business is established and thriving.  Depending on the tenant, retail leases typically range from 5 to 25 years and usually provide inflation related increases in rent.

Office properties probably have the highest risk of vacancy and can be the most expensive to re-tenant since office tenants do not depend on retail traffic to drive their business.  Office tenants can move at any time with no appreciable loss of business.  Competing office space is often plentiful, and owners of competing properties can successfully incentivize tenants to move from other buildings.  Also, once vacant, office owners face high tenant improvement (TI) costs to entice new tenants to the available space.  Partitions, walls, flooring, ceilings and lighting often must be completely remodeled.  Office leases are typically 5 years.

SUMMARY

Tenants-in-common (TIC) properties are available in the most popular property types, in all the different classes and in all the different markets across the USA .  It can be challenging to rationally compare residential to retail to office to industrial in all the different classes, markets and sizes.  Contact an expert, discuss your income objectives, risk tolerances, property type and regional preferences, and compare the attributes of the particular properties available.

Because of the income nature of most tenants-in-common properties and the tight spread between the returns provided by all the various property and quality types, I believe that safety is of primary importance.  Put another way, return-of-equity is as important as return-on-equity. 

Also, the quality of the income is as important as the quantity of income -- the largest, highest quality properties in the best markets will have the best-credit tenants, and these properties tend to produce a higher quality of monthly income.  

I also believe that superior size, quality and safety generally have higher upside profit potential upon final disposition.

Finally, experience has shown that diversification for the sake of diversification is not always the safest strategy, especially when a clearly superior or safer property is among the choices available.