SEC Release - NAR Exemption Request

Real estate, including tenant-in-common ownership, enjoys many benefits under current law, including a step up in basis upon death of the owner. Other benefits include the potential to generate income, shelter income through depreciation and appreciation.

A §1031 TIC exchange allows property owners to exchange their management-intensive property for a potentially institutional grade property. Since 2002 the tenant-in-common industry has exploded, but because of the nature of securities, real estate agents were not legally allowed to be compensated for selling tenant-in-common investments, which are sold as securities.

Security vs. Real Estate (for sales purposes)

Since TIC interests, if structured properly, are real property for tax law purposes, why can they be sold by securities reps but, most often, not by real estate brokers? The answer is that the interests are, with few exceptions, considered securities for securities law purposes.

The issue of whether an investment is a security can sometimes be complex. The Securities and Exchange Commission, the Financial Industry Regulatory Authority (FINRA - Created in July 2007 through the consolidation of NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange), state securities acts, federal law, and both federal and state cases all influence the determination of whether an interest is a security. It should be noted that both the FINRA and Colorado Division of Securities have been quite clear in their opinion that the vast majority of TIC investments are a security.

TIC sponsors have a built-in incentive to market TIC offerings through real estate brokers. After all, real estate brokers are generally involved in the sale of the relinquished property and marketing TIC offerings through those same real estate brokers would seem to be the most efficient way of identifying a prospective investor.

A conflict arises because FINRA has historically prohibited its members from paying persons, not registered as associated persons, a commission or fee derived from a securities transaction. Thus, payments that are transaction-based made by members who are registered broker/dealers to non-registered persons, including real estate agents, are prohibited under FINRA Rule 2420, "Dealing With Non-Members."

Given that real estate brokers have a long history of paying referral fees for client referrals, the FINRA rule prohibiting the payment of such fees has caused great consternation. It is unfortunate that the rule, intended to protect the investor, instead serves as a disincentive for real estate brokers with respect to making their clients aware that TICs can be a viable option for the down-leg of a §1031 transaction.

Possible Solution – NAR Exemption Request

The National Association of Realtors has been working with the SEC and other stakeholders to change that situation, and now it looks like a breakthrough may be close at hand. It should be noted that NAR’s request has been submitted in the form of an “Exemption Request” which would provide much stronger guidance from the SEC than the typical “No Action Letter.”

On Nov. 13, the SEC published NAR’s request for exemption as well as an SEC release summarizing the NAR request and requesting comment. The SEC Release and NAR Exemption Request, which consist of more than 40 pages, are available for download at www.1031exchange-tic.com/SEC Release - NAR Exemption Request.pdf . Here are the high points:

The SEC is requesting comment on the NAR request for exemption.
Any comments were due December 17th, 30 days from when it was published in the Federal Register.
The SEC invites comment whether the exemption should be granted, whether the conditions are appropriate, and if anything else should be added. The SEC also requests comment on a number of specific key points and concepts in the NAR request such as (i) what standards should apply to determine “substantial experience” in commercial real estate, (ii) are the obligations on B/Ds appropriate, etc.
The SEC will consider all comments and post them on its Web site
http://www.secgov/comments/s7-26-07/s72607.shtml
No active management hassles
The SEC will not take any action until after the comment period is over.

The following summarizes the SEC’s summary of the request. Since there are many pages of complex material, you should refer to the actual documents for complete details.

The NAR requests an exemption that would permit a licensed real estate agent or broker who is predominantly engaged in commercial real estate and who has substantial commercial real estate experience to receive a “Real Estate Advisory Fee” in connection with the sale of a TIC Security through a registered broker/dealer (B/D), provided certain disclosures and procedures are followed.

A real estate agent or real estate broker must have substantial experience. Meeting of the definition of “substantial experience” could be done through having a designation such as CCIM or SIOR, having similar educational and transactional background, or having participated in at least 5 commercial real estate transactions with $3 million in total value in the prior five years or at least 10 commercial real estate transactions in the last 10 years including three in the past three years.
Payment of a “Real Estate Advisory Fee” could be made by the client or by the sponsor on behalf of the client.
The securities commission to the B/D could be reduced by the amount of the Real Estate Advisory Fee.
The Real Estate Advisory Fee could be a flat dollar amount or based on a percentage of the total purchase price.
The TIC Security must qualify as a replacement property for purposes of a 1031 exchange, regardless of whether the client is purchasing the TIC security for that purpose.
Prior to the real estate professional discussing a specific TIC security with a client, the client must enter into an exclusive agreement to be represented by that real estate agent. (similar to a buyer broker agency agreement)
The buyer broker agreement must identify any other real estate person to be paid.
The real estate agent may discuss the real estate characteristics of a TIC security with the client and arrange for the client to visit the property before referring the client to a securities rep, but the real estate agent has to arrange the introduction to the securities rep upon the client advising the real estate agent that he/she is considering purchasing a specific TIC property.

The real estate agent may not:

List or advertise the availability of TIC properties or advertise that they represent clients in TIC securities.
Share a real estate advisory fee with any other person.
Handle securities or customer funds.
Negotiate terms of a TIC purchase.
Represent a client as a “purchaser representative” under Reg D.
Participate in the structuring of a TIC.
Have the authority to close a purchase of a TIC on a client’s behalf.
Assist a client in obtaining financing.
Be statutorily disqualified under securities laws.

The real estate agent may:

Transmit documents and information between the parties.

The real estate agent must:

Deliver a written statement to the Lead Placement Agent that they are not statutorily disqualified under securities laws.

The Selling B/D and the Lead Placement Agent must:

Deliver to the Lead Placement Agent a representation in writing that they did suitability analysis.
Inform the customer if the B/D considers the transaction unsuitable and may not do the TIC transaction unless the client affirms in writing that they want to go ahead with the transaction.
The Lead Placement Agent must maintain a copy of all of the documents associated with the deal for 3 years.

Certainly, there will be much analysis and debate in the next several months. In an effort to keep you informed, this page will be updated as more information and analysis become available.