What is Tenancy In Common?
A Tenancy in Common (“TIC”) is a legal way of holding an undivided interest in real property. The TIC Agreement is a private contract between parties assigning portions of a multi-unit property for exclusive use. It does not subdivide the property and a TIC Agreement is not recorded against title. Each owner/Cotenant does not “own” their unit; in the absence of a formal TIC Agreement, each owner has an undivided interest in the whole and no exclusive possessory rights to any portion of the property.
The TIC Agreement is critical and a common error is either not signing the TIC Agreement or failing to keep a fully executed copy readily accessible. All Cotenants (owners) should sign the TIC Agreement and keep a fully executed copy for each party’s files. It is advisable to keep a fully executed copy with the other important documents such as loan documents.
How are rights assigned?
Each Cotenant is assigned a specific unit (apartment) for his/her exclusive use. They are in turn responsible for all obligations associated with the unit, from the “walls in”. In addition, dependent upon the particular property, Cotenants may have certain portions of the Common Areas assigned for their exclusive use such as parking or storage. These assigned areas are designated “Exclusive Use Common Areas”.
These areas are not “deeded” to a particular Unit/Cotenant. They are contractual rights granted by the TIC Agreement.
How are obligations allocated among Cotenants?
A TIC Agreement specifies how the Cotenants will share responsibility for common expenses associated with the property. These obligations include insurance, painting, foundation, roof repair, garden maintenance, common area maintenance and, to the extent applicable, condominium conversion expenses. The percentage obligation per Cotenant do not necessarily correlate to title percentages or the price paid for the property. In addition, these expense obligations do not dictate property tax responsibility (based upon price, see below for more details) or debt obligation (based upon amount borrowed).
There are numerous methods for calculating expense allocations depending upon the particulars of the property. A good rule of thumb is that the expense allocations should make sense for successor owners as well as the original parties to the TIC Agreement, not unlike allocations in CC&Rs for condominiums. The TIC Agreement will specify obligations are according to expense allocation percentages unless specified otherwise. Therefore, it is logical to choose the allocation used most broadly for the expense allocation percentages and then have exceptions as appropriate.
By way of example, in a four unit building where there are no differing variables in size the group may elect to allocate expense allocation percentages of 25% for everything. However, if a property consisted of two large units and two smaller units, it may make sense to allocate insurance expenses by square footage of the units due to the fact that in the event of a casualty the larger units will have a higher cost to rebuild. In both situations the other common expenses such as yard maintenance, roof, painting, foundation, etc. may be allocated equally among all four owners as those particular line items are of equal benefit to all owners. Each property is unique and the allocation of expenses should be discussed in detail with counsel.
How are decisions made?
Each Cotenant should have one vote, regardless of many individuals constitute such Cotenant. Most decisions should be by majority vote, although certain decisions such as reallocation of spaces or expenses, will require unanimous approval. In a two unit property all decisions must be unanimous.
How does a TIC differ from a condominium?
A condominium is assigned an individual Assessor’s Parcel Number and has a separate property tax assessment. Condominiums are governed by Conditions, Covenants, & Restrictions (CC&Rs) which are recorded against title. Each owner has a mortgage only encumbering their condominium and the sale of a condominium does not necessitate the involvement of any other owner in the Association. In contrast an owner of an interest in a TIC only has rights vis a vis the TIC Agreement. There is only one property tax bill for the entire property and failure of any party to pay their portion of the taxes due will result in a lien on the entirety. Further, if a Cotenant desires to sell his/her interest in a TIC, dependent upon whether there is a group loan (encumbering the entire building) or fractional TIC loans (secured by each individual’s TIC interest pursuant to the TIC Agreement), there are certain formalities that must be followed including having the purchaser sign onto the TIC Agreement and the seller being released of further obligations.
Oftentimes parties contract to sell their TIC interests and do not anticipate the need to execute a formal amendment releasing them and adding on the buyer. This is a critical step to any sale of a TIC interest and should be addressed early in the process to avoid issues at closing. The other advantage to addressing the documentation process early in the sales cycle is the parties can determine in advance who will be responsible for associated expenses.
Price vs. Ownership Percentage; should they be the same?
Price for a particular interest in a TIC property will vary over time versus title percentage which is ostensibly permanent. The TIC Agreement dictates what usage and possessory rights an individual owner will have for the Cotenancy Share they are assigned. Oftentimes title percentages are determined by the seller or realtor marketing the property and may be based upon the individual prices at which the shares are being marketed. While this methodology is fine, it does not mean a person paying 15% higher than the person in the unit below should be owning 15% more of the building. Over the course of time the less expensive unit may be upgraded and resold for a much higher price, but the ownership percentage on title attributable to that share will not change. When parties are purchasing a property at the same time, the most important issue to be resolved is all parties paying what they each think is fair relative to the other purchasers for their interest. As stated above percentage ownership does not dictate how expenses are allocated. Expenses should be determined based upon a variety of characteristics (see above); not size, or value.
How specific should usage rules be in the Agreement?
The more specificity means the less room for interpretation. It is important that issues which matter to Cotenants be outlined in the TIC Agreement. For example, pet rules can be as specific as limiting breeds, weight, number and type of pets permitted. Once usage rules are established in TIC Agreement, they should only be changed upon unanimous vote and therefore it is important to discuss in detail what are the appropriate rules for a particular property; generic may not work.
How are maintenance obligations shared?
A TIC Agreement should differentiate between those obligations which are “common” vs. “individual”. Obligations for common areas, including maintenance, repair, improvements, and replacements, as applicable, are shared among Cotenants. The TIC Agreement should define what elements of the property are common areas vs. assigned units/exclusive use areas.
Expenses for maintenance of common areas are shared among the Cotenants and allocated as set forth above. Each Cotenant should pay his/her share of reserves for common expenses on a monthly basis into a group operating account. This account in turn will be the source for payment of expenses as incurred.
How should a group pay expenses, mortgage,etc.?
The goal of a TIC Agreement is to outline each Cotenant’s obligations and rights and create a mechanism for operating the property. The group should have an operating account into which each Cotenant pays, on a monthly basis, his/her share of mortgage (if group mortgage), property taxes, insurance, reserves for maintenance of common areas, and group utilities. Having each Cotenant pay his monthly expenses into a group account avoids the risk of multiple payments towards group expenses and the uncertainty of timing and provides a mechanism to ensure each party has made his/her payment on time.
NOTE: if there is no group mortgage and each party has fractional loans, they pay their loan payments directly to the lender, not the group account.
What happens if one cotenant wants to sell her/his interest?
One important function of a TIC Agreement is to allow parties to sell independent of one another and to realize the increase in value, if any, in their interest. For example, if one Cotenant remodels his/her kitchen, when they sell, the value of such remodel will be realized via the sale proceeds.
The next issue is how much that buyer can borrow towards the purchase. At the time of the sale the appraisal will determine the value of that portion of the property (i.e. unit and any assigned exclusive use areas) relative to the other portions of the property. This valuation serves two important functions: 1) to allow for fluctuation in values over time as a result of improvements or market factors, and 2) ensures that the transferring Cotenant and his/her buyer do not borrow against non-transferring Cotenant’s untapped equity in the property. The TIC Agreement should also outline how expenses associated with the refinance will be allocated among the Cotenants. NOTE: the amount borrowed and associated expenses are not an issue in a fractional loan scenario, only if there is a group loan encumbering the entirety of the property.
What is a fractional loan?
A fractional loan is an independent mortgage secured only by the borrower’s ownership interest in the property. In the event a borrower defaults on a fractional loan his/her interest is the only interest subject to foreclosure. In a group loan scenario the lender is not concerned with the content or existence of the TIC Agreement as the entirety of the property is secured by the note, whereas in a fractional loan the lender’s security is the undivided percentage interest and the rights/obligations assigned such interest under the TIC Agreement so it is critical to the underwriting and approval of a fractional loan. With fractional loans the credit risk of a group mortgage is eliminated, however there is still one property tax bill for the entire property and the failure of any one Cotenant to pay his/her share of taxes will result in a tax lien on the property.
How specific should usage rules be?
The TIC Agreement should specify rules regarding pets, smoking (if desired), quiet hours, parking rules, garbage, window coverings, amongst others. The more specific the rules are the easier they will be to enforce. Detailed discussions with all Cotenants at the inception will bring the potential issues to the surface and may mitigate disputes in the long term.