Complaints involving tenants-in-common (TIC) real estate investments are on the rise, as more disgruntled investors come forth with a laundry list of allegations – including inadequate pre-sale due diligence – against the broker/dealers and brokerage firms that recommended their investments.
TIC investments, or 1031 exchanges, are a form of real estate ownership in which two or more parties own fractional interests in a property. In the early 2000s, TICs entered into a new wave of popularity after a 2002 tax-code change allowed investors to defer capital gains on real estate transactions involving an exchange of properties.
Toward the end of 2008, however, the real estate market became mired in a full-blown crash, and TIC investments felt the effects. One of the biggest distributors of TICs, DBSI, Inc., filed for bankruptcy. Prior to becoming insolvent, investors in all 50 states had put approximately $1 billion into DBSI’s TIC investments.
Subsequent investigations into DBSI’s financials revealed that the company had begun to experience major liquidity issues beginning as early as 2004. By 2006, DBSI’s cash shortages had worsened considerably, prompting it to allegedly create fraudulent investment and tax structures as part of a $500 million fund to buy new properties and attract new investors.
DBSI would later fail to pay investors their dividends out of legitimate rents from the new properties; instead, it allegedly issued payments from profits made by marking up various properties and then selling them at inflated prices to unsuspecting investors. Many of these investors were introduced to DBSI by their broker/dealer.
Today, DBSI investors are filing arbitration claims against various broker/dealers for misrepresenting DBSI and failing to perform their required due diligence before recommending the investment to them.
Brokerage firms are obligated to perform certain duties for their clients. This includes researching a company whose investments they are marketing and selling and thoroughly investigating that company’s fiscal stability. Brokers also are required to inform their clients about an investment’s specific risks and other features, as well as ensure that the product they recommend is indeed suitable for the client’s investing objectives and risk tolerance.
In the case of DBSI, that didn’t happen. Stu Newman had begun to suspect that all was not right with his DBSI investment back in 2007. According to a 2009 article by the Orange County Register, Newman initially became suspicious about DBSI because of its unusually brief and poorly composed quarterly reports. When he and another DBSI investor later shared notes, neither could determine exactly how DBSI paid its investors.
“I was convinced that the only way they kept this going is by selling (to new investors),” Newman said in the article.
Future lawsuits and investigations would come to the same conclusion.
“About the only difference between Douglas Swenson and Bernard Madoff is a decimal point,” Newman says.