With the value of the commercial real estate (CRE) market in the United States projected to reach a massive $23,67 trillion in 2023, the demand for CRE will continue to grow over the coming years. CRE developers and investors looking to take up a share in this market, need to know and understand the different types of property ownership structures available, and how they differ from the residential market.
Choosing the right property ownership structure for your property, properties or portfolio can influence important factors such as an owner’s risk, liability, access to finance, probate, taxes, and more. In this guide, we’re delving into the seven main types of property ownership you’re likely to come across in your CRE investment journey.
1. Sole Ownership
Sole ownership is a legal arrangement where one individual is the only owner of a property or properties.
It is often used by single or divorced individuals. In some places, sole ownership is an option for a married person who wants to acquire property separately from their spouse.
In CRE, sole ownership refers to a single entity, such as a business, owning a commercial property entirely. An example in CRE could be a small business owner who purchases a retail space under their own name or business entity.
The benefit of sole ownership is that there are no claims to the property from other parties.
However, it may require probate if the owner passes away.
Decision-making is simpler because there is only one owner.
You can also gain tax advantages by recording the property's income and losses on your individual tax return.
Sole ownership by an individual can be risky, as you might be subject to unlimited responsibility should a legal dispute arise. This means that courts may seize personal assets to settle legal verdicts. Business entities, particularly if they are limited companies, will hold less risk as the courts can only seize the assets of the company.
2. Joint Tenancy
When two or more people purchase a property together, it is called a joint tenancy. Joint tenancy ownership is common between married couples.
In CRE, joint tenancy ownership happens when multiple parties come together to invest in a property. An example could be two independent retailers who invest together in a property, sharing the costs and benefits.
There are four conditions to joint tenancy. These are generally known as the Four Unities:
- Unity of Time: The tenants must get the property at the same time.
- Unity of Interest: Each tenant must have an equal stake in the property.
- Unity of Title: The title deed must be obtained by all tenants from the same document.
- Unity of Possession: All tenants must have equal ownership rights.
If any of the Four Unities are not met, the joint tenancy is destroyed, and it would become a ‘tenancy in common’.
When a co-owner passes away, their share of the property is transferred to the remaining owner/s. This means that the property has rights to survivorship. A joint tenancy is often done to avoid probate. Probate is the legal processes concerning a deceased person’s last will and testament, and distribution of their estate.
If one of the owners decides to sell, they may sell only to the other owners. If they want to sell to an ‘outside’ party, the whole property must be sold, and the profits shared. The property may then be repurchased, and the Four Unities must be met again.
3. Tenancy in Common
Tenancy in common (TIC) is a legal structure in which two or more parties share property ownership rights. There is no limit to the number of owners.
Each owner can own a separate section of the property, but all have equal rights.
TIC appeals to smaller investors who can't afford to own an entire property.
Each owner has access to the entire property, known as undivided interest, and can sell their share at any time.
TIC has no right to inherit, but when a tenant in common dies, they can leave their portion to a named beneficiary, leaving the shares with the other tenants in common.
Changes to ownership are easier than joint tenancy because members can simply sell or transfer their shares to other or new members. It’s thus ideal for groups of people looking to share property.
An example in CRE could be a group of independent investors who each buy a share in a large commercial shopping complex, sharing ownership.
TIC also appeals to married couples who don't want their share to automatically pass to the surviving spouse upon death. However, if a person doesn't have a will and holds title through TIC, their share will be allocated according to state probate laws.
4. Corporate Ownership
Corporate ownership is a common structure in CRE, in which a corporation or company owns the property.
In CRE, you might see a tech company, for example, purchasing an office building under its corporate name.
Corporate ownership provides liability protection and potential tax benefits for the investor.
Holding corporations are a method used by CRE investors to reduce their risk profile and liabilities. Properties held by a corporation are separated from an investor’s personal assets, thus limiting potential personal losses. This division also simplifies taxation and financial reporting.
Ownership is represented by holding stock shares. It is also easy to transfer ownership and raise capital using a corporate ownership structure.
There are various organizational structures for holding organizations, including:
- Limited Liability Companies (LLCs)
- C Corporations
- S Corporations
- Limited Liability Partnerships (LLPs)
LLCs offer asset protection. However, managing stockholders can still be sued if they commit fraud or misconduct.
Operating under an LLC simplifies tax separation for CRE assets. It offers significant deductions for business income in some states. This would be in addition to other tax breaks normally enjoyed by owners of commercial real estate, such as:
- Asset depreciation
- Property taxes
- Insurance
5. Trust Ownership
Commercial properties can be held in a trust to manage, protect, and pass on assets. Trusts can also provide certain tax advantages.
A CRE example could be an investor placing a retail center under a trust, with a professional trust management company overseeing its operations to ensure the asset's protection and steady income generation for beneficiaries.
Like a person or company, a trust is a legal entity with unique and separate rights. A trustee, typically an individual or entity, manages and safeguards the property, ensuring it's used as intended. The trustee has the authority to hold title to and administer assets for the benefit of a beneficiary.
Trust ownership is commonly used by individuals and businesses looking to protect their assets and efficiently pass them on to beneficiaries in future.
Added to that, trusts can cut down on paperwork and time.
Occasionally they can even lower inheritance or estate taxes. Drawbacks include administrative costs and limited control over the property while it's in the trust.
Overall, trusts can provide significant tax benefits and benefits for both individuals and businesses.
6. Partnership Ownership
Partnerships are common in CRE. They allow multiple parties to pool resources for property investments. The most common types are general partnerships and limited partnerships.
General Partnerships
General partnerships share responsibility for business operations and decision-making.
This collective responsibility encourages effective workload distribution and decision-making. In CRE, you might, for example, find a group of restaurateurs forming a general partnership to own and manage a commercial kitchen space.
General partnerships can be easily formed with little need for legal paperwork. They also provide flexibility in structuring to match the interests of the parties.
The pass-through taxation system reflects profits and losses on individual tax returns, potentially reducing tax loads.
Each partner bears equal responsibility and liability for the partnership's debts and liabilities, regardless of their unique ownership holdings. These partnerships may face difficulties in resolving agreements which could lead to potential litigation and even dissolution.
General partnerships can only obtain capital through personal assets or loans.
Their structure may also make it harder to attract outside investors or secure finance.
Limited Partnerships
Limited partnerships combine general and limited partners.
General partners have the same liabilities and responsibilities.
Limited partners have limited obligations and are not involved in everyday business affairs.
An example in CRE could be a group of investors forming a limited partnership to acquire a downtown commercial building. Half of them are general partners involved in daily operations, while the other ten are limited partners who have invested capital but are not involved in daily management.
Acquiring CRE through a limited partnership offers reduced liability for limited partners. They are only partially responsible for the partnership's debts based on their financial commitment. This structure also provides pass-through taxation. It allows individual reporting of gains and losses on partners' tax returns.
The disadvantages of limited partnerships include:
- Limited control
- Limited influence on management decisions
- Limited involvement in daily property management
- Higher costs for establishing and managing compared to general partnerships
Additionally, limited partners remain fully accountable for the partnership's debts. This is despite limited liability protection.
Types of Property Ownership Compared
The ownership structure should align with an investor’s financial aspirations and risk tolerance. Tax implications, exit strategies, and liquidity are all factors to consider when deliberating ownership options. These choices also directly influence other aspects of CRE, such as:
- Risk exposure
- Inheritance planning
- The ease of making changes to property ownership
- Investment strategies
- Asset management
Final Thoughts on Types of Property Ownership in CRE
The diverse property ownership options in CRE come with their distinct structures and implications. While some, like sole ownership, offer simplicity, they also bring about risks concerning portfolio, probate, and liability. Others, such as joint tenancy and tenancy in common, are tailored for shared ownership, each with its own set of advantages and potential complexities.
Corporate and trust ownership structures offer layers of liability protection and tax benefits, whereas general and limited partnerships come with varying degrees of responsibility and potential drawbacks.
Your choice of ownership type is a key decision that could significantly impact your investment's success in the CRE landscape. If unsure, consulting with a seasoned broker or solicitor is advisable to ensure the ownership structure chosen aligns well with your business objectives, safeguarding your legal, financial, and estate planning goals.
