REIT IPOs and Listing Transactions A Quick Guide
Table of Contents An Introduction to REITs 1 Going Public as a REIT 3 Benefits of Going Public 3 Downsides and Challenges of Going Public 3 Primary and Secondary Offerings 4 Public Non-Listed REITs 4 Planning for an IPO 6 Governance and Board Members 6 Executive Compensation 7 Financial Reporting and Accounting 9 The Offering Process 11 Diligence 11 Communications Matters 12 IPO Disclosure – The Prospectus 13 Submitting the Form S-11 to the SEC 14 Responding to SEC Comments 14 Frequent Areas of SEC Comment 15 The Underwriting Agreement and the Comfort Letter 17 Marketing the Offering 18 Pricing, Closing and the Post-Effective Period 18 I | 2024 Guide to REIT IPOs and Listing Transactions
UpREITs and Roll-Ups 19 UpREITs 19 Roll-Ups 21 Tax Matters 23 General 23 Hotel and Healthcare REITs 24 Non-Traditional REITs 24 A Final Thought 24 Additional Resources 25 Indicative IPO Timeline 25 IPO Accommodations for EGCs 27 The Likely Alternatives 28 NYSE vs. Nasdaq: Principal Quantitative Listing Requirements 29 About Morrison Foerster 31 Contributors 32 2024 Guide to REIT IPOs and Listing Transactions | II
An Introduction to REITs Bud and Gordon Jr. have a problem, albeit one that many might envy. They have built an impressive real estate portfolio over the years, initially through smaller funds with backing from friends and family and then larger funds with institutional limited partnerships, as well as secured debt financing. The co-founders believe there is value in their platform and management company (Bluestar Management, LLC) and want to continue pursuing attractive investment opportunities, but have tired of the process of raising private funds and want to be able to raise capital more quickly and efficiently. They also believe they could lower their cost of debt financing by having all of the properties consolidated under one company rather than in multiple separate funds. And although they have supportive partners, some are looking for liquidity, while others want to stay invested and not trigger taxes. What are the co-founders to do? They could stay the course, refinance existing debt, roll some partners into new funds, and cash out others; sell the management platform and the entire portfolio; or explore other alternatives. See “The Likely Alternatives.” One option that is near and dear to the hearts of these MoFos is the REIT IPO. A REIT is an investment vehicle designed to allow investors to pool capital to invest in real estate assets. REITs have certain advantages over other investment vehicles; in particular, a REIT is not subject to corporate level U.S. federal income tax on the taxable income that it distributes to stockholders, even if its equity is publicly traded. REITs perennially remain attractive to investors for this and other reasons. Investors seeking current income through regular distributions choose to invest in REITs because REITs must distribute at least 90% of their taxable income to maintain REIT status. To generate cash flow to make these required distributions, REITs generally finance their activities through equity and debt offerings. Although there is an active private market for REIT securities, REIT sponsors often have chosen to pursue IPOs. The industry and asset focus of REITs is diverse. Most broadly, there are equity REITs and mortgage REITs. Equity REITs primarily own interests in income-producing real property that is leased to tenants. Equity REITs typically concentrate on a market segment (e.g., office, self-storage, retail, commercial, residential, industrial or data center properties, among others) or a specific industry segment (e.g., healthcare or lodging properties). Mortgage REITs typically focus on originating or acquiring loans made to certain types of real estate borrowers (e.g., loans made to developers or distressed borrowers) or on particular loan types, such as first mortgages, distressed debt, or mezzanine financings. Although it is not unusual for REITs to invest in multiple property types, there are relatively few hybrid REITs that, in the ordinary course of executing their investment strategy, invest substantially in both operating real property and debt instruments secured by interests in real property. Mortgage REITs do, however, often invest in net lease assets. 1 | 2024 Guide to REIT IPOs and Listing Transactions
In addition, a REIT can be either internally or externally managed. In a REIT with an internal management structure, the REIT’s own employees (including its officers) manage its portfolio of assets. A REIT with an external management structure usually resembles a private equity-style arrangement, in which the external manager receives a base fee and sometimes an incentive fee for managing the REIT’s portfolio of assets, and the REIT has no or a limited number of its own employees, relying instead on employees of the external manager. Generally, externally managed REITs are not viewed favorably by investors due to actual or perceived conflict of interest concerns resulting from the compensatory and other arrangements between the REIT and its affiliated external manager. The market for REIT IPOs has been challenging in recent years, with no REIT IPOs in 2023 or 2022, and only four IPOs in each of 2021 and 2020. The real estate industry has faced an array of challenges in recent years, including inflation, rising interest rates, the COVID-19 pandemic, and the widespread adoption of hybrid working. However, fundamentals across many real estate sectors remain strong, and market conditions in 2024 have been more positive, with one REIT IPO completed and several others looking to execute in 2024. IPOs remain a key path to the realization of investor liquidity and a potential long-term corporate finance strategy for real estate companies seeking to access the public capital markets. Market conditions for IPOs change quickly; accordingly, planning and preparation for an IPO will allow a company to move quickly and capitalize on favorable market conditions when they arise. This Quick Guide provides a high-level overview of the process and considerations for a REIT IPO, other listing transactions, and the related structuring transactions for people like Bud and Gordon Jr., as well as for existing private real estate companies and public non-listed REITs. 2024 Guide to REIT IPOs and Listing Transactions | 2
Going Public as a REIT REITs become public companies in the same way as non REITs, although REITs have additional disclosure obligations and may need to undertake a more significant reorganization in connection with an IPO. See “UpREITs and Roll-Ups.” In addition, most public REITs are formed in Maryland as corporations under the Maryland General Corporation Law (“MGCL”) or as real estate investment trusts under the Maryland REIT law, as a result of Maryland’s well-developed history as a REIT-focused jurisdiction. This contrasts with other types of operating companies, which typically incorporate in Delaware if they are preparing for an IPO. In recent years, a limited number of companies have chosen to do direct listings rather than a traditional IPO. Although a direct listing will be less costly to pursue and offers existing investors quicker liquidity (no lockups), it also does not have the benefit of underwriters’ (and related equity research analysts’) input into valuation (unless accompanied by a capital raise) and disclosure or access to the underwriters’ balance sheets, research, or stabilization support offered by the syndicate in an IPO. Generally, direct listings are not accompanied by a capital raise that many IPO companies need to buy out existing holders, pursue acquisitions, or recapitalize their balance sheet, although recent stock exchange rules do permit companies to raise capital in connection with direct listings, subject to certain conditions. This often results in a much less active and less liquid trading market. Benefits of Going Public There are a variety of reasons why sponsors and management teams may decide to pursue an IPO. Some of the key benefits of an IPO often include: ■ Enhanced liquidity for owners of real estate assets; ■ Access to the public debt and equity capital markets to fund future growth, often on more favorable terms than are achievable as a private real estate company; ■ Ability to use OP Units and shares as acquisition currency (see “UpREITs and Roll-Ups”); ■ Enhancement of public profile and reputation; and ■ Greater ability to recruit and retain senior management, directors, and employees. Downsides and Challenges of Going Public Not with standing the potentially significant benefits of going public, there are a variety of reasons why private real estate companies and their sponsors may decide not to pursue an IPO. Some of the key downsides and challenges of an IPO often include: ■ The requirement to devote significant resources (both money and time) without certainty that a transaction can be executed on attractive terms, on the anticipated timeline, or at all; ■ The need to replace existing members of management, or hire new or additional members of management, with public company or other specialized expertise in line with expectations of IPO investors; 3 | 2024 Guide to REIT IPOs and Listing Transactions
■ Post-IPO SEC reporting obligations can be onerous and require the expenditure of significant resources (both money and time); ■ Access to the public debt and equity capital markets may be limited when the asset class is out of favor or there is significant market dislocation; ■ Enhanced scrutiny by investors, analysts, and plaintiffs’ law firms; ■ Potentially more attractive economic terms from private capital options during certain market cycles; and ■ Failure to meet market expectations can cause significant declines in equity value, credibility, and the ability to access additional capital. Primary and Secondary Offerings An IPO may consist of the sale of newly issued shares by the company (a “primary” offering), a sale of shares owned by existing stockholders (a “secondary” offering), or a combination of both. Underwriters for REIT IPOs typically prefer a primary offering because the company will retain all of the net proceeds that may be used to acquire additional assets, to repay indebtedness, or for other general corporate purposes. In contrast, the company’s existing stockholders would receive all of the net proceeds from an entirely secondary offering and a portion of the net proceeds in an IPO with primary and secondary components. Generally, significant roll-over of existing equity sends a strong signal to potential IPO investors of existing shareholders’ long-term belief and support for the REIT. IPOs may be structured to include both a primary and a secondary offering, either as part of the base offering or as part of the option granted to underwriters to purchase up to an additional 15% of the company’s shares sold in the IPO to cover overallotments (referred to as the “greenshoe”). A company must also consider whether any of its stockholders have registration rights that could require the REIT to register the resale of shares held by existing stockholders, either as part of the IPO or shortly thereafter, which could potentially put downward pressure on the share price in the aftermarket. Providing transparent and rational registration rights to large institutional investors, such as private equity funds who will be seeking liquidity at some point after the IPO, is also important to support the stock price. Public Non-Listed REITs Another alternative to a publicly listed REIT is a public non-listed, or non-traded, REIT, which is a REIT that has offered securities to the public pursuant to registered offerings under the Securities Act and is subject to the ongoing disclosure and other obligations of the Exchange Act, but its securities are not listed on a national securities exchange. Although most non-listed REITs provide some liquidity to their stockholders through share repurchase programs, shares of non-listed REITs are generally considered illiquid due to the lack of an active secondary trading market. This limited liquidity is one factor that may cause a non-listed REIT to pursue a listing of its common stock on a national securities exchange and a concurrent underwritten public offering. Although a non-listed REIT may have completed many registered public offerings, this listing of its common stock and concurrent underwritten public offering is often referred to as its IPO, or its first “listed” public offering. Non-listed REITs considering such an IPO will have to consider many of the same factors that are applicable to a private real estate company considering an IPO, but there are differences, including as a result of a non-listed REIT’s existing public disclosure and large stockholder base of primarily retail investors. 2024 Guide to REIT IPOs and Listing Transactions | 4
■ Structural Lock-Up of Existing Stockholders– Because most non-listed REITs have a substantial number of outstanding shares held by a widely dispersed group of stockholders, it is impractical for a company and the underwriters to enter into lock-up agreements with all existing stockholders that restrict their ability to sell shares immediately following the IPO. See “Controlling Your Shares and Lock-Ups.” Therefore, in order to provide for an orderly market and prevent existing stockholders from selling their shares immediately after the IPO (which would exert downward pressure on the trading price), many non-listed REITs effect a recapitalization to provide for a structural lock-up of existing stockholders. There are a variety of options for such a structural lock-up, and the company will work with its underwriters and counsel to determine the best structure for the company, balancing the competing desires for a successful IPO and liquidity for existing stockholders. ■ Stock Split – In connection with a structural lock-up described above or in order to achieve the desired public offering price per share in the IPO, a non-listed REIT may need to effect a reverse stock split or, less frequently, a forward stock split. Under the MGCL, a Maryland corporation with a class of equity securities registered under the Exchange Act can amend its charter, without a stockholder vote or other stockholder action, to effect a reverse stock split at a ratio of not more than ten shares into one share in any 12-month period. ■ Charter Amendments – In addition to charter amendments related to the structural lock-up and stock split, a non-listed REIT considering an IPO will need to review its governing documents to consider what other amendments are necessary or advisable in connection with the offering and listing, such as removal of provisions required by the North American Securities Administrators Association. The IPO timeline will need to account for any amendments that require stockholder approval. ■ Internalization of Management – Most non-listed REITs are externally managed. A non-listed REIT considering an IPO should consider internalizing its management team in connection with the IPO due to the negative perceptions of externally managed REITs in the public markets. 5 | 2024 Guide to REIT IPOs and Listing Transactions
Planning for an IPO Advanced planning is critical to executing a successful IPO, and preparations should begin well in advance of the IPO organizational meeting. Most companies must make legal and operational changes before proceeding with an IPO to position themselves for success and ensure compliance with SEC and stock exchange requirements. In particular, many corporate governance and compensation matters (including substantive obligations and disclosure items arising under federal securities law requirements, such as PCAOB-compliant audited financial statements), as well as applicable securities exchange requirements, must be satisfied by the time the IPO registration statement is publicly filed with the Securities Exchange Commission (the “SEC”), or the company must commit to satisfy them within a set time period. A company proposing to list securities on a national securities exchange should review the governance requirements of the different exchanges, as well as their respective financial listing requirements, before determining which exchange to choose. Although most REITs choose to list on the New York Stock Exchange (“NYSE”), a company proposing to list its securities may choose to list elsewhere for business or other reasons. See “NYSE vs. Nasdaq: Principal Quantitative Listing Requirements” A company must also address other corporate governance matters, including board and committee structure and composition (including taking diversity, equity, and inclusion (“DEI”) and broader environmental, social, and governance (“ESG”) considerations into account), director independence, related party transactions, cybersecurity and privacy matters, and director and officer liability insurance. See “Governance and Board Members.” Additionally, a company should undertake a thorough review of its existing and contemplated compensation for its directors and officers, particularly with respect to its use of stock-based compensation. See “Executive Compensation.” Companies pursuing an IPO should also exercise care in selecting the investment banks that will act as underwriters in the IPO and in designating which underwriters will act as the “bookrunners,” who will lead the IPO process, versus the “co managers,” who typically have significantly smaller roles. Key considerations include the investment bank’s reputation and knowledge of the REIT space (or a particular sector of the REIT space), the proposed mix between institutional and retail sales in the IPO, and the ability to provide post-IPO support, including access to their balance sheets through corporate facilities and reputable analyst coverage, as well as the ability to help stabilize the market for the IPO shares post-IPO. In addition, companies should consider personality fit, keeping in mind that the lead investment banks will be integral in crafting the company’s IPO equity “story” and will lead the marketing process. Governance and Board Members All public companies, including REITs, must comply with significant corporate governance requirements imposed by the federal securities laws and the regulations of the applicable securities exchanges, including with regard to the oversight responsibilities of the board of directors and its committees and, more recently, as to DEI matters, ESG/sustainability initiatives, and proposed climate disclosures. 2024 Guide to REIT IPOs and Listing Transactions | 6
A critical matter to consider and address is the composition of the board itself. All exchanges require that, except under limited circumstances, a majority of the directors be “independent,” as defined by both the federal securities laws and the applicable stock exchange listing rules. In addition, boards should include individuals with: appropriate financial expertise and relevant real estate industry experience; an understanding of risk management; ESG, cybersecurity, and privacy issues; and public company experience. A company should begin its search for suitable directors early in the IPO process. The company can turn to its large investors, as well as its legal counsel and underwriters, for references regarding potential director candidates. In recent years, REITs, management teams, investors, and proxy advisory and governance firms have placed a higher priority on ensuring that REIT boards of directors and management teams are diverse in terms of experience and personal background, among other considerations. In 2021, the SEC approved two new Nasdaq listing rules that require most Nasdaq-listed companies, including REITs, to have or explain why they do not have at least two directors that identify as diverse (including at least one female) and to publicly disclose certain diversity statistics about their boards on an annual basis. These new Nasdaq listing rules began phasing in during 2022 and are indicative of a trend toward focusing on diversity in board composition. Certain states also have enacted, or are considering enacting, requirements related to board diversity. In addition, in recognition of the value of diversity, the National Association of Real Estate Investment Trusts (“Nareit”) established the Dividends through Diversity, Equity and Inclusion (“DDEI”) Initiative in 2021 to promote the recruitment, inclusion, and advancement of women and members of other diverse groups in REITs and the broader commercial real estate industry. Several studies have demonstrated a positive link between board diversity and financial performance. The benefits of diversity of experience and background should be considered to ensure that decision-making reflects diverse perspectives. REITs incorporated in Maryland or operating as Maryland REITs have had the ability to make various elections regarding opting out of (and the ability to opt-in later without stockholder consent) corporate governance matters before going public, including, but not limited to, considering whether to: opt out of the Maryland Unsolicited Takeovers Act (“MUTA”), a provision of the MGCL that provides for classified boards without stockholder approval; require super-majority votes to remove directors; require that the number of directors be fixed only by a vote of directors; require current directors to fill vacancies on a board; require no less than a majority of stockholders to call a special meeting of stockholders including to amend the REIT’s Bylaws; and include Bylaw provisions regarding “proxy access” (which enables stockholders to use the REIT’s annual proxy statement to nominate directors). However, certain of these provisions have been criticized as being too company-friendly, and therefore, companies should weigh—with input from legal counsel and the underwriters—the pros and cons of adopting any of these governance provisions. Additionally, the size of the board and the number of “insider directors” and relationships or compensation to “independent” directors (the Chairman role in particular) needs to be carefully considered. Companies should carefully evaluate which corporate governance provisions are most advantageous, including by assessing the potential views of investors and proxy advisory firms (such as ISS, Glass Lewis, and Green Street) that will analyze the company once it becomes public (and probably before the IPO). Executive Compensation Well before its IPO, an issuer should begin to approach executive compensation in a manner that is similar to a public company’s approach. The IPO registration statement requires the same enhanced executive compensation disclosures that public companies provide in their annual proxy statements, including a discussion of compensation philosophy, an analysis of how compensation programs implement that philosophy, and a discussion of the effects of risk when taking on compensation decisions. In mortgage REITs and REITs that are not self-managed or self-administered, the REIT will also be required to provide extensive disclosure of both the compensation paid to the managers and the process to manage conflicts of interest. 7 | 2024 Guide to REIT IPOs and Listing Transactions
Under the JOBS Act, an emerging growth company (“EGC”) is required to include only summary compensation information in the IPO registration statement rather than the more extensive discussion and analysis of compensation required for a nonEGC. However, an EGC should always keep in mind that it may be required to include more substantial executive compensation disclosure in future filings or in the registration statement for marketing purposes, and should also consider how investors and proxy advisory firms will view the company’s executive compensation arrangements. For a comprehensive discussion of executive compensation in the REIT space, please see our “Guide to REIT Executive Compensation.” EXECUTIVE COMPENSATION PLANNING Systematizing compensation practices. Compensation decisions should be made more systematically—doing so will require: ■ Establishing an independent compensation committee of the board of directors; and ■ Using more formal market information to establish a compensation philosophy and set compensation, which can often be achieved by engaging a compensation consultant familiar with the REIT industry and establishing a regular compensation grant cycle. Adopting plans. An issuer will have greater flexibility to adopt equity compensation plans (including employee stock purchase plans) prior to its IPO. Accordingly, planning ahead is essential. In consultation with the lead underwriters and its legal counsel, an issuer should develop and adopt the equity incentive and other plans it will use to make awards as a public company. The number of shares reserved for future equity grants, after giving effect to any equity grants that will be made to directors and officers at the closing of the IPO, should be sufficient to enable the REIT to make equity awards for the first two or three years after the closing of the IPO. When the number of shares available for future issuance under the equity plan is reduced to a point that could make it challenging for the REIT to attract, recruit, and retain directors and officers, the REIT will be required to obtain stockholder approval to amend the equity plan to increase the share authorization or to adopt new plans. Section 162(m). Section 162(m) of the Code (“Section 162(m)”) generally precludes a publicly held corporation from taking a federal income tax deduction for annual compensation in excess of $1 million provided to certain of its executive officers. Before the Tax Cuts and Jobs Act of 2017 (“TCJA”) was signed into law in 2017, compensation that qualified as “performance-based” under Section 162(m) was not subject to Section 162(m). Under the TCJA, this performance-based exception was repealed, and the coverage of Section 162(m) was expanded to include additional executive officers. In REITs that utilize the UpREIT structure, often much of the compensation paid to executive officers relates to services that the executive officer provides to the operating partnership, rather than the REIT. The IRS issued private letter rulings addressing this structure in four letter rulings issued between 2006 and 2008. In these rulings, the IRS concluded that Section 162(m) did not apply to an operating partnership with respect to compensation paid for services performed as an employee of the operating partnership, nor did it apply to the REIT with respect to its distributive share of income or loss from the operating partnership that includes the compensation expense to the extent that such compensation expense is attributable to services performed as employees of the operating partnership. Consistent with these rulings, many REITs took the position that compensation expense for services performed for the operating partnership was not subject to the Section 162(m) deduction limit. However, following the changes to Section 162(m) ushered in by the TCJA, regulations were issued reversing the position expressed in these private letter rulings, effectively making them obsolete. Specifically, the regulations modified the definition of compensation for purposes of Section 162(m) to include an amount equal to a parent entity’s distributive share of the operating partnership’s deduction for compensation expense attributable to the compensation paid by the operating partnership after December 18, 2020, which was the date that the final regulations were made publicly available. Consequently, unless a limited grandfathering rule for compensation paid pursuant to a written binding contract that was in effect on December 20, 2019 (which was not subsequently materially modified) applies, the prior exception to Section 162(m) for compensation paid by the operating partnership is no longer available. 2024 Guide to REIT IPOs and Listing Transactions | 8
Financial Reporting and Accounting An IPO registration statement must include audited financial statements for the last three fiscal years (two years for EGCs) and financial statements for the most recent fiscal interim period, compared with interim financial information for the corresponding prior fiscal period. The SEC also requires special income statement and balance sheet captions for REITs. A REIT may not be able to provide full financial statements with respect to significant real estate assets or businesses that were recently acquired or that are probable candidates for acquisition. For most equity REITs, the SEC will require audited statements of revenue and certain expenses (i.e., financial statements required pursuant to Rule 3 14 of Regulation S-X) with respect to significant real estate assets to be acquired; however, some REITs must prepare audited financial statements in accordance with Rule 3-05 of Regulation S-X, which is required when an issuer acquires a significant business. For instance, lodging REITs must prepare audited Rule 3-05 financial statements with respect to acquisitions of hotels that are “significant” in accordance with Rule 3-05 of Regulation S X. In 2021, the SEC amended the thresholds for “significance” under Rules 3-14 and 3-05 to generally mean that a transaction exceeds 20% under one of three tests: the income test, the investment test, or the asset test. Companies will need to provide the required financial statements in their IPO registration statements for all acquisitions or dispositions (or groups of related acquisitions or dispositions) that are deemed “significant” under the applicable rules and that have occurred or are considered “probable.” These assessments can be complicated and time consuming and often involve discussions with the company’s independent auditors, as well as the staff of the SEC. Early on, the issuer should identify any problems associated with providing the required financial statements (including any complex predecessor analysis or similar issues in a “roll-up” IPO) in order to seek necessary accommodations from the SEC. These statements must be prepared in accordance with GAAP, as they will be the source of information for the MD&A disclosures. Pre-Filing Correspondence with the SEC REIT formation transactions can be complex, often resulting in significant accounting and financial reporting issues. The SEC is available to discuss these accounting and financial reporting issues even in advance of a confidential submission or public filing of a registration statement, and it is advisable to approach the SEC early in the process to avoid costly delays. If an issuer is unable to prepare the necessary financial statements or is uncertain with respect to its identification of the REIT’s “predecessor” or “accounting acquirer,” the issuer should seek relief or guidance from the SEC staff in the form of a “preclearance” letter, which may result in the SEC allowing the issuer to include more limited financial information than would otherwise be required under the SEC’s rules. The identification of a “predecessor” or “accounting acquirer” can require complicated analyses that often take time, and the process of obtaining a “pre clearance” letter can further delay the IPO timeline. Measuring Performance ■ Funds from Operations (“FFO”) The real estate industry discloses a unique operating metric that the SEC has traditionally allowed. FFO is the most common financial metric used to measure a REIT’s operating performance. Nareit defines FFO as net income (computed in accordance with GAAP) excluding gains or losses from sales of most property and depreciation of real estate. REIT professionals believe that FFO provides a more accurate picture of the REIT’s performance than earnings calculated in accordance with GAAP, which includes non-cash items. FFO is not the same as Cash from Operations, which includes interest expenses. FFO was originally defined by Nareit in its White Paper in 1991 and subsequently revised from time to time, including most recently in December 2018. Most REITs disclose a modified or adjusted FFO, although the SEC requires them to present the standard Nareit definition as well. For more information, please read “Nareit Funds From Operations White Paper – 2018 Restatement.” ■ Other Performance Measures Most REITs also disclose a variety of other non-GAAP financial measures, such as net operating income (“NOI”), adjusted FFO (“AFFO”), normalized FFO (“NFFO”), cash/funds available for distribution (“CAD/FAD”), earnings before interest, taxes, depreciation and amortization (“EBITDA”), adjusted EBITDA, and EBITDA for real estate (“EBITDAre”). NOI is the operating income after operating expenses but before 9 | 2024 Guide to REIT IPOs and Listing Transactions
income taxes and interest are deducted. AFFO/ NFFO are equal to FFO after adjustments for certain non-comparable items. Depending on the adjustments, the AFFO/NFFO calculation varies from company to company, which can make a comparability analysis difficult. CAD/FAD is used to measure a REIT’s ability to generate cash and to distribute dividends, and is generally equal to FFO minus recurring capital expenditures. EBITDAre was introduced by Nareit in its September 2017 white paper to provide a more widely known and understood measure of performance for real estate operating companies. Additionally, mortgage REITs may use other non-GAAP financial measures, such as “core earnings” (or other similarly titled measures). Core earnings is typically defined as net income (loss) excluding realized and change in unrealized gains (losses), gains (losses) on financial derivatives, and any other nonrecurring items of income (loss). Core earnings and similar metrics are typically useful for mortgage REIT investors because they assess a mortgage portfolio’s performance by evaluating its effective net yield. Internal Control Over Financial Reporting Public companies are required to establish and maintain a system of internal controls over financial reporting that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. However, an issuer will not be required to include either a management’s report on its internal control over financial reporting or an auditor’s report on such internal control until the second annual report following its IPO. In addition, as long as the company is an EGC under the JOBS Act, it will be exempt from providing an auditor’s report on the effectiveness of such internal controls. SEC TREATMENT OF NON-GAAP FINANCIAL MEASURES Regulation G requires issuers to include a reconciliation and general disclosure with respect to any non-GAAP financial measures that are publicly disclosed. The reconciliation requirement provides that whenever an issuer publicly discloses (whether in an SEC-filed report or in an earnings call or investor presentation) material information that includes a non-GAAP financial measure, it must accompany that non-GAAP financial measure with (i) a presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and (ii) a quantitative reconciliation of the differences between the non-GAAP financial measure and the most directly comparable GAAP financial measure. In addition, the GAAP measure must be presented with equal or greater prominence, which generally means that the most directly comparable GAAP measure should be presented before the Non-GAAP measure. Regulation G and Item 10(e) of Regulation S-K permit a public REIT to disclose FFO as defined by Nareit as a non-GAAP financial measure. As described in further detail below, the disclosure of FFO must be quantitatively reconciled with the most directly comparable GAAP financial measure (generally, net income) used by the REIT. The SEC Staff has issued, and periodically updates, Compliance and Disclosure Interpretations (“CD&Is”) on the use of non-GAAP financial measures. The updated C&DIs included certain updates to the use of the FFO and AFFO performance metrics. The SEC staff continues to accept Nareit’s definition of FFO, as a performance measure and does not object to such presentation on a per share basis. The C&DIs also state that a REIT may present FFO on a basis other than as defined by Nareit (such as AFFO), provided that any adjustments made to FFO must comply with the requirements of Item 10(e) of Regulation S-K for a performance measure or a liquidity measure. If AFFO is intended to be a liquidity measure, it may not exclude charges or liabilities that are required or will require cash settlement and may not be presented on a per share basis. For more information, please see our publication “Frequently Asked Questions about Non-GAAP Financial Measures for REITs.” 2024 Guide to REIT IPOs and Listing Transactions | 10
The Offering Process As described in more detail below, the IPO process is divided into three periods: ■ The pre-filing period is the time period between mandating investment banks for the IPO and the first public filing of the IPO registration statement with the SEC. During this time, the company is in the “quiet period” and subject to limits on public disclosures relating to the IPO. ■ The waiting or pre-effective period is the time period between the date of the first public filing of the IPO registration statement with SEC and the date on which the SEC declares the IPO registration statement “effective.” During this period, the company may make oral or written offers but may not enter into binding agreements to sell the offered security. ■ The post-effective period is the time period between effectiveness of the IPO registration statement and the 25th day after effectiveness. During this period, the underwriters may publicly sell the securities by delivering the prospectus contained in the IPO registration statement or a notice with respect to its availability. Diligence A company should keep in mind that underwriters have at least two conflicting responsibilities—to sell the IPO shares on behalf of the company and the selling stockholders, if any, and to recommend to potential investors that the purchase of the IPO shares is a suitable and compelling investment. In order to better understand the company—and to provide a defense in the event that the underwriters are sued in connection with the IPO—the underwriters and their counsel typically spend a substantial amount of time performing business, financial, accounting, and legal due diligence in connection with the IPO to avail themselves of an affirmative “due diligence” defense under the federal securities laws. During the pre-filing period, key management personnel generally will make a series of presentations to the underwriters covering the company’s business and industry, market opportunities, and financial performance. The underwriters typically will use these presentations as an opportunity to ask questions and establish a basis for their affirmative “due diligence” defense. In particular, underwriters will want to visit the most significant properties owned by equity REITs and analyze the mortgage loan portfolios of mortgage REITs. Furthermore, it is important that any material items identified during the due diligence process are appropriately reflected in the IPO prospectus to ensure that there are no material misstatements or omissions in the disclosure in the IPO registration statement and the included prospectus. 11 | 2024 Guide to REIT IPOs and Listing Transactions
EMERGING GROWTH COMPANIES The JOBS Act amended the Securities Act and the Exchange Act to include a type of issuer called an EGC. An issuer qualifies as an EGC if it has a total gross revenue of less than $1.235 billion during its most recently completed fiscal year, subject to inflationary adjustment by the SEC every five years. An issuer will not be able to qualify as an EGC if it first sold its common stock in an SEC-registered offering before December 8, 2011. A company that elects to file as an EGC can benefit from the following reduced disclosure obligations: ■ Disclosure of only two years of audited financials (instead of three); ■ No requirement to include financial information in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) disclosure for periods before those required to be presented in the IPO prospectus; ■ Option to rely on certain scaled disclosures available to smaller reporting companies (such as for executive compensation); and ■ Exemptions from: ■ Advisory stockholder votes on executive compensation (“say-on-pay”) and golden parachute payments; ■ Disclosing the relationship between executive compensation and financial performance; ■ Disclosing CEO pay-ratio; ■ Auditor attestation of internal controls under Section 404 of Sarbanes-Oxley; and ■ Compliance with new or revised accounting standards until the date the standard becomes broadly applicable to private companies. An issuer will remain an EGC until the earliest of: ■ The last day of the first fiscal year in which the issuer’s total annual gross revenues are $1.235 billion or more; ■ The last day of the fiscal year following the fifth anniversary of the issuer’s IPO; ■ The date on which the issuer has issued more than $1.0 billion in nonconvertible debt during the previous three years; or ■ The date on which the issuer is deemed to be a “large accelerated filer,” as defined in Rule 12b-2 under the Exchange Act. Communications Matters From the first all-hands organizational meeting forward, all statements concerning the company should be reviewed by the company’s legal counsel to ensure compliance with applicable rules. Communications by an issuer more than 30 days prior to the date on which the registration statement is publicly filed are permitted as long as they do not reference the securities offering and certain other conditions are satisfied. In contrast, public statements made within 30 days of filing a registration statement that could be considered an attempt to condition the market or pre sell the IPO shares may be considered an illegal “offer” outside of the prospectus, creating a “gun jumping” violation, which may result in the SEC delaying the IPO or requiring disclosure in the prospectus regarding these potential securities law violations and the existence of potential rescission rights. Press interviews, participation in investment banker-sponsored conferences and new advertising campaigns are generally discouraged during this period. In 2012, the JOBS Act softened gun-jumping fears by permitting EGCs to engage in test-the-waters communications with certain sophisticated investors (referred to as qualified institutional buyers, or “QIBs”) and institutional accredited investors to gauge interest in the IPO during both the pre-filing period and after filing without being required to file written communications with the SEC. And, in 2019, the SEC expanded this exception to all issuers, not just EGCs. However, the SEC will ask to review copies of any written materials used for this purpose. An issuer should consult with its counsel and the underwriters before engaging in any testing-thewaters communications. Current market practice has been to use testing-the-waters communications, which usually take place at some point after the first confidential submission of the registration statement and prior to the first public filing of the registration. The testing-the-waters meetings should happen early enough in the process to allow the working group to respond to investor feedback but not too early such that the feedback is stale by the time of launching the IPO road show. Testing-the-waters 2024 Guide to REIT IPOs and Listing Transactions | 12
IPO Disclosure – The Prospectus The IPO registration statement includes a prospectus that describes, among other matters: the offering terms; the anticipated use of proceeds; the REIT; its industry, business (including competitive strengths and growth strategies), management and ownership; and the REIT’s historical results of operations and financial condition. Although the prospectus is principally a disclosure document, it is also crucial to the marketing and sale process. As a result, the underwriters and the company will work together to draft a compelling description of the REIT’s business as an attractive investment proposition. As a disclosure document, the prospectus functions as an “insurance policy” of sorts in that it is intended to limit the issuers’ and underwriters’ potential liability to IPO purchasers. If the prospectus contains all SEC-required information, includes robust risk factor disclosures that explain the material risks and uncertainties that the REIT may encounter, and the related consequences if those risks were to be realized, and has no material misstatements or omissions, it will be challenging for investors to recover their losses in a lawsuit if the price of the stock drops following the IPO. A prospectus should not include “puffery” or overly optimistic or unsupported statements about the company’s expected future performance. Rather, it should contain a balanced discussion of the company’s business (with meaningful cautionary language relating to potential future events), along with a detailed discussion of risks, material operating and financial trends, and material uncertainties that may affect its financial condition, results of operations, and prospects. SEC rules set forth specific disclosures to be made in a prospectus for an IPO, as well as for ongoing disclosures once the issuer is public. The general form for an IPO by a U.S. domestic entity is Form S-1. However, real estate companies, including REITs, are instead required to use Form S-11. In addition to the disclosures required by Form S-1, Form S-11 sets forth the following disclosure requirements: ■ Investment policies with respect to investments, mortgages, and other interests in real estate in light of the issuer’s prior experience in real estate; ■ Location, general character, and other material information regarding all material real properties held or intended to be acquired by or leased to the issuer or its subsidiaries. For this purpose, “material” means any property that has a book value of 10% or more of the total assets of the consolidated issuer or the gross revenues from which are at least 10% of the aggregate gross revenues of the consolidated issuer for the last fiscal year; ■ Operating data of each improved property, such as occupancy rates, number of tenants, and principal provisions of the leases; and ■ Arrangements with respect to the management of the issuer’s real estate and its purchase and sale of mortgages. Furthermore, and in contrast to the general requirements of Form S-1, which is applicable to non-real estate companies, Form S-11 and the SEC’s Industry Guide 5 contain detailed disclosure requirements regarding real estate ownership, investment policies, operating data, descriptions of real estate assets, and, with respect to blind pool REITs, disclosures about the prior performance of sponsors and their affiliates. Most new REITs will qualify, however, as EGCs and can take advantage of the scaled disclosure requirements available for smaller public reporting companies. See “Emerging Growth Companies.” Regardless of EGC status, however, an issuer should be prepared for a time consuming drafting process, during which the issuer, the underwriters, the independent auditors, and their respective legal counsel work together to craft the prospectus disclosure. Blind pool REITs, which are REITs that do not own assets and do not identify specific real properties or real estate related debt instruments to be acquired with substantially all of the net proceeds from the potential IPO (with the properties or loans being determined after the closing of the IPO in accordance with a predetermined investment strategy), are also subject to the SEC’s Industry Guide 5, which sets forth the following additional disclosure requirements: ■ risks relating to: (i) management’s lack of experience or lack of success in real estate investments, (ii) uncertainty if a material portion of the offering proceeds is not committed to specified properties, and (iii) real estate limited partnership offerings in general; ■ the general partner’s or sponsor’s prior experience in real estate presented in tabular format outlining, among other items, historical returns; and ■ risks associated with specified properties, such as competitive factors, environmental regulation, rent control regulation, and fuel or energy requirements and regulations. 13 | 2024 Guide to REIT IPOs and Listing Transactions
In addition, the federal securities laws, particularly Sections 11 and 12 under the Securities Act and Rule 10b-5 under the Exchange Act, require that documents used to sell a security contain all of the information material to an investment decision and do not omit any information necessary to avoid misleading potential investors. Federal securities laws do not define materiality; the basic standard for determining whether information is material is whether a reasonable investor would consider the particular information important when making an investment decision. That simple statement is often difficult to apply in practice. Submitting the Form S-11 to the SEC While there is no prescribed time period, typically four to six weeks will pass between the distribution of a first draft of the registration statement to the working group (consisting of the issuer, the underwriters, their respective counsel, and the auditors) and its filing with, or confidential submission to, the SEC. To a large extent, the length of the pre-filing period will be determined by the amount of time that is necessary to prepare the required financial statements to be included in the registration statement. An issuer may confidentially submit a draft registration statement to the SEC for non-public review prior to publicly filing, but must publicly file (referred to as the “public flip” or “going live” on the filing) its registration statement at least 15 days prior to commencing the IPO road show. The confidential submission process allows an issuer to commence the SEC review process without publicly disclosing sensitive information and to work through the SEC comment process without the glare of publicity and without competitors becoming aware of the proposed IPO. Furthermore, if the issuer determines that the market will not be receptive to the IPO (through a test the-waters process or otherwise) or that other alternatives are more appealing, it can withdraw from the process without the stigma of a failed deal. To ensure that the SEC has the opportunity to fully review and comment on the company’s proposed disclosures to investors, any confidential submission or public filing should be materially complete—companies that make significant changes to the prospectus disclosure after the initial submission or filing of the registration statement run the risk of generating new, potentially significant comments from the SEC, which could result in a delay in the IPO process. With respect to financial statements in draft registration statements confidentially submitted to the SEC, issuers can omit financial information for historical periods otherwise required to be included in their draft registration statements if they reasonably believe that such financial information will not be required at the time of the contemplated offering due to the passage of time and the need to include more recent financial information before the registration statement becomes effective. However, interim financial information that will be included in a historical period that a non-EGC reasonably believes will be required to be included at the time of its first public filing may not be omitted from its filed registration statements. Responding to SEC Comments An integral part of the IPO process is the SEC’s review of the registration statement. Once the registration statement is filed or confidentially submitted, a team of SEC staff members is assigned to review the filing. The team consists of accountants and lawyers, including examiners and supervisors. The SEC’s principal focus during the review process is on disclosure. In addition to assessing compliance with applicable SEC disclosure requirements, the SEC endeavors to assess disclosures through the eyes of a reasonable investor in order to determine the type of information that would be considered material. The SEC’s review is not limited to just the registration statement. The SEC staff will closely review websites, databases, and magazine and newspaper articles, looking in particular for information that the SEC staff thinks should be in the prospectus or that contradicts information included in the prospectus. Initial comments on Form S-11 are typically provided by the SEC staff approximately 30 days after the initial filing or submission—depending on the SEC’s workload and the complexity of the filing, the receipt of first-round comments may be sooner or later. The company and its counsel will prepare a complete and thorough response to each of the SEC staff’s comments. In some instances, the company may not agree with the SEC staff’s comments and may choose to schedule calls to discuss the matter with the SEC staff. The company will publicly file, or confidentially submit, an amendment revising the registration statement in response to the SEC staff’s comments and provide the response letter along with any supplemental information requested by the SEC staff. The SEC staff generally tries to address response letters and amendments within 14 days, but timing varies considerably. 2024 Guide to REIT IPOs and Listing Transactions | 14
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