■ Investment Diversification – The UpREIT structure offers property contributors the ability to diversify their holdings. Indeed, by contributing interests in a single property or a small group of properties that are concentrated in terms of geography, asset type, or tenants in exchange for OP Units, a seller/contributor receives an interest in an entity (i.e., the Operating Partnership) that owns multiple properties, often in multiple real estate markets, which can diversify the contributor’s investment holdings and, as a result, mitigate the impact of a decline in the value or performance of any particular property. ■ Depreciation Deductions – In the case of a newly acquired or developed real estate property, OP Unitholders will receive a share of the depreciation deductions from the depreciable asset in accordance with their respective interests in the Operating Partnership. These depreciation deductions will reduce the taxable income allocated to the OP Unitholders by the Operating Partnership with respect to their OP Units. However, OP Unitholders may be subject to limitations in their ability to use depreciation deductions and to subsequent adverse tax consequences in the future, such as depreciation recapture upon a later disposition of either the depreciated property or their OP Units, including pursuant to a redemption as described above. ■ Estate Planning – OP Units are helpful for estate planning purposes. For example, an OP Unitholder can transfer OP Units to multiple beneficiaries as part of estate planning, and each beneficiary can choose either to hold his or her OP Units and receive quarterly distributions or tender the OP Units for redemption for cash or, at the REIT’s election, for REIT shares. In addition, when an individual partner holds the OP Units until death, the tax rules generally allow for a “step up” in tax basis of the OP Units, effectively permitting the beneficiaries to subsequently tender the OP Units for cash or REIT shares without incurring tax on the built-in gain in the OP Units at the time of death. Despite the benefits described above, UpREIT structures can have some drawbacks that should be considered by sponsors and property sellers. UpREIT structures introduce a level of complexity that would not otherwise exist within a REIT structure that does not include an Operating Partnership subsidiary. Additionally, the disposition of property by an UpREIT may result in a conflict of interest with the contributing partner because any disposition of that property could result in gain recognition for that partner. As a result, contributing partners often negotiate mandatory holding periods and other provisions to protect the tax deferral benefits they expect to receive through contribution of appreciated property to an UpREIT. Roll-Ups A REIT can either acquire a property, mortgage loan, or other real estate asset directly or through a “roll up” process in which the REIT acquires the entities (partnerships or limited liability companies) that own the real estate asset in exchange for securities of the REIT or its Operating Partnership. As noted above, the UpREIT structure provides tax deferral advantages. From the securities law side of the transaction, the question is whether the REIT is conducting an offering of its securities to the holders of the interests in the entities. The REIT could affect the roll-up transaction as a registered offering separate from the IPO; however, this approach is not typical, as registering a roll up involves significant time and expense. The more common process is one or more private placements by the REIT or the Operating Partnership to the holders of the real estate assets. In the case of an issuance of OP units, the REIT may then enter into a registration rights agreement with the holders of OP units relating to the shares of common stock issuable upon redemption of the OP units. The REIT may also consider a tax protection or tax matters agreement providing indemnification for the sale of properties where built in gain is triggered and will need to consider other ongoing tax matters. In the late 1980s, the management of a number of finite life entities, whether public or private, decided to convert their entities into, or to cause interests in such entities to be exchanged for securities of, publicly traded perpetual life REITs. Typically, these transactions involved a number of these entities being “rolled-up” into one publicly traded REIT. The SEC saw a number of conflicts and abuses arising from this process. In response, the SEC issued rules on “roll-up transactions,” Congress enacted Section 14(h) and related provisions of the Exchange Act in 1993, and the Financial Industry Regulatory Authority (“FINRA,” then the National Association of Securities Dealers) also issued rules governing the responsibilities of broker dealers in roll-up transactions. 21 | 2024 Guide to REIT IPOs and Listing Transactions
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