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Mid Atlantic R eal E state J ournal Publisher ............................................................................ Linda Christman Publisher ............................................................................... Joe Christman Publisher/Senior Account Executive ................................. Elaine Fanning Section Publisher .................................................................... Steve Kelley Senior Editor/Graphic Artist .................................................Karen Vachon Production Assistant ....................................................................Julie King Office Manager .................................................................... Joanne Gavaza Guest Columnist ...................................................................... Rich Murphy Mid Atlantic R eal E state J ournal ~ Published Semi-Monthly Periodicals postage paid at Rockland, Massachusetts and additional mailing offices Postmaster send address change to: Mid Atlantic Real Estate Journal, 312 Market St. Rockand, MA 02370 USPS #22-358 | Vol. 26 Issue 16 Subscription rates: $99 - one year, $198 - two years, $4 - single copy REPORT AN ERROR IMMEDIATELY MARE Journal will not be responsible for more than one incorrect insertion Toll-Free: (800) 584-1062 | MA: (781) 871-5298 | Fax: (781) 871-5299 www.marejournal.com The views expressed by contributing columnists are not necessarily representative of the Mid Atlantic Real Estate Journal
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Rich Murphy
UPREITS: Tax-Driven Conversions For PropertyOwners
O
ne of the more under- discussed aspects of REITs are how they
can benefit a seller of real estate. By contributing a prop- erty to a REIT you can achieve many of the same benefits as- sociated with a §1031 exchange including deferral of gain rec- ognition. For the owner looking to monetize their investment in a tax advantaged manner with the possibility of additional up- side this option deserves some additional examination. Of the different types of RE- ITs that exist, one sticks out as being particularly useful to sellers of real estate. The UP- REIT. An UPREIT (Umbrella Partnership REIT) structure is one that has a REIT at the top of the structure and a partner- ship, which directly owns the real estate below it. Thus, the REIT simply owns an interest in the underlying partnership and not title to the actual properties themselves. (See figure 1) Some REITs, known as DOWNREITs will acquire some properties outright, and also have interests in a lower tier partnership, which directly owns properties. This article will focus on the UPREIT how- ever it’s worth pointing out that the outcome for a contributor of property from a tax perspective is the same with an UPREIT as it is a DOWNREIT. The major question is why the seemingly convoluted structure? One of the mechanisms by which these UPREITs acquire properties in their lower tier partnership (the “OP” or op- erating partnership) is by contribution. That is to say, an owner contributes their property into the OP in return for an ownership interest in the partnership, usually referred to as “units”. These units are typically transferable one for one with shares of the REIT’s stock. The number of units received for the property is negotiated in much the same way it would be if the property were being sold for cash. For example, if the property being contributed had a fair market value of $1Mil and the stock of the REIT was trading for $25/Share than the contributor of the property
are just that, stocks. While it is helpful to think of them as real estate mutual funds they tend to behave as stocks not as real estate. This should come as no surprise; however it’s worth mentioning as many people use them as a way of exposing their portfolio to real estate. Strictly speaking REITs may not be best option for accomplishing this as they track with the S&P 500 much more closely than they do any real estate benchmark (i.e. interest rates). With that said, probably the most obvious benefit of this characteristic over a tra- ditional piece of real estate is liquidity. Under the best circumstances, a real estate in- vestment will take 90-180 days to monetize. By contrast, an OP unit holder could convert his units and sell his shares within days or weeks. This inherent liquidity is one of the biggest differences between holding an actual property versus be- ing an OP unit holder or REIT shareholder . Management, or the absence of having to do it is yet another. A REIT is very much an oper- ating business. In other words it has staff, managers and officers, and their abilities or lack thereof will play a large role in the success or failure of the REIT. Far more so than say the management team of a mutual fund to which REITs are often compared. REITman- agement can greatly influence the operating results of their properties by executing leas- ing plans, utilizing leverage, and engaging in other property level management strategies in a way that a mutual fund manager cannot influence the underlying businesses that they own shares in. The fund manager will time the buying continued on page 12A
would likely receive 40,000 units. As a function of the tax rules at work governing such a transaction, this is in and of itself not a taxable event. It is not until, the now partner converts his or her units into shares of REIT stock that he/ she must recognize any gain . The benefit here is that you can defer the recognition of gain on the sale of your prop- erty until you want while at the same time largely locking in your profit (provided the value of the REIT shares don’t fall). Further, there is the possibil- ity of additional upside in the deal. For instance, using our example above, if the share price had risen to $30/ share when we converted our units to shares we could achieve an ex- tra $200K profit by redeeming stock worth $1.2Mil versus the $1Mil that we agreed to back at the initial contribution. Obvi- ously, the same math works in reverse too. One might ask “How is a such a transaction more ad- vantageous than say a §1031 exchange?” It all depends on who you are and what you’re looking for. (See Table 1 for Pros/Cons) For example, if you only own a single property, the entirety of your risk associated with real estate is concentrated in that one asset. By contributing that prop- erty to the REIT and receiving OP units in return you are effectively now diversifying that risk across all the proper- ties in the REIT of which your property is now one. This abil- ity to diversify, and therefore decrease risk is a common motivation amongst not only property contributors but also REIT investors in general. One thing to bear in mind however is that REIT stocks
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