UPREIT - What You Need to Know

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On occasion, one will hear about an “UPREIT exchange” in the commercial real estate sector.  These transactions can be very beneficial to real estate owners, so we wanted to provide some insight as to the structure, potential benefits and possible situations where UPREIT exchanges are useful.  Get to know the important facts about UPREIT transactions.

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What is an UPREIT?

“UPREIT“ is an acronym that stands for “Umbrella Partnership Real Estate Investment Trust”.  It is a type of property acquisition transaction, where a property owner contributes his/her property to a Real Estate Investment Trust (a “REIT”) in exchange for ownership in the REIT.  It is also referred to as a “Section 721 Exchange” (based on section of the Internal Revenue Code) and is similar to a 1031 Exchange in that it can allow property owners to defer capital gains on appreciated real estate.

How does an UPREIT work?

In a typical UPREIT exchange transaction, property owners contribute their real estate directly to an Operating Partnership (“OP”) subsidiary of a REIT in exchange for REIT OP units.  These OP units can, in most cases, be converted to REIT shares on a one-to-one basis, providing the property owner with an interest in a diversified portfolio of properties and the potential for future liquidity.  If the owner had sold his/her appreciated property for cash, that transaction would trigger an immediate capital gain tax liability.  In and UPREIT exchange, owners of these OP units are typically able to defer gains on any appreciated property until such time as either the OP units or the underlying property are sold.  UPREIT exchange property owners can be individuals or partnerships.

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What situations would be appropriate for considering an UPREIT exchange?

An UPREIT transaction makes sense for a variety of properties and situations. Here is a sample of the situations where an owner could benefit from a potential UPREIT:

A property owner looking to sell appreciated commercial real estate, but not wanting to trigger a large capital gain and pay the related taxes, especially if they have a low basis.

A property owner who is interested in passive income from commercial real estate but no longer wants to assume the property management responsibilities of their real estate portfolio.

A property owner who has only one or a few commercial properties and is looking for greater diversification provided by a much larger REIT portfolio.

Families or partnerships looking to sell jointly-owned properties to address unresolved succession issues or complicated administration.

Business owners who lease properties to their businesses and want to mitigate risk or “take some money off the table” without triggering large tax bills.

What are the benefits/advantages of an UPREIT?

UPREITs provide a number of potential benefits to property owners:

Tax Advantages

deferral of capital gains, especially for properties with low tax basis.

Continued Passive Income

often a seller of appreciated property not only faces a material tax bill but must source, evaluate and acquire another investment to provide passive income.  By becoming a holder of OP units, the owner automatically receives REIT distributions.

Diversification

as a shareholder in the REIT, the owner benefits from an investment in a larger portfolio that is diversified in terms of tenant mix, geographies, etc.

Future Liquidity

as the OP units are typically convertible to REIT shares, the owner has some ability to control his/her timing for future liquidity (although it may trigger capital gains recognition and liquidity may be limited).

Simplification

UPREITs also allow for a simplification of the property owners estate, as OP units can be divided amongst heirs in a way that a single property cannot.  Also, in certain circumstances, so owners can receive cash and others OP units without trigging capital gains.

Royal Oak Realty Trust Offers UPREIT Transactions

Royal Oak Realty Trust is structured as an UPREIT and can enter into UPREIT exchange transactions with property owners.  By working with Royal Oak, property owners not only gain the important tax advantages mentioned above but can continue to derive income from a diversified portfolio of real estate that can provide attractive returns.  Property owners often do not have good investment alternatives for the proceeds from the sale of their properties, so an UPREIT with Royal Oak can be an attractive solution. UPREITs possess a number of beneficial characteristics and should be a consistent presence on any list of real estate sale options.

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