What UpREITs Offer High-Net-Worth Investors

Jonathan Hipp

To paraphrase an old TV ad, in commercial real estate, it is never about what you earn. It is, however, about what you keep, especially after taxes, and particularly in uncertain economic environments.

Enter the UpREIT, a vehicle that surprisingly gets little attention but can provide an interesting option for tax deferral on a property sale, particularly for high-net-worth investors, that 1031 like-kind exchanges cannot.

Before we delve further into the benefits of an UpREIT, let’s define our terms. Simply put, in an UpREIT, or Umbrella Partnership REIT, an individual property owner can contribute their property for operating partnership units in the REIT. The REIT, for its part, simply owns an interest in that partnership without title to the actual property itself. The property owner’s OP units are transferable for shares of the REIT’s stock, typically on a one-for-one basis. Price and sales terms are going to be like a traditional sale of your property, but in this case, because you get OP units and not cash, there’s very little out of pocket for the REIT and that may be advantageous for them.

So, as an example, if the property being contributed had a fair-market value of $20 million and the stock of the REIT was trading for $25 per share, the contributor of the property would likely receive 800,000 units.

Several benefits accrue to the contributor doing an UpREIT that you cannot get from a traditional 1031 for estate planning purposes:

1. There is upside potential on the value of the REIT stock, although it could, of course, go down as well. However, because a publicly traded REIT stock is more liquid than the real estate, you can choose your future exit timing with more precision.
2. The contributor gains diversification via the REIT’s geographic and asset class diversity.
3. The assets in the portfolio, including that of the contributor, are now professionally managed.
4. Risk is now diversified over the breadth of the properties in the REIT’s portfolio.

Tax Benefits of UpREITs

Current tax rules dictate that the contribution is not a taxable event. It becomes so only when the contributor opts to exchange their OP units for shares of the REIT (presumably when they want to sell them for cash). This allows you to defer the recognition of the gain on your property’s sale while still locking in the profit.

REITs, of course, like all investment vehicles, are subject to market shifts, and the above good news is dependent on the sustained value of the trust. But there’s no surprise there. Real estate is still a cyclical business, and the REITs best suited for an UpREIT are public companies providing full transparency.

Also, UpREITs are not for everyone. Typically, owners of larger single assets of $20 million or more in value, or perhaps owners of a portfolio of at least that size, could consider it. Assets or portfolios smaller than that may not be worth it for the REIT.

There are two more important benefits that make an UpREIT an intriguing possibility: simplicity and predictability. Holders of OP units can, essentially, sit back and collect. They can rely on regularly scheduled cash distributions and dividends that likely will rival the cash flow they were previously generating from their property.

These are interesting times. There is increasing market uncertainty concerning the attitude of the Fed, interest rates and shifts in the tax policies (especially as they concern like-kind exchanges). While UpREIT contributions are not for everyone, for a great many high-net-worth investors, they represent a serious option for preserving not what you earn but the profits you keep.

Jonathan Hipp is head of the U.S. Net Lease Group at Avison Young.