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Lawyer Explains How Operating Partnership Units Changed REITs

01/07/2014 | By Allen Kenney

Ettore Santucci, a partner with the law firm Goodwin Procter LLP, joined REIT.com for a video interview at REITWorld 2013: NAREIT’s Annual Convention for All Things REIT at the San Francisco Marriott Marquis.

Santucci discussed the role that operating partnership units (OPUs) and the UPREIT structure played in the growth and evolution of the REIT industry. He cited the wave of REIT initial public offerings (IPOs) in 1993 as a key point in the industry’s history, noting that OPUs and UPREITs helped solve a dilemma for commercial real estate owners at the time.

“You had a confluence of events,” Santucci said. “You had lots of great real estate owned by the wrong people. It needed to be moved to new owners. The problem was that there was a huge impediment, and that was the built-in gain that all these old owners had that basically made it completely unattractive to roll these assets over straight up. Basically, the economic gain in the assets wasn’t sufficient to compensate for the tax friction that would have been created. This real estate was depreciated real estate that was being held in partnership and had created lots of negative capital. The tax costs would have been prohibitive.”

Santucci discussed the benefits of OPUs for real estate owners.

“You have a bunch of people who own real estate in closely held partnerships, and you just want to move it over to a new, pooled vehicle that owns lots and lots of assets—a diversified solution,” he said. “The cash flow is better. The risk is lower. You can refinance the debt. You can have lower leverage. You can have a growth vehicle. You can have equity. You can have access to the capital markets. It’s beautiful.”

Santucci also explained how the structure works.

“All you need to do is put a partnership underneath the REIT vehicle and allows the owners of equity in the special-purpose entities to exchange,” he said. “The tax cost evaporates. The new owners get what they want: great real estate in a diversified vehicle. The old owners get to continue to play.”

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