Wednesday, March 9, 2011

UPREITs: An Old Idea is New Again

Net Lease investments have long been a haven for those looking to invest in real estate without the headaches associated with management. Owners can rely on a predictable cash flow stream and a risk profile that’s essentially a function of their tenant’s credit.

Still though, there is an inherent lack of liquidity in real estate investments, triple-net or otherwise. Also, the notion of management and diversification takes on new meaning depending upon whether you own one property or twenty. Once you eclipse ten or twenty properties in a portfolio, even triple-net ones, management can become an issue. A tenant will always be rolling, and issues will present themselves regularly that need to be dealt with whether we want to or not.

At the other end of the spectrum, perhaps you own just one large property. An industrial warehouse, or a big box store, perhaps it was inherited. Now, all your eggs are in one basket from a diversification standpoint.

For the family, portfolio, or large single asset owner another ownership option is the REIT. Specifically, the UPREIT. These types of REITs are the perfect fit for the investor who doesn’t want any management responsibilities or the large single asset owner looking to diversify.

The way it works is the property owner contributes their property to the UPREIT in return for units in a partnership, which are transferable into shares in the REIT. The contribution of the property doesn’t trigger any tax gain. It’s not until the units are swapped for REIT shares that any tax is incurred. In this way it’s similar to a 1031 exchange. Additionally, like a 1031 exchange, it’s basically a cashless transaction from the perspective of the seller/contributor.

The difference is you are trading into something which is very liquid (assuming it’s a public REIT), as opposed to another piece of real estate. There is also potential upside in that the value of the stock can increase. Additionally, if you contribute one property into the REIT you’re now effectively diversified -- owning part of all the REIT’s properties. This is in contrast to exchanging one property for another. Furthermore, by not recognizing gain until you convert your units, you can choose the timing of your gain recognition.

Lastly, during your holding period you’re still receiving regular distributions. You still have a solid income producing investment.

None of this is new. This structure has existed for years. Recently, the startup of several new Net-Lease REITs (some public) has shined a new light on this opportunity. We’ve actually just put together a new whitepaper, which illustrates the process; its pros and cons.

Click Here to get it.

Many of the new funds and REITs that have started up recently have been having the same problem that every net lease investor has been having; the utter lack of quality inventory. It will be interesting to see if UPREIT contributions free up some of the quality product that has thus far been on the sidelines.

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