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REIT 101

What are “Alternative Investments?”
What is the criteria necessary to qualify as an “Accredited Investor?”
What is a REIT?
What does “Net Lease” mean? What about “Triple Net Lease?”
What is an UPREIT transaction and how does it work?
What is a 1031 exchange and how does it work?
How do I invest with Broadstone?

What are “Alternative Investments?”

An alternative investment is one that does not involve the traditional investments of stocks, bonds and cash. It includes tangible assets such as precious metals, art, antiques, or coins, as well as financial assets such as commodities, private equity, and hedge funds. Real estate often falls under the term “alternative investment.” Such investments are often used to diversify, thereby reducing overall risk.

Alternative investments such as real estate often require a high degree of investment analysis before buying. They may also be relatively illiquid.

 

What is the criteria necessary to qualify as an “Accredited Investor?”

According to the Securities and Exchange Commission, Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as “accredited investors.”

The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:

  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation, or partnership with assets exceeding $5 million;
  • a director, executive officer, or general partner of the company selling the securities;
  • a business in which all the equity owners are accredited investors;
  • a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

See the Securities and Exchange Commission Website for more information.

What is a REIT?

Short for Real Estate Investment Trust, a REIT is an organization that owns—and usually operates—income-producing real estate. It can include commercial and residential properties. A REIT can deduct dividends paid to its owners and avoid incurring all or part of its U.S. federal income tax liabilities. REITs are required to distribute all of its net annual income to its shareholders.

REITs were first introduced in the U.S. to provide all investors an opportunity to invest in large portfolios of income-producing real estate through the purchase of liquid securities. A REIT is in many ways like a mutual fund for real estate with investors obtaining the benefit of a diversified portfolio under professional management.

What does “Net Lease” mean?  What about “Triple Net Lease?”

A net lease requires the tenants to pay some or all of the property expenses that are otherwise paid by the property owner, such as real estate taxes, insurance, maintenance, and utilities.

A triple net lease is an agreement in which the tenant is solely responsible for all of the costs related to the property they’re leasing, in addition to rental fee. The name “triple net” comes from the three types of costs the tenant has to pay—net real estate taxes, net building insurance, and net maintenance.

What is an UPREIT transaction and how does it work?

Short for Umbrella Partnership Real Estate Investment Trust, an UPREIT is an entity structure used by REITs to allow property sellers to convert their ownership into an interest into a private or public security.

In the basic UPREIT structure, all REIT properties are acquired and owned directly or indirectly by its “umbrella partnership.” The umbrella partnership is the entity through which the REIT operates and collects all income from the properties, which is why the umbrella partnership is commonly referred to as the “operating partnership.” The REIT does not directly own any real estate properties in the UPREIT structure, rather it owns substantial interests in the operating partnership as both its sole general partner and one of its limited partners.

In the case of our structure, Broadstone Net Lease, Inc. is the REIT and the managing member of Broadstone Net Lease, LLC, which is the “operating company” of the REIT. See the last page of this memorandum for a basic diagram of Broadstone’s UPREIT structure.

In an UPREIT transaction, property owners contribute their properties in exchange for ownership units in an operating partnership (“OP Units”). UPREIT transactions provide an attractive tax deferred exit strategy for owners of real estate who will recognize a significant taxable gain in a cash sale of a highly appreciated property with a low tax basis.

If real estate is sold or contributed directly to the REIT, it would result in a stepped-up cost basis in the property for the REIT and a taxable event for the contributing property owner. However, by contributing the property to the operating partnership instead of the REIT, the contributing property owner’s historical cost basis is maintained.

Indeed, the primary incentive for a selling property owner in entering into an UPREIT transaction is that it can be completed on a tax deferred basis.

Again, the owner of the property being contributed to the operating partnership does not recognize immediate gain on the transaction because the owner does not acquire shares of stock in the REIT, but rather receives OP Units in the REIT’s operating partnership.

In addition, if the OP Units end up in the owner’s estate, the ultimate recipients of the OP Units will receive a stepped-up basis equal to the value at death and the inherent gain resulting from the UPREIT transaction will not be subject to capital gains or income tax. The tax deferral or avoidance, as the case may be, gives REITs utilizing the UPREIT structure a large advantage over cash purchasers of real estate.

While tax deferral/avoidance may be the primary incentive to entering into an UPREIT transaction, there are many other great benefits for selling property owners as a result of completing an UPREIT transaction. See the “Summary of Benefits” listed below.

Summary of Benefits:

  • Provides a viable tax deferral/avoidance exit strategy to property owners facing significant capital gain tax liabilities on the sale of appreciated property with a low tax basis
  • Diversification of real estate holdings (i.e., OP Unit Holders have an interest in a portfolio of properties instead of just one)
  • Potential to convert illiquid, long-term assets (i.e., real estate) into more saleable securities (i.e., OP Units  REIT Shares  Cash)
  • No property management responsibilities or concerns
  • Quarterly income distributions
  • Potential to recognize unrealized gains as earnings
  • Professional management and expertise in capital markets
  • Avoids risk of negative cash flow
  • Estate simplification
  • Allows the owner to dispose of its property in a way that maximizes its value
  • Improved cash position through potential leveraging of OP Units

One of the more notable benefits of an UPREIT transaction is that, in becoming an OP Unit Holder, the property owner essentially converts an interest in one or more specific properties into an interest in a larger and more balanced portfolio of properties. The operating partnership’s portfolio is often diversified as to property type and geography, and usually benefits from the economies of scale and management that a larger entity can offer.

Also noted as one of the more important benefits of an UPREIT transaction, is that such a transaction allows an interest in illiquid real estate properties to become more easily saleable. This is because OP Units may be converted, subject to minor restrictions, on a one-for-one basis for shares of common stock of the private or publicly-traded REIT. While such a conversion to stock may trigger recognition of taxable gain, the flexibility permits the owner to unlock value and access capital as needed.

What is a 1031 exchange and how does it work?

Perhaps the most well-known way for an owner of real estate to defer the tax on capital gain is to exchange the real property for another real property in a 1031 exchange (after Section 1031 of the Internal Revenue Code). In a 1031 exchange, the property being sold in the exchange is referred to as the “relinquished property” and the property being acquired in the exchange is referred to as the “replacement property.” According to IRS requirements, within 45 days after the sale of the relinquished property, the owner must identify the replacement property.

Once identified, the owner must acquire the replacement property within 180 days after the sale of the relinquished property. Thus, the property owner faces challenging time frames to identify the replacement property and to negotiate and close the sale and the purchase. And because the owner has sold one property and acquired another, there will be no change in liquidity and likely no change in property management responsibilities.

To discuss a potential UPREIT or 1031 transaction, please contact our Acquisitions Team.

How do I invest with Broadstone?

Click on the Investor Kit on the left-hand side of this page to request more information.