Real Estate Weekly, April 9, 2003

INSIDERS OUTLOOK
The benefits of selling property through an UP-REIT

By Georgia Malone
President
Georgia Malone & Co., Inc.

It's one of real estate's best kept secrets. Two owners sell identical debt-free properties worth $20 million at 10%cap rates. The first seller pays capital gains of about $6.5 million and earns net cash proceeds of $13.5 million. The second seller pays no capital gains and receives $20 million of value in the form of a partnership interest that pays quarterly cash dividends. The scenario assumes the property had no debt to be paid off.

What happened? The second seller sold her property to a Real Estate Investment Trust (REIT), a publicly traded company that invests in real estate. In doing so, she used a ve­hicle known as an umbrella partnership real estate in­vestment trust (UP-REIT). The transaction is similar to the better known 1031 tax exchange whereby a seller contributes the pro­ceeds of one sale to buy another property within a prescribed time, and in doing so avoids or defers paying capital gains on the initial sale.

The difference between the two transactions is the flexibility gained by the seller. An UP-REIT transaction does not require a seller to take pos­session of another property. Instead the seller re­ceives what are called operating partnership units, a.k.a, OP units, that earn dividends and are convert­ible into common Stock, (note: The seller has the option of taking some cash that would be taxable plus the OP units that would become taxable when thev are sold.)

REITs can tailor OP Units to accommodate the seller's specific needs for lax purposes. When the common shares are sold by the seller, it is at that point that the proceeds become taxable. But sellers to REITs retain a flexibility and control that do not exist in a 1031 exchange or in a straight cash deal. In REIT transactions, sellers can pay taxes at the time and amount they wish or they don't have to pay them at all by holding on to the stock.

So if the REIT transaction is such a great deal why don't more sellers take advantage? First, the opportunity for owners of property to book their equity in what is known as a Section 721 Exchange is not well known to many attorneys, accountants and investors.

Secondly, not all REITs are structured as UP-REITs and able to make an exchange for an eq­uity interest in real properly. Thirdly, there is significant amount of time and expense needed to perform due diligence and work out a transaction with the target REIT. Fourthly, some REITs are only interested in purchasing large institutional type properties.

But remember our opening example. The second seller earned an additional

$ 6.5 million. So while an UP-REIT transaction may not be for everyone, it is certainly one that should be considered by any­one owning a property or properties who does not need the cash right away. UP-REIT transactions are particularly well suited for estate planning, portfolio liquidation, or in cases where sellers have owned properties for many years and have low basis.

Family-owned real estate concerns will find a great advantage in selling to an UP-REIT because of the flexibility offered to different members of the family ownership.

Cousins with little interest in day-to-day real estate management would be able to draw income from the RE1T instead of the family business.

Other relatives could stay in the business or cash out as they saw fit.

The same flexibility would hold true at death, OP units held by either one property owner or members of a group or family would be recognized for the individual holders and because of their REIT status would not be subject to capital gain. In addition, only a portion of the OP units held, and not a whole property, would have to be liquidated to cover any estate taxes outstanding.

There is also the advantage of speed and confi­dentiality. Some public REITs have gone from let­ters of intent to closing in less than 45 days under the veil of secrecy- Well-heeled, focused REITs can move fast without the general public ever knowing that the property was up for sale.

Where do you find a REIT which is structured to perform a 721 Exchange for your property? There are hundreds of REITs in the U.S., many specializing in office buildings, storage units, residential apartments, and shopping centers, You will need to make a search and then verify that the REITs you have chosen to consider are UP-REITs.

A good place to start is the National Associa­tion of REITs (NAREIT), www. nareit.com. Or you can inquire around to brokerage firms.

Our firm, Georgia Malone & Co., is actively seeking sellers of apartment buildings in New York on behalf of AIMCO, a $14 billion NYSE-listed apartment REIT which owns about 380,000 apart­ments throughout the country. AIMCO is able to move quickly and discreetly often in 45 days or less to fulfill a transaction. In addition AIMCO can deliver a range of tax-advantaged transactions that go well beyond what has already been discussed.

Whichever REIT you decide to sell to, it is es­sential you make sure they arc a reputable and well-managed UP-REIT and able to continuously provide value for the shares you will receive in consideration for your sale.

Selling lo a REIT is an excellent opportunity, but you must approach it as you would any pru­dent investment and work with competent advi­sors and brokers. If you are fortunate enough to be able to take advantage of this special opportu­nity, you and your partners or family members can reap major benefits that arc not obtainable through a traditional cash transaction.