REITs and UPREITs
Real Estate Investment Trusts (REITs) are investment vehicles that own, operate, and manage a diversified portfolio of real estate assets. They offer public investors a way to participate in the real estate market without directly owning property. Most investors are familiar with REITs that are listed on the public market. Publicly-traded REITs are highly correlated with the stock market and are subject to market volatility.
Umbrella Partnership REITs (UPREITs) are a variation of the REIT model structure that involves an operating partnership (the “Umbrella Partnership”) in which the REIT holds a majority interest. UPREIT’s are valued based on Net Asset Value (NAV) audits and property appraisals, tend to be either Publicly Listed Non-Traded (PLNT) or Private REITs and require investors to be accredited. In contrast, UPREITs have a low correlation to the publicly traded markets.
The 721 Exchange
REITs have historically and continue to focus on institutional caliber assets for their 721 exchanges. This largely excludes smaller individual investors from participating in a direct property for OP Units, 721 exchange. In response, the DST space has evolved as the “bridge” between individual investors and a REIT OP Unit investment.
DST 721 Process:
- J 031 Exchange into DST: Investors initially use a 1 031 Exchange to acquire DST Interests. DSTs are fractional interests in real estate that allow for tax deferral on gains from a previous property. These DST interests are offered by a REIT that is acting as a DST sponsor. The DST interest hold periods tend to range from 2-1 0 years.
- 721 Exchange into REIT: Since the DST’s property/portfolio aligns with the REIT’s acquisition strategy, the REIT eventually purchases the DST property up into the REIT and investors can contribute their DST equity interests to the REIT in exchange for OP Units.
Advantages of the 721 Exchange
- Capital gains and depreciation recapture tax deferral enables investors to reinvest 100% of their exchange proceeds into a diversified real estate portfolio.
- OP Units can be converted into REIT shares and redeemed back to the REIT, offering investors liquidity options that are not available with individual properties or DST Interests. Redemption windows are typically open quarterly and are subject to UPREIT guidelines. Unit redemption is restricted through the first 12 months after the 721 exchange.
- After the initial 12-month hold, OP Unit holders can choose if and when to convert their OP units to REIT shares and redeem them back to the REIT for cash. This provides investor control over if and when they will realize their capital gains. Heirs receive a stepped-up basis upon an estate event.
- UPREITs typically own a variety of property types across different markets, which reduces concentration risk and provides exposure to multiple real estate sectors. Since PLNR and Private UPREITs have the advantage of low correlation with the stock market volatility, their managers are more likely to focus on long-term investment goals than public REITs which must pay closer attention to short term fluctuations.
- Heirs inheriting the REIT units can immediately redeem them with minimal or no capital gain taxes at the stepped-up basis. Traditional DST's without an UPREIT option are less liquid and investors and their heirs are expected to adhere to the sponsor's prescribed hold period, regardless of an estate event.
- Investing in a REIT simplifies the tax reporting process for 721 Exchange investors. REITs often handle the calculation and tracking of depreciation, and file composite state tax returns. This reduces the complexity and administrative burden associated with multi-state tax filings, which is often a challenge for individual property owners or DST investors.
