Asset managers tend to continually evaluate their capital sources and often seek to expand their investor base.
Many managers have concluded that the future lies with retail investors, a large and growing segment of the capital markets. Real estate managers and sponsors are no exception, and many are exploring ways to tap into the retail market.
What is a REIT? A real estate investment trust, or REIT, is a type of entity that primarily owns real property (and must accordingly meet certain asset and income tests to qualify to elect REIT status) and receives special tax benefits pursuant to its tax classification as a REIT. Most notably, the REIT benefits include the ability for the REIT to reduce its taxable income by distributing the income to its shareholders, effectively eliminating the “second layer” of tax ordinarily arising at the corporate level.
Let’s talk about some reasons to put these two together – to form an Opportunity Zone Fund that also qualifies as a REIT.
First, a REIT structure provides a great deal of flexibility on exit. One key limitation of the Opportunity Zone rules is that investors must exit by selling their interest in the Opportunity Zone Fund. A REIT, however, can meet this requirement by selling its assets and immediately liquidating, as a sale of assets and liquidating distribution are generally treated for tax purposes as a disposition by the shareholders of their interests in the REIT. There is no analogue for this treatment in other common real estate vehicles such as a partnership or LLC, and accordingly the ability to engage in an asset sale may be limited for such entities in the absence of further Opportunity Zone guidance. REIT shares also can be listed on a national securities exchange, which can provide additional exit opportunities in case the preferred exit is not a sale of the assets and liquidation of the REIT. Listing REIT shares on an exchange provides shareholders the flexibility to exit the investment on their own, with control over the amounts and timing of their sales. On the other hand, the sponsor would continue to effectively control a permanent capital vehicle.
So – are Opportunity Zone REITs a path to the retail market?
The short answer, again, is yes – Opportunity Zone REITs should be considered as a possible path to raising retail capital. The simplified reporting requirements and the expanded set of potential exit structures make REITs an attractive investment vehicle both for investors generally and for investors in Opportunity Zone Funds. There may, of course, be reasons not to use a REIT in a given deal, and other structures may provide other advantages – and it is possible that future tax regulations may provide additional benefits to Opportunity Zone Funds formed as partnerships or LLCs (for example, regarding ability to make distributions). Nevertheless, the benefits of a REIT structure are significant, and may especially be so for certain investors.