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What are the advantages of forming a REIT for a foreign institutional investor?

We are a Chinese fund that owns three hotels, two on the East Coast and one in Texas. We are looking to acquire more properties in a variety of asset classes and were wondering if there would be a benefit for us in forming a REIT? Would we be able to meet all the requirements for being a REIT?

  • March 23, 2018

    The biggest benefit is to US investors that require protection from UBTI. Many institutional investors, foundations, or pension funds require REIT structures for these investments, and therefore you open yourself up to new investor pools. The REIT structure comes with a bunch of compliance requirements and you will likely need to form a blocker entity in the US to achieve compliance.

  • Farazad Investments
    March 23, 2018

    REIT has many advantages; however, based on the number of assets you currently have in your portfolio, I think it would be both pragmatic and beneficial to add few more assets to your portfolio in different classes to easily meet all necessary criteria's of REITs.

  • Seyfarth Shaw LLP
    March 23, 2018

    REITs are typically specialized by property type (apartments, shopping malls, industrial facilities, etc.) While it will be fact-specific, generally, REITs offer higher dividend yields, the taxes are fairly straightforward, REIT shares trade on a stock exchange and typically have a diversified portfolio. Given the tax nature of REITs, it is best to consult a tax advisor before proceeding.

  • Greenberg Traurig, LLP
    April 01, 2018

    There are several important advantages and disadvantages to the REIT structure. First, the disadvantages. REITS must own assets that qualify as proper assets for the category as passive real estate investment assets. So, owning operating hotels, parking garages, restaurants and other operating businesses built on real estate do NOT qualify. In the case of hotels, the way to qualify ownership, and not operations, as qualifying for a REIT is that the REIT may hold title to a hotel property and lease it to another entity that is not a REIT. The income received from the tenant of the hotel would qualify as "good" REIT income, but may not share in the profit or net income of the hotel operations. The lessee may either be an arms length third party, such as a major hotel operating company (i.e. a Hilton or Marriott) or an affiliate of the REIT which is known as a TRS, or taxable REIT subsidiary, which is an entity that is taxable in the US as an ordinary C corporation. The other disadvantage of a REIT is that it MUST distribute 90% of its income to its shareholders, giving it little ability to retain earnings for growth or capital expenditures. In addition, REITs must have at least 100+ shareholders. In a private, closely held REIT, this qualification is satisfied by having one of several service companies that provide small amounts of preferred equity to the REIT and are issued preferred shares in small amounts (often $10,000 per investor or even less) to 100+ shareholders, who receive a fixed, preferred return on their investment ahead of the common shareholders in order to meet this test. If a REIT fails one of its qualifying tests at any time, they may be subject to a loss of REIT status and then be subject to be taxed as a C corporation, creating a double layer of tax: a tax to the corporation of its income (formerly at 35%, now reduced to 21%) and upon distributing the after tax income to shareholders, another tax at the individual level of up to 37%, plus applicable state and local taxes at each level. So, once being formed as a qualifying REIT, maintaining REIT qualifying status is essential to avoid additional taxes and penalties. The advantages are that qualifying REIT income does not get taxed at the corporate level, and is only taxed to shareholders receiving distributions, much like an LLC or partnership in the US. Until January, 2018, the individual federal tax maximum rate was 39.5%, but this has been lowered to 37% under the new tax law; however, under the new tax law certain types of investment income, which would include dividends from REITS, are only taxed at 21%. So, a REIT would not only eliminate tax at the REIT/corporate level but also have the benefit of having a lower tax rate applicable to distributions of 21%. This lower rate of 21% would may not be available to real estate held through partnerships or LLCs under the tax law, though many think some tax law clarifications may change this in the future. The other principal advantage of a REIT is for foreign investors that can structure their real estate investments into a domestically controlled REIT. Most foreign pension fund and sovereign wealth investors have invested in US real estate in this manner for many years. This means that more than 50% of the REIT is owned by a US domestic corporation (which may be a REIT) that is fully subject to US taxes, and the foreign investor would hold the non-controlling interest in the REIT, which would enable the foreign investor to reduce its FIRPTA/tax liabilities, on a properly structured sale. These aspects are fairly complicated and you should seek advice from experienced REIT legal and tax experts to properly establish and maintain a REIT if this is something you desire to pursue, which is something my firm does extensively.

  • SPC Advisors, LLC
    April 03, 2018

    I understand your question; one of the main reason Chinese investors like the tax advantages of investing in a REIT (a public REIT) is that if the investor holds 5% or less of the REIT stock, the stock can be sold without a FIRPTA tax. As far as the best structure for holding existing and future assets, there may well be a benefit to creating a REIT. I normally ask clients a list of questions to determine the most favorable structure for them, coordinate with my favorite tax counsel and we go from there. Among the questions is the source of the funds, whether you are looking to add investors, the type of business you want to engage in. There is a benefit of having an umbrella entity so you can offset tax gains against tax losses. But the most favorable structure may require a combination of debt and equity.