On March 14, 2016, the staff of the Securities and Exchange Commission (SEC) issued an interpretative letter providing that a stockholder’s Rule 144 holding period for shares of common stock of a publicly traded real estate investment trust (REIT) acquired in exchange for privately placed units of the REIT’s operating partnership (OP Units) commences with the shareholder’s acquisition of the OP Units, not the later acquisition of the REIT shares. The position is significant both for holders of OP Units and for REITs structured as umbrella partnerships (UPREITs) that have issued or may issue OP Units. As a result of this interpretation, holders of OP Units may sell REIT shares received in exchange for OP Units more quickly and easily. In addition, certain REITs may be able to avoid the time and expense associated with registration rights obligations for such shares.
The letter is available here.
In the typical UPREIT structure, the REIT owns all of its real estate assets and operates its business through an operating partnership. The REIT serves as the general partner (or controls the general partner) of the operating partnership, and the REIT’s only material assets consist of OP Units issued by the operating partnership. The operating partnership may issue OP Units to other investors in private placements, typically in exchange for assets that are contributed to the operating partnership.
Normally, an OP Unit is the economic equivalent of one share of the REIT’s common stock (REIT Share). The holder may request that an OP Unit be redeemed (typically after an initial holding period) by the operating partnership for cash equal to the market price of one REIT Share at the time of redemption. Once the OP Unit holder makes such a request, the REIT may elect to pay in cash or exchange the OP Unit for a REIT Share. In practice, REITs usually elect to exchange OP Units for REIT Shares rather than paying cash.
REIT Shares are registered under the Securities Exchange Act of 1934 (Exchange Act) and are listed on a national stock exchange. In contrast, OP Units have no public market. Customarily, the operating partnership’s partnership agreement significantly restricts transfers of the OP Units. Both the exchange of REIT Shares for OP Units and any resale of such REIT Shares must be registered under the Securities Act of 1933 (Securities Act) or exempt from registration. If the exchange itself is registered, the REIT Shares are not "restricted securities" (as defined below) and resales may be made immediately in reliance on statutory trading exemptions. If the exchange is unregistered, however, the REIT Shares are restricted securities so that reliance on Securities Act Rule 144 is needed to establish the exemption for public resales of the shares.
Rule 144 under the Securities Act provides a "safe harbor" from registration under the Securities Act for public resales of securities first issued in a transaction not involving a public offering (restricted securities). The Securities Act defines "underwriter" to include any person, without regard to profession, "who has purchased from an issuer with a view to … the distribution of any security." With exceptions not relevant here, sales by underwriters are always required to be registered. Rule 144 allows a holder of restricted securities to disprove distributive intent through satisfaction of a holding period (in addition to other requirements for affiliates of the issuer). The holding period for securities issued by companies that have been required to file reports under the Exchange Act for at least 90 days is six months from the purchase and full payment for the securities. A 12-month holding period is required for securities issued by other companies. In certain circumstances, Rule 144 allows a holder of restricted securities to add (or "tack") the holding period of other parties or related securities to the holding period for the currently held securities.
For OP Units and REIT shares, the SEC staff had never published an interpretation stating whether a holder of REIT Shares received in exchange for OP Units could tack the holding period of the OP Units. Some practitioners had taken the view that tacking was not permitted and that a new holding period was required. Under this interpretation, holders of REIT Shares received in exchange for OP Units had to wait at least a further six months to sell their REIT Shares under Rule 144. To allow such holders to sell sooner, REITs often agreed to register the exchange of REIT Shares for OP Units and/or the resale of such shares under the Securities Act.
The new SEC staff interpretation provides that, for purposes of Rule 144, the holding period for REIT Shares received in exchange for OP Units will commence on the acquisition of such OP Units. In other words, the holding period of such REIT Shares and the related OP Units is the same.
The SEC staff cited four representations critical to its conclusion:
- the holders of the OP Units paid the full purchase price for the OP Units at the time they were acquired from the operating partnership;
- an OP Unit is the economic equivalent of a REIT Share, representing the same right to the same proportional interest in the same underlying pool of assets;
- the exchange of REIT Shares for OP Units is entirely at the discretion of the REIT; and
- no additional consideration is paid by the holders of the OP Units for the REIT Shares.
Impact on Holders of OP Units
The new SEC staff interpretation should provide earlier liquidity for REIT Shares received in exchange for OP Units. Holders should be able to sell under Rule 144 REIT Shares received in exchange for OP Units immediately following such exchange (provided the OP Units had been held for at least six months) rather than having to hold such REIT Shares for an additional six months and/or waiting for such exchange or sale to be registered under the Securities Act.
In addition, from a contractual standpoint, the interpretive letter may also allow holders of OP Units to be able to elect to redeem their OP Units more quickly than was traditionally the case, as the SEC’s position may cause operating partnerships to abandon a common contractual provision that prohibits holders of OP Units from requesting the redemption of such OP Units for a period of 12 months after their issuance.
Finally, it is possible that the SEC’s interpretive letter may lead lenders to concluded that OP Units are a more attractive asset to serve as security for a loan, as lenders may determine that, after foreclosing on any such OP Units, they may be able to more readily resell under Rule 144 REIT Shares received in exchange for such OP Units.
Impact on UPREITs
For UPREITs, the SEC staff’s new Rule 144 interpretation may facilitate the argument that registration rights in connection with OP Unit issuances are unnecessary. A holder of OP Units recognizes any taxable gain at the time OP Units are exchanged for REIT Shares; accordingly, such holder has an interest in being able to make an immediate sale to fund any income tax liability. Historically, holders of OP Units had to wait (absent registration) at least six months to be able to sell REIT Shares received in exchange for OP Units under Rule 144, which justified demands for registration rights to allow for immediate resales to cover taxes. Now that the SEC staff has provided that sales under Rule 144 of REIT Shares received in exchange for OP Units can occur immediately following such exchange (provided the OP Units have been held for at least six months), REITs may be able to argue that registration rights are unneeded and that the REIT should not be required to incur the time and expense of registration.
In addition, some registration rights agreements provide that registration rights obligations terminate once the applicable securities are eligible for resale under Rule 144. Given the SEC staff’s position, UPREITs with existing registration rights obligations should check the terms of the related registration rights agreements to determine whether such obligations have ceased to apply and/or whether any existing registration statements could be terminated.