Overview

In March, the U.S. Securities and Exchange Commission (SEC) issued a no-action letter regarding satisfaction of the required holding period under its Rule 144 safe harbor for certain resales of “restricted securities” without registration under the Securities Act of 1933 (the “Securities Act”), in the context of sales of common stock of a public real estate investment trust (REIT) acquired in exchange for the same REIT’s operating partnership (OP) units. In contrast to the SEC staff’s general position that a holder exchanging a security of one issuer for a security issued by a different (albeit related) entity may not satisfy the safe harbor’s requirements by “tacking” its holding period for the two securities, this letter affirmed that when REIT common stock is received by holders in exchange for OP units in a customary umbrella partnership real estate investment trust (UPREIT) structure, notwithstanding that the REIT and its OP are not the “same issuer,” such holders generally may count their holding period for the OP units, plus their holding period for the REIT common stock following such exchange, in determining whether they meet Rule 144’s holding period requirement.

The Basics

Generally, securities issued without registration – which is normally the case for OP units issued in exchange for real property as well as common stock that may be issued in exchange for OP units in a typical UPREIT structure – are classified as “restricted securities” under the Securities Act. In order to avoid Securities Act registration for the resale of restricted securities by not being classified as “underwriters” pursuant to the Rule 144 safe harbor, a holder must satisfy a number of requirements, including a requirement under Rule 144(d) that such securities have been held for a period of at least six months[1] before they are transferred or sold.

UPREIT partnership agreements typically require that OP units issued in exchange for a contribution of real property assets must be held for a specified period (usually one year) before they may be exchanged for REIT common stock, which represents an economic interest in the underlying portfolio of real estate assets substantially identical to that of the OP units. Notwithstanding this fact, prior to this no action letter informal SEC guidance under Rule 144 indicated the SEC would not allow holders to “tack” the holding periods of the two securities. Thus, the REIT common stock had to separately satisfy the Rule 144(d) holding period before it could be sold without registration under Rule 144. Under this new guidance, the holding period generally will begin to run as soon as the OP units are acquired.

The Application

The guidance issued will be applicable to transactions that conform to the facts and circumstances addressed in the underlying no-action request submitted on behalf of Bank of America, N.A, Merrill Lynch, Pierce, Fenner & Smith Incorporated (“BAML”). Because that request did not address a particular REIT or transaction, however, it should be applicable for all exchanges of UPREIT OP units that conform to the four factors cited by the SEC as the basis for its grant of the required “no action” relief:

  • Unit holders must pay the full purchase price for the OP units at the time they were acquired from the OP[2];
  • An OP unit must be the economic equivalent of a share of REIT common stock, representing the same right to the same proportional interest in the same underlying pool of assets;
  • The exchange of REIT common stock for OP units must be at the discretion of the REIT; and
  • No additional consideration is required to be paid by the OP unit holders for issuance of the shares of REIT common stock in exchange for the OP units.

The SEC noted that absence of any of these factors could result in a different conclusion concerning the application of the Rule 144(d)(1) holding period to the exchanged shares.

What This Means to You

This guidance should benefit both REITs and the holders of their OP units by eliminating the need, in most cases, for a “selling stockholder” registration statement or prospectus to be filed under the Securities Act before the REIT common stock issued in exchange for OP units may be sold into the public market by the exchanging holder. Where exchanging holders of OP units have been granted the right to have the REIT register their securities for public resale under the Securities Act, such agreements typically provide that no registration statement need be filed, or that an existing resale registration may be discontinued, if the selling holders are able to utilize the Rule 144 safe harbor for their transactions. The elimination or significant reduction of such resale registration statement filings will save REITs both time and money, and may also avoid potential conflicts with primary offerings by the REIT, under a shelf registration statement or otherwise, in other capital raising transactions.

OP unit holders also benefit from this guidance, which provides additional flexibility and certainty concerning their ability to freely transfer REIT common stock acquired upon the exercise of OP unit exchange rights without the delays previously associated with waiting for a resale registration to be completed or for the full Rule 144 holding period to run after acquiring their stock.