Pursuant to an interpretative letter issued on March 14, 2016 by the Securities and Exchange Commission (SEC), 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 (OP Units) of the REIT’s operating partnership (OP) commences with the shareholder’s acquisition of the OP Units, not the later acquisition of the REIT shares. The ability to “tack” such holding period is beneficial to both (1) holders of OP Units, who can now sell REIT shares received in exchange for OP Units directly into the public market without registration rights so long as the OP Units were held for six months in most circumstances, and (2) REITs structured as umbrella partnerships (UPREITs), which may be able to avoid the time and expense associated with registration rights obligations for such shares if holders can satisfy the Rule 144 holding period more quickly.
Rule 144 under the Securities Act of 1933, as amended (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) if certain criteria, including a holding period, are satisfied. The holding period for securities issued by companies that have been required to file reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for at least 90 days is six months from the purchase and full payment for the securities. A one-year 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.
In a typical UPREIT structure, a REIT owns all of its real estate assets and operates its business through an OP, which typically is organized as a limited partnership. The REIT serves as the OP’s general partner (or controls such general partner through a wholly-owned subsidiary of the REIT), and the REIT’s material assets consist solely of OP Units. The OP may issue OP Units to other investors in private placements, with distributions on OP Units equivalent to distributions on REIT shares. The issuance of OP Units to investors other than the REIT typically is in exchange for real estate assets contributed to the OP, and, contributors acquire their OP Units at the full purchase price, based on the value of the REIT shares at the time such property is contributed. Typically, an OP unit holder has a redemption right (after an initial one-year holding period pursuant to the OP’s partnership agreement), and upon a redemption request, the OP is required to redeem such units for cash equal to the market price of the corresponding REIT shares. However, upon a redemption request, the REIT may, at its option, assume the OP’s redemption obligation and elect to acquire such OP Units in exchange for REIT shares.
While OP Units are not listed on a stock exchange or traded over the counter, the REIT shares are registered under the Exchange Act and listed on a national stock exchange. OP Units are subject to significant transfer restrictions under the OP’s partnership agreement. Both the exchange of REIT shares for OP Units and any resale of such REIT shares must be registered under the Securities Act or exempt from registration. The REIT shares will not be “restricted securities” if the exchange is registered, and resales may be made immediately in reliance on statutory trading exemptions. However, the REIT shares will be restricted securities if the exchange is unregistered, and Rule 144 is needed to establish an exemption for public resales of such shares.
Prior to the SEC’s no action letter, some practitioners had taken the view that tacking was not permitted and that a new holding period commenced upon the acquisition of REIT shares in exchange for OP Units. To enable such holders to sell before the holding period elapsed, and alleviate the tax burden triggered by the exchange (the exchange of OP Units for REIT shares generally is a taxable transaction for U.S. federal income tax purposes), REITs often agreed to register the exchange of REIT shares for OP Units and/or the resale of such REIT shares under the Securities Act; however, such registration process results in costs to the REIT. The new SEC interpretation confirms that, for purposes of Rule 144, the holding period for the REIT shares issued in exchange for OP Units commences on the acquisition of the OP Units. As such, holders of such REIT shares do not need to wait at least six months from the time of acquisition of their REIT shares to sell such shares pursuant to Rule 144, and can potentially sell such REIT shares immediately upon exchange. Sales by affiliates of the REIT will still be subject to the volume limitation and other requirements of Rule 144, whether they hold existing publicly traded REIT shares or received such REIT shares upon conversion of OP Units. The increased liquidity obviates the need for REITs to offer time-consuming and costly registration rights in connection with such exchange.
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 OP;
- 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.
The interpretive letter also has other implications beyond Rule 144 and registration rights. For example, on the upside, the new guidance should also assist lenders when considering whether to accept OP Units as collateral for loans. The guidance does not impact the tax treatment of an exchange of OP Units for REIT shares whereby a new holding period (for tax purposes, not securities law purposes) will commence upon the day after the exchange of OP Units for REIT shares, so a sale within one year after the start of such holding period would result in short-term capital gain to the extent the REIT shares have appreciated in value since the exchange.
The SEC staff guidance was specifically based on the UPREIT structure, but represents an interpretive position on which any holder of REIT shares received in a covered exchange transaction may be able to rely, given that the parties submitting the no-action request did not identify specific parties or specific transactions to which the SEC staff directed its no-action relief (the letter was just on behalf of Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporated and their affiliates as clients of the authoring law firms). Whether this new guidance will assist in assessing holding periods in other transaction structures and/or whether the SEC staff will offer further guidance on this issue is unpredictable.