On March 14, 2016, the Staff of the SEC issued interpretive guidance with respect to the application of Rule 144 under the Securities Act of 1933 in the common situation involving the exchange of operating partnership (OP) units into shares of the parent real estate investment trust (REIT). Specifically, the interpretive guidance provides that, under certain conditions, the holding period for REIT common stock acquired upon an exchange of units in the REIT's OP commences upon the unit holder's acquisition of the OP units, rather than at the time the REIT common stock is acquired. The Staff's guidance provides long-awaited relief to REITs structured as umbrella partnerships or "UPREITs" that seek to issue OP units as part of their consideration for real estate acquisitions through their OPs.
To review the SEC's interpretive guidance, click here.
Background; REIT Structure
In an UPREIT structure, the public company REIT's only material assets are its partnership interests in an operating partnership, or OP units. Further, all of the REIT's real estate properties are held directly or indirectly by the OP, which operates and collects all of the income from the properties. The REIT is the general partner (GP) of the OP (or controls the GP) and the majority holder of OP units. Other unit holders hold OP units, which they acquired in non-public offerings typically in exchange for real estate assets contributed to the OP or other consideration. By exchanging real estate assets for OP units, these unit holders are able to defer taxes payable on the gains from the sale of such real estate. Such taxes become due upon the redemption of OP units for cash, or the exchange of OP units for REIT common stock. The OP agreement usually provides liquidity for unit holders by permitting them to redeem OP units after an initial one-year holding period. Upon redemption, the OP redeems the OP unit for cash, or the REIT, at its sole option, may assume the redemption obligation and exchange the OP units for REIT common stock.
Rule 144 Holding Period
Rule 144 provides a non-exclusive safe harbor from the definition of "underwriter" in Section 2(a)(11) of the Securities Act. Rule 144(b) provides the conditions that must be met for sales of restricted securities under the Rule 144 safe harbor. Among other requirements (including certain requirements applicable to affiliates of the issuer), Rule 144(b) provides that a person may rely on the safe harbor if the holding period requirement set out in Rule 144(d)(1) has been satisfied. The relevant Rule 144(d)(1) holding periods are as follows:
- if the company is, and has been for at least 90 days prior to the sale, subject to the reporting requirements of the Securities Exchange Act of 1934, a minimum of six months must elapse between the date of the acquisition of the securities and any resale of such securities; and
- if the company has not been subject to the reporting requirements of the Exchange Act for at least 90 days prior to the sale, a minimum of one year must elapse between the date of the acquisition of the securities and any resale of such securities.
The interpretive guidance was issued in response to a request for interpretive guidance submitted by Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporated and their affiliates (BAML). In the letter, BAML sought guidance on the application of Rule 144 in the following fact pattern:
- All of the REIT's investments (i.e., real estate assets) are acquired and owned directly or indirectly by its umbrella partnership, which is organized as a limited partnership;
- The OP is the entity through which the REIT operates its business;
- The REIT's only material assets are its interests in the OP represented by OP units, and the REIT serves as the general partner of the OP (or controls the GP);
- Other unit holders also own OP units, typically acquired privately in an exchange for real estate assets they contributed to the OP;
- The REIT's common stock is registered under Section 12 of the Exchange Act and is publicly traded on a national securities exchange such as the NYSE or NASDAQ;
- There is no public market for OP units and the agreement governing the formation of the OP (the OP agreement) contains significant restrictions on the transferability of OP units; and
- The cash value of the OP unit at redemption directly corresponds to the market value of the REIT's common stock at that time.
In transactions involving the above fact pattern, the Staff expressed its view that for purposes of Rule 144(d)(1) under the Securities Act, the holding period for REIT common stock acquired upon an exchange of OP units commences upon the unit holder's acquisition of the OP units, rather than at the time the REIT common stock is acquired, which was the Staff’s prior position. In reaching its conclusion, the Staff noted the following representations:
- The OP unit holders 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 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 is entirely at the discretion of the REIT; and
- No additional consideration is paid by the unit holders for the shares of REIT common stock.
Eligible OP unit holders should benefit from this new interpretive guidance because, in many cases, they may be able to freely transfer, sell or otherwise dispose of the REIT's common shares immediately upon receiving such shares upon exchange of OP units, regardless of whether the transaction is registered under the Securities Act. In addition, REITs that seek to use OP units as consideration in the acquisition of real estate assets should also benefit because the ability to sell under Rule 144 would, in many cases, dispel of the need to file a registration statement under the Securities Act to register the primary issuance of REIT common stock to OP unit holders upon tender of those OP units for redemption and/or the resale of the REIT common stock by the selling stockholders.