The Benefits of Investing in UPREITs

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By Cliff Berryman

While the Coronavirus has caused the commercial real estate markets to pause and take a breath, the current medical real estate environment has physician sellers still capturing record high sales prices and buyers lining up to make offers. While real estate and the general economy have been on an upward trend for the past decade, medical real estate has outperformed other asset classes because of investors who see opportunity and security in the growing need for healthcare providers.  

Physicians and independent clinics are selling their real estate for a multitude of reasons. We have heard many sentiments from our clients, including:

Our younger partners have no interest in buying into our real estate ownership.”

“We recently affiliated with the hospital and they are encouraging (or requiring) us to sell our real estate.”

“Our group is looking to grow and the millions we have tied up in our real estate could be reallocated.”

“My partners and I are thinking of retiring in the next couple years.”  

If any of those statements sound familiar and you are exploring the sale of your medical property, the positive news is that you can directly control the pricing you receive for your building. Much of your building’s value can be created by the lease that you put into place through what is known as a sale leaseback. If you are planning to stay in the property for a long time, you should agree to sign the longest lease possible. Leases with longer terms, higher rental rates, and triple-net expense structures will garner the highest possible price.  Additionally, certain buyers are able to provide sellers with tax benefits where you can defer paying taxes on the sale of your property indefinitely, while diversifying your real estate exposure and earning an attractive return.   

Over the lifetime of building ownership, many property owners have been forced to manage the maintenance, accounting and general upkeep of a property, distracting practice managers or physicians from their core duties. These common demands of property ownership further make the thought of passive returns from owning shares instead of a physical building attractive to many. Larger buyers are often able to provide equity in the form of operating partnership units in addition to cash in conjunction with the purchase of a building. This allows active owners of real estate to become passive investors while diversifying from a single building to a portfolio of properties. Typically, this occurs when selling a property to a real estate investment trust (REIT) or an investment fund where the transaction is commonly referred to as an “UPREIT” or a “721 exchange,” after the section of the tax code that describes the structure.   

This is viewed for tax purposes as the seller contributing their building, or portion of their building, to the real estate investment trust and defers the capital gains on the sale. Depending on the REIT, sellers generally have the flexibility to receive sale proceeds in any ratio of cash and REIT partnership units. 

Similar to a 1031 exchange, a 721 exchange provides sellers with deferred tax treatment on the portion of the proceeds the seller elects to receive in equity, as opposed to cash. In an UPREIT transaction, understanding the culture of the buyer group is as important as the negotiated sale price, as well as the historical performance and future growth prospects of the new owner. A sale-leaseback transaction does not end when the sale of the building occurs; the relationship you have with your landlord will continue for many years, so you should ensure they are a good cultural fit with you and your partners. 

Whether you are looking for a new capital strategy or a way to diversify you investment, the UPREIT is a fantastic option, especially right now, and one that all owners should consider. From 2004 to 2019, REIT’s have outperformed the S&P 500 by 9% with an increase of 228.4%, which is a testament to real estate investment trusts as a solid long-term investment. Between defering your taxable gains or moving your capital to a passive real estate investment vehicle, the UPREIT gives an owner the power to maximize their long-term income. It is always best to consult your accountant before pursuing an UPREIT to find the most pertinent and creative ways to implement a plan based on your specific needs. 

Cliff Berryman is EVP of Acquisitions for Flagship Healthcare Properties.

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