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Is An UPREIT Transaction The Right Strategy For Today’s Multifamily Owners?


When the dust settled from the initial disruption caused by the pandemic, it was clear that two commercial real estate asset classes came out on top: multifamily and industrial. Industrial saw gains thanks to the surge of e-commerce activity, and multifamily rents continued to rise in 2020 and soar even higher in 2021.

CBRE predicted that 2022 will be a record-breaking year for multifamily investment volume. Although many owners may be looking to strike while the iron is hot and sell their properties now, they should consider alternative strategies before committing to a cash deal. 

“Multifamily had a historical run in 2021, owners saw their valuations rise and now there are very motivated sellers, but that doesn’t mean that a cash sale is always the best option,” Bonaventure CEO Dwight Dunton said.

Founded in 1999, Bonaventure is a vertically integrated real estate private equity firm, specializing in the development, investment, construction and management of multifamily communities across the mid-Atlantic and Southeast. Bonaventure offers a variety of private investment strategies.

The firm operates an Umbrella Partnership Real Estate Investment Trust, or UPREIT, which is a real estate investment trust that’s inorganic growth stems primarily from 721 exchanges. In a 721 exchange, real estate owners contribute their property to an operating real estate partnership, or OP. In exchange, they gain interest in that partnership, while deferring taxes on the sale — no tax is due on the contribution or receipt. These owners can then take a loan on their new equity stake in the REIT for immediate tax-exempt liquidity.

REITs often use OP exchanges — usually through OPs with a large number of properties — to scale their portfolios in a tax-friendly way. Along with deferring capital gains taxes, property owners who exchange real estate for OP units gain interest in a larger, more diversified portfolio, and eventually, they can convert their units into shares of an UPREIT to gain liquidity. 

Dunton said that since Bonaventure is vertically integrated, the firm is able to conduct advanced due diligence, improving returns for investors, often sourcing off-market deals. The acquisitions team targets newer, Class-A, stabilized multifamily properties valued between $30M and $100M in the mid-Atlantic and Southeast. 

He further explained why the firm is effective at conducting 721 exchanges. 

“While this option is available to all, only certain types or sizes of firms can truly take advantage of this tool,” Dunton said. “If a manager has too many assets under management, they don’t have time to negotiate these complex deals one-by-one like Bonaventure and our dedicated acquisitions team. If a manager is too small they are limited in the size or quantity of deals they can do, which may make complex efforts like the 721 not quite worth it.”

Dunton said that while some of the largest multifamily market-share companies have to make deals that may not always be the right choice for their investors in order to put their capital to work, Bonaventure's private structures allow it to say “no” when the deal is not right for its strategy. 

“We aim to be methodical and intentional in our approach in every deal that we do,” he said. “They are not just beneficial to us as a firm, but to our end investors as well. We want it to work for each side of the deal.”

An alternate option to deferring taxes upon the sale of a multifamily investment is through a 1031 exchange. A 1031 exchange allows investors to carry forward the cost basis of their ownership stake in certain types of investments — including multifamily real estate properties — without creating a taxable event. 

These are highly beneficial for families who have a net worth below the U.S. estate tax threshold and who intend to manage their properties until their death, Dunton said. Per IRS rules, these investors can continue to 1031 exchange their properties and fully avoid a taxable event. This is because those properties get a “stepped-up” cost basis upon the owner’s death.

Dunton presented a hypothetical scenario to better understand why some owners prefer an UPREIT tax deferral to a 1031 exchange.

An owner of a $100M multifamily property is interested in selling their building and retiring. They have three options available: option A is a cash sale at $100M; option B is a 1031 exchange into a new $100M building; and lastly, option C is a 721 exchange at a $92M valuation.

Initially, option C looks terrible, until the owner conducts a deeper analysis of their options.

Assuming they pick option A, they may only walk away with $65M in cash after paying taxes.

If they instead choose option B, they have six months to find a suitable new property to buy with their $100M and walk away with a new valuable property, $0 in cash and the need to pay a property manager so they can retire.

“If they pick option C, they walk away with $92M in shares of an UPREIT,” Dunton said. “They are paid distributions on these shares as if they still owned the underlying property, they can take loans on these shares for immediate lump sum liquidity, their shares will appreciate in value with the value of the underlying properties, they are invested in a more diversified portfolio, and they avoid the need to manage their property.” 

Option C may value the property at a lower value, but it puts the most cash in the pocket of a property owner seeking retirement, he said. 

Dunton summed up the strategies up by explaining that each option offers benefits, depending on the goals of the investor.

“For multifamily investors seeking tax deferral options, 1031 exchanges are the preferable option if they are seeking to continue active investment, while UPREITs — 721 exchanges — are preferable to investors seeking passive investment options,” he said.

Bonaventure does not provide tax advice. Please consult a tax expert before consideration of an UPREIT transaction.

This article was produced in collaboration between Studio B and Bonaventure. Bisnow news staff was not involved in the production of this content.

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