April 15, 2025 - UPREITs, or “umbrella partnership real estate investment trusts,” are an increasingly popular exit option for property owners. But how do they work?

Similar to a Section 1031 exchange, UPREITs allow selling owners to avoid the hefty capital gains tax in selling a property under Section 721 of the Internal Revenue Code. However, they also come with additional benefits, including lessening management overhead, generating reliable quarterly income, and giving the owner more flexibility in terms of liquidity.

This article explains the corporate structure of an UPREIT, the benefits and potential risks of this structure, and what investors should consider when planning their exit strategy.

Overview of the UPREIT Corporate Structure

An UPREIT is a structured partnership between an umbrella partnership and a real estate investment trust (REIT). This hybrid model functions as a kind of specialty REIT, allowing for unique benefits within the REIT structure.

An UPREIT allows property owners to transfer ownership of their real estate assets to the partnership and receive operating partnership (OP) units equivalent to the property's fair market value. The umbrella partnership takes ownership of the property and adds it to the REIT’s portfolio under centralized management. The REIT takes over the property’s ongoing care and maintenance, relationships with tenants and vendors, and anything else involved with managing the property.

In exchange, the selling owner receives OP units that can be converted to shares in the REIT, giving them a much more diverse real estate portfolio and benefits like quarterly dividends and the ability to convert their shares to cash more easily.

The partnership between the UPREIT and the REIT is governed by an agreement outlining the relationship's governing terms, including distribution policies, redemption options, capital calls, and any other terms.

We have written previously about the benefits of this structure for those who are selling property and converting it into an UPREIT, including:

• Eliminate the management hassles of owning real estate
• Diversify your portfolio through their shares in the REIT
• Upgrade to institutional quality real estate
• Receive consistent quarterly income
• Simplify estate planning

While there are many reasons a seller might consider an UPREIT, it is not without risks.

Potential Risks of UPREITs

All transactions, including UPREITs, come with risk. These are important for selling owners to be aware of before embarking on an UPREIT transaction so they can make an informed choice:

• Portfolio market risks: While REITs tend to be safer investments than individual properties due to their diverse holdings, they can still be impacted by market forces, especially if the REIT is concentrated in a specific sector (such as office buildings during COVID-19).
• Financing risks: Since REITs tend to rely on leverage, they can be vulnerable to changes in interest rates, especially unexpected rate hikes. Having a healthy debt-to-equity ratio is critical to avoid becoming overleveraged.
• Conflicts of interest risks: The larger and more complex the REIT becomes, the greater the chance it will enter into agreements with other organizations with which it has pre-existing relationships. These “related party” transactions create the potential for conflicts of interest. For instance, if an existing shareholder in the REIT participates in an UPREIT, there is potential for a conflict of interest because the seller may prioritize their personal financial gains over shareholder returns. Note: Publicly traded REITs are obligated to disclose any related-party transactions.
• Increased tax compliance risks: UPREIT structures come with additional tax compliance risks from requiring that the REIT meets certain organizational requirements including not being closely held as well as needing to carefully monitor and pass asset and income tests.

Selling owners can help mitigate these risks by carefully evaluating the REIT they plan to participate in before initiating the UPREIT transaction. Here are the evaluation criteria we recommend:

• Key metrics: Potential investors should review the REIT’s funds from operations (FFO), net asset value (NAV), and debt-to-equity ratio to ensure the REIT is in a healthy financial position.
• Management: Knowing who the management team is and what their track record for success with other properties is essential. Sellers should consider whether the REIT’s management team has experience managing the type of property they plan to convert into an UPREIT and their history.
• Portfolio makeup: Sellers should be aware of the risks of the REIT they are investing in and ensure it aligns with their own goals and risk tolerance. This includes evaluating how diversified the portfolio is, what kinds of properties are included, and what the occupancy rates are like.
• Growth strategy: How does the REIT intend to generate value for investors? Sellers should consider the overall growth strategy, from planned acquisitions to new developments.

Considerations for Your Exit Strategy

One reason someone may consider an UPREIT is to diversify their real estate holdings while deferring the taxes on a large real estate transaction. For investors who have this goal in mind, it is important to have an exit strategy that plans for taxable events. For example, redeeming OP units for cash or converting OP units into shares in the REIT are taxable events that can be done incrementally over time so that the tax impact can be proactively managed. The ability to control the taxable events also creates opportunities for estate planning in allowing for a more tax efficient transfer of wealth to multiple beneficiaries over time. Each beneficiary can choose either to hold their OP Units and receive quarterly distributions, redeem their OP Units for cash, or convert their OP units to shares in the REIT. In addition, if an OP unit holder still owns their OP units at the time of their death, then their tax basis in their units may be stepped up to the fair market value at the time of death, leading to the beneficiaries being able to redeem the OP units for cash or convert them to REIT shares without incurring any tax.

If you would like assistance in evaluating an UPREIT structure or planning your exit, please contact Citrin Cooperman’s Real Estate Industry Practice or reach out to Stephen Lee for more information.