Unlocking shareholder value

www.pwc.com/us/realestate

Unlocking shareholder value

Real estate monetization strategies

February 2018

Dear Friends,

In recent years, many companies have been reconsidering their real estate strategies. This is

especially true for companies that own and utilize significant real estate in their business. In many

cases, this is either part of an effort to unlock untapped shareholder value in existing assets or to

provide growth capital for the continued expansion of capital-intensive industries. Increasingly,

activist investors are driving these pressures. Recent tax reform legislation and the coming required

adoption of the new lease standard are also factors driving additional considerations.

The universe of what is considered to constitute “real estate” continues to expand to cover an ever-

broadening range of physical assets currently owned by companies and directly used in their

businesses. This is evident in the significant increase of sale-leaseback activity and in the rise of the

so-called, “non-traditional” REIT formations or conversions, which are being used to bring a wide

variety of new asset types into the REIT world. A few of these “non-traditional” asset types include:

timber, farmland, cell towers, billboards, and infrastructure assets of all types in the retail,

healthcare, gaming, telecommunications, energy, storage, and many other real estate-heavy sectors.

We believe this transaction activity will continue as the financial markets strive to satisfy the

voracious need for real estate growth capital – both in the US and globally.

It is important to recognize that the pressure from shareholder activists is not likely to go away any

time soon. Management of companies of all sizes and in all industries need to be prepared to provide

shareholders and investors with a well-articulated strategy that is supported by a proactive

assessment of the company’s existing property portfolio. By telling a clear story and openly

communicating with shareholders and investors, companies both minimize the risk of becoming an

activist target and help build shareholder value.

Recent tax reform legislation signed into law in December of 2017 introduces new interest deduction

limitations for many companies. However, the legislation provided a significant exception for borrowers

engaged in real estate businesses. As a consequence, businesses with significant real estate businesses or

assets may consider strategies to isolate real estate related activities and assets to reduce the burden of

the new interest deduction limitations. Other businesses may consider various monetization

strategies that result in proceeds being used to pay down existing debt and reduce the interest

expense subject to potential limitation. These transactions may be coupled with other structures that

could convert interest otherwise subject to interest limitations to other expenses not subject to the

interest limitations, such as rental expense. Other facets of the tax legislation, including the

reduction to the general US corporate tax rate, retention of like-kind exchanges for real estate,

limitations on state and local tax deductions, may also increase the potential benefits of engaging in

real estate monetization transactions.

This is where we can help. Through our specialists’ global presence and extensive knowledge of

capital markets, PwC can provide you with the insight you need to achieve increased organizational

transparency for investors and shareholders. We believe PwC offers a powerful combination of

personal service, specialized experience, and global reach that sets us apart and helps you achieve

your goals.

Byron Carlock, Jr. Tom Wilkin

US Real Estate Leader Real Estate REIT Practice Leader

[email protected] (214) 754 7580

[email protected] (646) 471 7090

Byron Carlock

Tom Wilkin

Unlocking shareholder value | Real estate monetization strategies 3

Table of content

Emerging trends ................................................................................... 1

Market conditions ................................................................................ 5

Factors to consider ............................................................................... 6

Expanding the possibilities .................................................................. 9

Tax definitions ................................................................................... 10

Overview of various monetization transactions ................................ 12

PwC’s strengths to serve you ............................................................... 17

Appendix A – Example of value creation through a credit lease ....... 20

Appendix B – Other PwC real estate thought leadership .................. 22

Contact us ........................................................................................... 24


Emerging trends

Despite the fact that real estate may

make up the most significant portion

of a company’s assets, operating

costs, or strategic value drivers, the

existing corporate real estate

structures currently used by many

were either initially designed to

support a very different operational

structure than needed today or

motivated by financing, accounting,

or tax considerations that are no

longer relevant. Furthermore, other

factors are on the horizon – such as

changes in lease accounting – that

will also affect the way many

companies think about their real

estate operating strategies. Real

estate also plays a key part in long-

term corporate sustainability.

In many organizations today, the

corporate real estate department is

viewed as more of an administrative

function or cost center, instead of as

a strategic or competitive advantage.

Also often overlooked is the fact that

market shifts frequently result in an

entity’s real estate being valued at

amounts significantly higher than

before – especially for companies

that have built and developed a

portfolio of assets over a long period

of time or through substantial

acquisitions.

Unfortunately, there is no one-size-

fits-all answer to how companies can

either realize or create enhanced real

estate value because the right answer

for one company may be completely

different for another. Optimal

decisions around real estate strategy

are affected by a large number of

factors, including the perceived need

to control particular assets,

operational flexibility, the availability

of alternatives, common industry

practices, tax and regulatory impacts,

and the expectations of management

and investors. A careful

consideration of any given company’s

unique circumstances is crucial in

deciding on an effective approach to

capitalizing on real estate’s true

value. Even within the same

company, different transaction types

may be more appropriate for

different departmental needs,

making it necessary to apply several

different methodologies to reach its

ultimate goals.

Today, many companies are

evaluating the feasibility, benefits,

costs, and other factors associated

with potential real estate

monetization strategies. While

some of these strategic evaluation

initiatives have been spearheaded by

company management, others have

emerged as a result of pressure from

activist shareholder groups and

investment bankers.

In an effort to realize untapped value for shareholders, many real estate-heavy companies are looking to the monetization of their real estate assets to fund core operations and expansion plans. Traditional real estate monetization methodologies include nonrecourse financing, sale leaseback transactions, and more recently, REIT conversions/spin-offs.

2 Unlocking shareholder value | Real estate monetization strategies

Impact of Tax Reform

The signing of “Tax Cuts and Jobs

Act” (TCJA or Tax Reform) into law

in December 2017, represents the

broadest reaching changes in tax law

in over thirty years. Many companies

are considering the impacts of these

changes on their existing and future

real estate strategies. These include

strategies that allow companies to

isolate real estate businesses to

potentially reduce the burdens

associated with the new interest

deduction limitation, identifying

existing assets that might be held in a

real estate investment trust (“REIT”),

existing and future investments from

outside the United States, and other

strategies that address the tax

changes. Other tax changes relevant

to the real estate industry include a

reduced tax rate on REIT ordinary

dividends, the reduced corporate tax

rate, and various other limitations on

the ability of individual’s to deduct

mortgage interest and state and local

taxes. Taken together, the tax

changes are generally expected

to spur additional investment in

real estate and interest in

monetization.

Rise of activist investors and

real estate-driven M&A

Activist investors are increasingly

focusing on the value of a company’s

real estate. Why now? These types of

monetization transactions are not

new – they have been employed by

many in the past.

Since World War II, owning real

estate has generally been viewed as

favorable, but now, we seem to be in

an aggressive cycle of trimming real

estate ownership in favor of selling

and leasing back.

Who wins and who loses? In many

cases, everyone wins!

Many private equity firms that

acquire companies with large

amounts of owned real estate use

sale/leaseback structures as a means

to finance their acquisitions, but they

are not the only ones thinking about

monetization. As companies monitor

and respond to market trends, an

increasingly wide variety of

transactions and restructurings have

emerged. Also increasing is the

pressure companies feel directly

from corporate activist investors or

as a result of takeover activity. A

common focus of many of these

investors is identifying companies

they perceive to have hidden value

that can be unlocked through

structural changes or divestitures,

such as a spin-off. Given the volatility

of real estate valuations, changing

dynamics in their use, and the

market’s quest for yield, real estate is

a common focus of these activist

investors and acquirers.

These activists may espouse

transactions where underlying

financial theory suggests that total

value can be created, through

financial surgery, to separate the

bond-like elements of a company –

such as real estate that can pay a

stable yield from rental income –

from the company’s more cyclical

operations. As a result, the

operations of the company can be

free of the capital intensity often

seen in the real estate industry and

offer higher equity returns. Their

premise appears to be “asset light”

companies outperform the market.

Companies see their stock prices

increase because capital can be

invested into higher ROI-yielding

activities, rather than weighing

down the balance sheet with real

estate capital investments. The real

estate could also trade in a separate

vehicle or be sold to realize its

benefits.

Other drivers of activist pressure on

companies are the beliefs that: a

company’s corporate structure may

not be the most tax-efficient way to

hold the real estate, assets are

underutilized by the existing

company and would be more

valuable if repurposed or split into

separate parts, or a portion of the

business is capital-starved and

needs to be separated to reach its

true potential.


Activist pressure on management

increases even more when a

competitor demonstrates the

potential value that can be derived

from a real estate monetization

transaction. When investors and

shareholders see how successful

various real estate monetization

methodologies are for others, they

want to know why their organization

is not doing this, too.

As industry participants continue to

discover how broad the category of

real estate truly is, the number of

methods used for realizing the value

of this real estate also continues to

expand. Often, organizations attempt

to share the same success as

competitors by mimicking their real

estate monetization strategies,

which, in turn, instills those

transactions/structures as a normal

operating procedure for the entire

sector, over the course of several

years. For example, over the past ten

to fifteen years, we have seen entire

industry business models migrate to

real estate structures, such as a REIT

through REIT conversions or the

consummation of REIT spin-offs.

This occurrence is even more

pronounced in so-called non-

traditional real estate transactions,

such as timber, cell towers,

billboards, and, more recently, power

transmission, gaming and

telecommunications infrastructure.

Finally, the value of an organization’s

real estate may not be leveraged to its

full potential or highest and best use.

This is often difficult for

management to address or even

accept – especially for companies

that are otherwise performing well.

For example, the value of a specific

property, used by the company as a

discount retail operation, may be

worth more used by a high-end

retailer, subdivided and used by

multiple users, or converted to

another use – such as a hotel. In

other cases, for companies in the

midst of an operational transition or

with financial difficulties, it is clear

to management that real estate must

be addressed as a part of broad,

strategic change. Perhaps the most

difficult situation for management to

acknowledge – and the most

significant source of activist

pressure – is in cases where the value

of real estate is higher than the value

of an entire company.

Activist investors: Taking a

preemptive approach

Activist investors actively study many

companies operations in an effort to

identify perceived inefficiencies that

indicate the potential opportunity for

outsized returns – one of which is the

potential to unlock the hidden value

of real estate holdings. Management

should assess for themselves whether

they could be such a company.

In order to make this assessment,

management and the board should:

Be proactive. Don’t wait until a

shareholder activist takes a

position in your company.

Preemptive measures can

prevent the need for reactive,

defensive actions.

Be strategic. Assess if your

company owns or controls real

estate or qualifying real estate

assets that present valuable

monetization opportunities,

drive tax efficiencies, or provide

cost effective ways to redeploy

capital that is more strategically

aligned with business needs –

factors that shareholder activists

are likely to focus on. Use an

integrated approach to conduct

an analysis and develop

responses that align with the

overall objectives of the company

and its shareholders.


U.S. commercial real estate stock

reached a record $16 trillion in

January 2018, up from $14 trillion in

January 20171. Across the globe, a

number of regions have already

recovered from the economic

downturn and exceeded their

previous real estate valuation peaks.

Real estate investment volume, as

measured by the number of

transactions, is growing across the

world although real estate volume as

measured by value is down. Global

real estate investment activity

reached $1.0 trillion through 3Q2017

– an increase of 11 percent over the

same period one year earlier.

However, activity on income

producing properties is down 3

percent over the same periods with

total volume buoyed by investment

in development sites, most notably

in Asia.

The decrease in transaction activity

has continued for seven consecutive

quarters, but demand and capital

allocated to real estate across the

world is still on the rise.

According to Preqin Real Estate

Online, managers of global closed-

end private real estate funds have

$249 billion in capital available to

invest, including the 265 real estate

funds that raised an aggregate of $111

billion of capital in 2017. In addition,

there are currently 573 real estate

funds in the market hoping to raise

an additional $191 billion dollars to

be deployed in real estate.

1 Source: Green Street, January 2018

The rising inflow of capital, current

cycle dynamics and limited amount of

new supply being delivered to the

market has increased the competition

for assets. This competition is leading

investors to look for different

investments in which to allocate

capital. The improving economic

situation in many markets, along with

improving real estate fundamentals,

is giving investors the opportunity to

look for enhanced returns through

value-added and opportunistic

investments. Core real estate

investments, however, remain

popular with investors. As of the third

quarter of 2017, 55 percent of

institutional investors planned to

target core investments within the

next 12 months. This is down from

the 61 percent of investors targeting

core as of the third quarter of 2016,

this strategy remains the most

popular among institutional investors

in the near term. Net lease assets,

both traditional and non-traditional,

from monetization transactions are a

good fit for many of these investors.

While the varying nature of these

transactions make it difficult to

measure just how much the market

for these monetized assets has

grown, it has clearly increased over

the past 7-10 years. This is evidenced

by the following market activity:

The value of traditional sale-

leaseback transactions have

increased since 2016.

As of January 2018, the REIT

conversions or spin-offs

completed since 2011 have a

market cap of approximately

$235 billion.


Market conditions

While concerns about the expected

rise in interest rates in some

markets, like the US, may negatively

impact the long- term pace of

growth, the transaction volume

continued to be significant in 2017

and does not appear to be abating in

the foreseeable future. In fact, in the

short-term, it may spur increased

transaction volumes, as companies

rush to take advantage of interest

rates still near historic lows despite

the recent Federal Reserve actions in

the past two years.

Value creation through lease

structure

Fundamentally, the value of the same

piece of real estate can vary

significantly depending on whether it

is vacant or occupied by a long-term

tenant. Buildings leased on a long-

term basis remain an attractive

target for core investors. Core real

estate investors’ benefit from the

reduced risk that accompanies this

type of property, as the income they

provide is more solidified and, in

turn, often leads to significantly

higher property values.

This value creation can be observed

in the potential value boost seen

when comparing a valuation for

property with a long-term tenant

compared to the same property as

vacant. If you assume standard

market parameters around leasing

expenses, lease up period, probability

of renewal, discount rate, terminal

cap rate, and selling costs, the fully

leased property could easily be

valued 50 percent higher than a

similar, vacant property. An

illustration of how the creation of a

long term credit lease creates value

has been provided in Appendix A.

Real estate fundamentals continue to steadily improve along with a substantial increase in their underlying values in many geographic markets across the globe.

The rapid pace of economic recovery has bolstered demand while limiting the availability of new supply being delivered to the market. The improvement in space market fundamentals now often leads to accelerated rent growth.


Factors to consider

Do you have a significant amount

of real estate (as broadly defined

later in this publication in the

section titled, Expanding the

possibilities) on your balance

sheet or possess long-term leases

for real estate?

Do you expect to be subject to

limitations on your ability to

deduct interest as a result of the

recent tax reform changes?

Have you assessed whether all

or a portion of your assets may

be held in a real estate

investment trust?

Have you considered the impact

of individual tax changes on the

location of your workforce and

office locations?

Have you assessed the current

usage of the properties you own?

Do you have vacant, unused, or

excess properties, and would you

benefit from a hold vs. sell

analysis?

Are you looking for excess capital

to support growth or expansion

plans – particularly, real estate-

dependent growth?

Are you reassessing your current

delivery model, and if so, how

does this impact your current

real estate footprint?

Has your business model

changed and should you consider

repurposing your assets?

Does your existing delivery

footprint efficiently and

effectively meet the needs of

both your organization and

customers?

Do you have the right

infrastructure and positioning to

support your operations?

Do you currently focus on real

estate as a critical success driver?

Are you supporting it that way?

Do you have an abundance of net

operating losses (NOLs) ready

to expire?

Are you coming to a juncture

where you are becoming taxable

in corporate form?

Perceived benefits

While one could argue that a primary

driver for many of these transactions

is the pursuit of corporate tax

efficiency, it is not all about tax

benefits. In fact, many argue that the

tax effect of some common real

estate transactions are not

eliminated, but instead, are merely

moved from an inefficient double

taxation (i.e., taxation at both the

corporation and the investor level) to

a more efficient, single taxation

regime, at the investor level. There

are a number of other, key benefits

that may be part of such

transactions, including:

Trading

Expansion

Capturing real estate’s appeal to

yield hungry investors

Improved access to secured and

unsecured debt markets or

equity growth capital for real

estate-based capital projects

Facilitating a beneficial capital

reorganization or an operational

restructuring

Ability to use operating

partnership units as tax efficient

currency for acquisitions in

fragmented industries –

specifically, in REIT conversions

or spin-offs

Trading multiple expansion is a

common theme seen in many

divestiture strategies, and those

divestitures – partially driven by

significant real estate concentrations

– are no different. For many spin-off

transactions, the increase in value,

which allows for trading multiple

expansion, is perceived to come from

separating businesses with different

characteristics, capital needs, or

specialized management

requirements, in order to fully

capitalize on their value.

However, recent trends in corporate

real estate transactions have often

gone a step further by separating the

real estate used in an operation from

the operation itself. For example, in a

REIT spin-off, one of the goals is to

expand the aggregate value of the

company by creating two securities:

one with the growth characteristics

that appeal to certain growth/

operational investors – the operating

company (OpCo) – and the other in

the property company (PropCo),

which is either a partnership or

entity electing REIT status, that will

Is your company a potential real estate monetization candidate?


appeal to investors looking for fixed

income or dividend yields and better

financing costs. Such a separation

may also have a positive effect on

actual operating results, as the

property company would generally

be managed by real estate

professionals that may bring cost

efficiencies throughout the

development and management

process. Further, these real estate

professionals may be able to utilize

their skill sets to implement

strategies that optimize assets no

longer needed by the operating

company and could venture out to

acquire, develop, and manage

specialized properties used by and

leased to other parties.

Control verses flexibility

Clearly, one of the key drivers of real

estate monetization has been the

unrelenting investor market demand

for yield. This has driven down cap

rates and in turn, increased the value

of properties with long-dated,

bondable credit tenant leases.

In addition to an overall increase in

real estate value, many monetization

strategies inherently rely on creating

value through transactions in which

the real estate ownership is removed

from an entity, then leased back. In

this scenario, it’s the lease that drives

the value. The better the lessee’s

credit, the longer the term, and the

higher the lease payments, the more

perceived value created.

One of the biggest concerns

expressed about monetization

transactions is the struggle for

organizations to maintain control of

essential, physical assets while,

simultaneously, balancing

operational flexibility. While long-

term leases allow the operating

company to maintain property

control, they also limit the

organization’s operational flexibility.

For example, a retailer who enters

into a long-dated master lease of

multiple stores may not be able to

close underperforming locations due

to ongoing lease payments on these

locations. Shorter leases can be

utilized while still maintaining

control of critical assets, through the

use of optional extension periods, at

either fixed prices or at market rates.

This creates more operational

flexibility for the operating company.

However, for the property company,

it creates an increase in certain risk

factors – such as added uncertainty

around lease renewals – and is likely

to reduce the value of the real estate.

This would also reduce the benefits

obtained in the monetization

transaction. The potential impact on

an asset’s value of a shorter leases is

typically correlated with how unique

the asset is and how difficult it would

be to find a replacement tenant.

Similarly, higher lease payments –

despite potentially enhancing

perceived real estate value and tax

efficiencies realized during the

transaction – also may put too much

financial stress on the lessee’s

operations, ultimately hurting both

parties. Further, many rating

agencies treat lease payments as a

form of debt and build them into

their analyses.

Tailoring and optimizing the

transaction to a company’s specific

circumstances requires careful

analysis and judgment. Optimizing is

a very different goal then merely

maximizing proceeds. Success

depends on an organization’s ability

to balance competing elements of

value creation, control, and

operational flexibility.

Financing, taxes, accounting, and

regulatory factors also come in to

play. It is no small endeavor for

companies to embark on, and many

times, it is only attempted as a result

of external or internal pressure.

Merely maintaining the status quo is

an entirely different story – one

which may not, in fact, be optimal.

Tax ramifications

The tax ramifications of a particular

monetization transaction must be

carefully considered in light of recent

tax reform. Some transactions such

as secured borrowings are not

themselves taxable events. Others,

such as sale leasebacks are taxable

events and the acceleration of tax

impacts may represent a cost to be

considered in the transaction.

These monetization transactions

should be viewed through the lens

of tax reform. There may be

opportunities to couple real estate

monetization structures with

structures beneficial from interest

deduction and shareholder

perspectives. These changes along

with other related tax changes may

serve to improve transaction


pricing and may further spur real

estate monetization transactions

Accounting ramifications

Monetization transactions are often

associated with complex accounting

r e q u i r e m e n t s , such as a need

to evaluate the transactions under

intricate leasing and sale-leaseback

rules in the United States. These

rules apply to any transaction for

which the real estate is sold or

transferred, then leased back (e.g.,

sale-leasebacks, contribution

leasebacks, or spin-off leasebacks).

For many transactions, the

ultimate goal is achieving qualified

sale-leaseback treatment in which

the leaseback is an operating lease;

therefore, the lessee is able to

eliminate both the asset and

liability of the lease on its books.

However, the benefits of achieving

such a goal may be short-lived. The

Financial Accounting Standards

Board (FASB), responsible for

establishing generally accepted

accounting principles in the United

States, issued a new accounting

standard that must be adopted by

calendar year reporting companies

in early 2019. This standard will

significantly change lease

accounting.

Such changes would have leased

assets and a liability on the books of

the lessee. However, for income

statement purposes, the expense

charge would be similar to today’s

operating leases – except for those

still considered to be finance leases.

From a balance sheet perspective,

this means there would not be as

significant of a difference between

leasing and owning assets. However,

as noted above, there may be

significant tax differences between

owning real estate assets and

separating real assets into a lessee

vehicle that may benefit from the

real estate business exclusion from

the new interest deduction

limitation rules and rental

expense tax deductions.

Corporate real estate

departments

The drive to monetize real estate

assets often provides a catalyst for

change within an organization,

with an added focus on driving

operational efficiencies as it

pertains to real estate. As part of

this process, companies should

consider how to best rationalize

their real estate functions.

The real estate departments of

some companies are considered

key, strategic value drivers and

viewed as integral to strategic

planning and operations. Such

companies may be able to utilize

their strategic competency in real

estate for additional growth,

utilizing capital generated by

monetization transactions. This

competency can also be leveraged

to create added value for

shareholders through the creation

of a PropCo REIT, which becomes

an asset accumulator or finance

source for the OpCo and other

entities in the same or similar

industries.

On the other end of the spectrum,

many corporate real estate

departments are frequently

undermanned and often, do not

have the infrastructure or systems to

effectively track, manage, and

optimally finance the real estate for

which they are responsible. These

entities may benefit from the

introduction of professional real

estate finance and property

managers.


Expanding the possibilities

“Traditional” property generally

encompasses assets held by

mainstream REITs, such as office

buildings, apartments, retail strip

centers, malls, industrial

warehouses, and even hotels.

Many monetization transactions

are, in fact, done with traditional

real estate assets. After all, is

there any real, physical difference

between a retail space owned by a

landlord and one owned by the

retail company itself? Generally,

the only real difference between

the two is the existence of a lease.

“Non-traditional” property

transactions, on the other hand,

have been more of a recent

phenomenon and represent

anything that can be categorized

as real estate for finance,

accounting, and tax purposes but

does not fit into the category of

traditional real estate. Even real

estate professionals are

sometimes surprised at the broad

scope of real estate today. The

broadening range of transactions

involving non-traditional real

estate has resulted in the

formation of various niche

finance players for unique assets

and the expansion of the net lease

or bondable lease market – an

expansion that has greatly

bolstered the benefits and

desirability of such transactions.

As those markets have expanded,

they have become more efficient

and investor cap rates have

declined, making monetization

transactions for non-traditional

real estate assets even more

desirable.

Real estate and rents from

real property

Because taxes play such a

significant role in real estate

transactions, they have also had a

significant impact on the trends

mentioned above. Real estate can

have favorable tax treatment for

certain investors and structures,

like REITs. Accordingly,

distinguishing what real estate is

has substantial ramifications on a

company’s ability to engage in

certain types of transactions with

their physical assets.

The IRS has considered several

Private Letter Ruling (PLR)

requests related to non-

traditional REIT assets. Favorable

rulings in this area are grounded

on principles that have been

established and applied by the

IRS to distinguish real estate

from other property. The IRS

finalized regulations in 2016 that

clarify the definitions of “real

property” and “rents from real

property” for REIT purposes.

The following sections outline

these definitions.

What is real estate? Simple question, right? Not exactly.


Tax definitions

Real property

Treas. Reg. Section 1.856-3(d) provides that the term “real property” means land or improvements

thereon, such as buildings or other inherently permanent structures thereon (including items which are

structural components of such buildings or structures). In addition, the term “real property” includes

interests in Real property. Local law definitions are not authoritative for purposes of determining the

meaning of the term “real property.”

The term “real property” includes things, such as the wiring in a building, plumbing systems, central

heating, or central air-conditioning machinery, pipes or ducts, elevators or escalators installed in the

building, or other items which are structural components of a building or other permanent structure.

The term “real property” does not include assets accessory to the operation of a business, such as

machinery, printing presses, transportation equipment that is not a structural component of a building,

office equipment, refrigerators, individual air-conditioning units, grocery counters, furnishings of a

motel, hotel, or office building – even if such items are termed “fixtures” under local law.

Rents from real property

Section 856(d)(1) provides that the term “rents from real property” includes (subject to exclusions

provided in Section 856(d)(2)): (a) rents from interests in real property; (b) charges for services

customarily furnished or rendered in connection with the rental of real property, and (c) rent attributable

to personal property which is leased under, or in connection with, a lease of real property, but only if the

rent attributable to such personal property does not exceed 15% of the total rent for the taxable year

attributable to both the real and personal property leased under, or in connection with, such lease.

The term “rents from real property” does not include rents based on net profits or income. However, the

term does include rents based on gross revenues. The term also does not include rents paid by related

parties or rents if certain services are provided.


Non-traditional real estate trends

Over the last 5 to 7 years, we have

seen significant activity involving the

monetization of non-traditional real

estate assets, generally accomplished

through borrowing, sale-leaseback

transactions, and REIT conversions

or spin-offs. We expect this trend to

continue. The following is a summary

of different types of non-traditional

real estate assets that have been

monetized through transactions

similar to those discussed above.

Existing In process Potential future candidates

Timber

Agriculture/farmland

Cell towers

Hotels

Casinos/gaming

Hospitals/nursing homes

Golf courses

Data centers

Billboards

Prisons

Record warehousing

Telecom infrastructure

Transmission/distribution lines

Cold storage

Schools/higher

education facilities

Railroads

Docks/marinas

Landfills

Toll roads/bridges

Energy infrastructure

- Pipelines

- Solar/wind farms

What’s next?


Overview of various monetization transactions

While some of this complexity is necessary to

derive specific benefits, it may significantly

increase the time, effort, and cost of these

activities.

A careful evaluation of the different transaction

strategies is crucial in order to make the right

decision for the future.

Types of real estate monetization strategies

3 – 6 months 18 – 30 months Implementation time

Isolated transactions New business setup Business transformation

Securitize debt with existing real estate

Prepaid lease/leaseback

Publicly traded REIT

Spin off/Split off

High dependency on tax & finance considerations (e.g., taxpayer)

Individual sale-leaseback transactions

UPREIT joint venture

Valu

e

Real estate monetization transactions may be transactional or transformative, depending on the various, unique circumstances of any given company.

Monetization, in its simplest form, can be merely consummating secured borrowings against operating assets; however, the range of possible transactions and their associated complexity is substantially broader than that.


The term REIT conversion is used

broadly to describe a very wide range

of transactions in which the original

entity transforms – either partially or

entirely – into a REIT, including

spin-off transactions. Such a

transaction may be considered either

traditional, if the property involved is

similar to those normally seen in a

REIT (e.g., retail or office buildings),

or non-traditional, if the property is

more unique to the REIT market

(e.g., billboard, timber,

wires/infrastructure, etc.).

These transactions have notable

complexities – most of which are

further elaborated upon in PwC’s

guide for these transactions entitled,

Non-traditional REIT

Transactions: An emerging

trend, which is available on our

website: cfodirect.com.

A brief description of each

transaction type, their associated

pros and cons, and other, key

characteristics are provided below.

Additionally, the unique needs and

desires of any given organization are

accounted for by leveraging the

different variations of each type of

transaction to more closely satisfy its

particular needs.

Factors that impact how you

considered monetization

strategies

Transformation or growth plans

and their related costs

External borrowing ability and

debt limitations or covenants

Fair market value of the real

estate and its tax basis, and

whether or not there would there

be a significant tax gain if sold

Ability to deduct net interest

expense for tax purposes

Effective tax rate of

separated entities

Long-term need to control

specific real estate by ownership

or lease

Time required to implement

monetization strategies

Existing debt covenants and

other restrictions of third party

leases and transactions

Relative cost to implement

different real estate monetization

strategies verses their benefits

Market conditions for real estate

transactions with single-

tenant properties

Secured borrowings/

securitization transactions

Perhaps the simplest form of

monetization is merely to borrow

money against the asset. These

transactions can take the form of a

simple commercial mortgage, from a

bank, or a more complicated

transaction, such as an attempt to

take advantage of the Commercial

Mortgage Backed Securities market.

These transactions can be on

individual properties or on cross-

collateralized or cross-defaulted

pools.

These transactions have also been

increasingly done in local currencies

to take advantage of lower borrowing

rates in international markets.

Pros

Simple, well understood

Relatively short time to complete

transactions

Relatively low transaction costs

(e.g., no transfer taxes)

Limited corporate-level tax

consequences

Cons

Limitation on borrowing

amounts (e.g., 50-75 percent

loan-to-value)

Possible limitation on interest

deductibility for tax purposes as

a result of Tax Reform

Increases company's leverage for

debt covenant purposes

Cross-collateralization or cross-

default provisions may limit

operational flexibility

Company still exposed to

residual real estate risks

Individual or portfolio sale-

leaseback transactions

The property is sold to a third party

and leased back to the company.

These transactions can be on

individual properties or under a

master lease for multiple properties.

These transactions have potentially

significant tax costs to sellers if the

tax basis in the assets are low. This

creates a significant toll charge on

completing such transactions, which

may discourage potential, and

otherwise qualified, candidates from

engaging in these transactions. On

the other hand, some have utilized

sale-leasebacks to trigger tax gains,

utilizing tax assets- such as

accumulated net operating losses

(NOLs)-before they expire.

The financial accounting for these

transactions can be complex,

especially in the United States, which

has specialized rules in this area. The

lease literature in this sector is

proscriptively rule-based and

prohibits many forms of continuing

involvement in the assets other than

the leaseback. Failure to comply with

these rules can cause the transaction

to be treated as a financing or

deposit, instead of as a sale. Even if


the sale is recognized, some or all of

the gain may be deferred and

recognized over the term of the

leaseback, making a careful

evaluation of each proposed

transaction essential.

Generally, the owner of mission-

critical real estate assets wants to

maintain the control and use of an

asset throughout the terms of the

lease -either through the initial term

or its potential extension options.

This puts stress on qualifying for

sale-leaseback accounting and

ensuring the leaseback is not a

considered a capital lease. In either

case, the asset might not be removed

from the balance sheet and a liability

will be recorded for the failed sale-

leaseback or capital lease.

Pros

Moderate transaction costs-

potentially including transfer

taxes

Increasing number of buyers for

bondable leases has led to

improved pricing

Possible tax deduction for rental

payments

Many buyers exist and they can

close transaction in reasonably

short periods

Full realization of

monetization value

Company no longer exposed to


Cons

Toll charge of tax consequences

can be significant (depending on

tax basis of assets), although

such costs were recently reduced

with the reduction of the

corporate tax rate in the U.S.

from 35% to 21%.

Operating charge to P&L where

there previously was no rent

expense or need to pay market-

based rents

Buyer generally looking for

longer lease durations




Accounting can be complex

unless normal leaseback is

attained

Pre-paid leasebacks

This transaction type is a variation

on the sale-leaseback. Rather than

selling the asset, the company enters

into a lease whereby it leases the

property to a third party. The terms

of this lease-out provide for a single,

lump-sum payment by the

counterparty to the company at the

inception of the lease

The company then leases the

property back from the counterparty

for payments over the agreed

upon term.

Pros

Low transaction costs

Corporate tax consequences

are limited

Cons



No derecognition of assets

More complex, may take

relatively longer to close than

alternative financing or sale-


Additional leverage of financial

statements added in the form of

prepaid lease liability

Contribution leasebacks

In these transactions, the company

contributes real estate into

partnership structures, which may

either be a separate vehicle or part of

an Umbrella Partnership REIT

(“UPREIT”) or Down REIT of an

existing, public REIT. The company

would then lease back the property

from the vehicle. In exchange for the

contributed real estate, the

contributing companies would

receive Operating Partnership Units -

units potentially convertible to

shares of an existing third-party

REIT. This may allow for

monetization over time, as units are

converted and sold into the market.

Pros

Limitation on amount of

borrowings

Potential access to professional

real estate management of the

property at lower operating cost

Immediate corporate tax

consequences limited

Cons

Potentially disguised sale issues

for tax

More complex, may take

relatively longer to close than

alternative financing or sale-


Buyer generally looking for

longer lease durations




Accounting can be complex

unless “normal leaseback”

is attained



REIT conversions

The term REIT conversion is used

broadly to describe a very wide range

of transactions in which the original

entity transforms-either partially or

entirely-into an REIT, including

spin-off transactions. Such a

transaction may be considered either


“traditional,” if the property involved

is similar to those normally seen in

an REIT (e.g., retail or office

buildings), or "non-traditional," if

the property is more unique to the

REIT market (e.g., billboard, timber,

wires/infrastructure, etc.).

In a simple REIT conversion, the

majority of the company's assets and

operations qualify under the REIT

tax requirements and are either

owned directly by the REIT or its

subsidiaries. Any remaining,

nonqualified operations can reside in

a taxable subsidiary. In some cases,

the company may need to divest

itself of non-qualifying operations, if

they are too large.

While their potential for tax savings

clearly benefits an organization, the

decision to undergo a REIT

conversion or spin-off is often made

for additional reasons. There are

other, potential benefits, including

the perceived impact on financing

costs, monetization of non-core

assets, and the company's share

price. Over the last few years,

investors have been searching for

yield and have been willing to pay

more for higher dividend stocks,

including REITs. Investor interest

may see a slight decline in the face of

potential interest rate hikes and

other factors impacting the market,

but all indications are that these

investment types are here to stay.

Many common REIT structures, like

the Umbrella Partnership REIT

(UPREIT), provide a company with a

tax advantaged currency to acquire

properties in fragmented industries.

Finally, some companies are taking

advantage of these transactions to

reorganize themselves and

recapitalize their balance sheets.

A REIT conversion is certainly not

without challenges. A company may

need to substantially change the way

it does business with its customers to

bring its business in line with the

technical REIT requirements. In

other cases, a company may need to

sell or spin-off portions of its

business so that the remainder can

elect REIT status. There will likely be

many challenges in both completing

the REIT conversion transaction

itself and in maintaining REIT status

post-conversion. There are also

REIT-specific tax, operational,

accounting, and financial and

investor reporting issues that will

need to be addressed considered

from a costs/ benefit standpoint.

Pros

Significant reduction in ongoing,

combined taxes at entity level

due to REIT status-presumably,

this drives an increase in

aggregate shareholder value

Cons

Complex transaction or

reorganization may be required,

generating significant

transaction costs, need for

management attention, and time

to consummate

May need to make a significant

distribution to purge pre-REIT

accumulated taxable earnings

and profits

Operating as a REIT may

require the reorganization of

or modification to business

operations, contracts,

and processes



Spin-off leaseback

This transaction involves separating

out the real estate from an existing

company and moving it into a new

company. This new real estate

company will, then, frequently elect

to be taxed as an REIT. In such cases,

the existing company continues to

own the operating business and

leases the real property from the

REIT entity at current market rates.

Due to tax law changes, it is often

difficult to achieve a tax-free spin-off

of real estate. That said, a taxable

spin of assets may still provide

beneficial in light of the

considerations described throughout

this paper and the recently reduced

corporate tax rate (35% to 21%).

Assessing the amount of the tax due

as a "toll charge” on getting the real

estate out of a corporation will be

critical to the economic analysis of

possible alternatives.

Pros

Reduction in combined taxes for

recurring operations

Potential to structure as a tax-

free spin-off (may now be

limited, see above), but requires

an additional, unrelated business

that meets size limitations

Cons

Tax “toll charge” can be

significant if

Costs were recently reduced with

the reduction of the corporate

federal tax rate in the U.S. from

35% to 21%.

Complex, significant transaction

costs and time to consummate

Tax-free spin-off requirements

can add complexity to the


transaction from a business, tax,

and regulatory filing perspective

May need to make a significant

distribution to purge pre-REIT

tax earnings and profits

Concentration of credit with

single tenant may not price

favorably, so PropCo may need

or want to acquire additional

properties after the transaction

to diversify the credit exposure

and continue adding value for

shareholders

Market pricing needed in setting

initial rents

Business concerns around

whether OpCo will be

comfortable with an independent

PropCo as its landlord, dictating

lease renewal terms, dealing with

underperforming properties, and

potentially leasing property to

OpCo's competitors

PropCo REIT exposed to residual

real estate risks


PwC’s strengths to serve you

A proven track record of

assisting clients who are

contemplating real estate

monetization

Our approach to serving clients who

are contemplating real estate

monetization transactions leverages

collaboration between real estate

specialists, specialists specific to your

industry (including deals, tax,

accounting, valuation and systems),

and expert project managers for

insight and assistance specially

tailored to your unique

organizational needs.

We believe this approach

encompasses a powerful combination

of personal service, specialized

experience, and global reach, setting

PwC apart from the rest.

The process of evaluating and

executing various real estate

monetization strategies can be

extremely complex and time-

consuming, so the support of a

professional services firm that truly

understands your business and its

financial transactions is pivotal to

successful decision-making. PwC’s

experts possess extensive accounting,

tax, and regulatory knowledge,

equipping them with an exceptional

ability to navigate through various

monetization transaction types and

mitigate associated risks.

Today, PwC is one of the preeminent

providers of services that can help

you navigate the intricacies of

evaluating and executing complex

real estate monetization strategies.

We also have a long track record of

delivering a knowledgeable

perspective on what it will take to

support the evaluation and

implementation of various real estate

monetization strategies without

disrupting business operations.


A practice built on industry-

specific knowledge and

experience

We also serve a wide range of clients

in the real estate industry, including

many of the largest and most

prominent public REITs, real estate

opportunity funds, private real estate

owners, operators and developers,

homebuilders, traditional real estate

advisors, separate insurance

company accounts, international real

estate investment vehicles, and

public real estate operating

companies. Insights garnered from

our experience with these clients will

help us provide insight on how

various transactions may be

perceived by various stakeholders,

including investors, analysts,

lenders, and the SEC.

Our experience in these areas will

enable us to help you address today’s

problems, as well as assist you in

identifying opportunities or

challenges which will affect you

tomorrow as you implement your

long-range business plans. Our real

estate professionals have a first hand,

in-depth understanding of every

aspect of real estate

operations/transactions, including

valuation, reorganization, deal

advisory, corporate services,

accounting, and tax.

The PwC advantage: Cultivated

experience and in-depth

knowledge

We have been a market leader in

providing tax, audit, and advisory

services for major REIT conversion

transactions for more than fifteen

years, including many of the most

recent non-traditional REIT

conversions. We also have extensive

experience with real estate sale-

leaseback transactions and similar

exchanges, which are essential tools

for many holistic real estate portfolio

monetizations. Our depth of

experience has made us a leading

professional services firm in this

specialized area.

In addition to real estate deal

advisory, securitization, and

litigation services, PwC has overseen

the valuation of multi-billion dollar

real estate and enterprise valuations

of TSRs and participated in multiple,

high-profile real estate transactions

for various real estate lenders and

investors. Our knowledgeable real

estate professionals take great pride

in anticipating and responding to

market trends and are recognized as

thought leaders in the industry.

PwC provides audit, tax, or advisory services

to 80% of the REITs listed in the

S&P 500 index.

In addition, PwC has provided audit, tax, or advisory services to

23 of the 30publicly announced REIT

conversions/spin-offs that have occurred since 2011.


Appendices a. Example of value

creation through a credit lease

b. Other PwC real estate thought leadership


Appendix A – Example of value creation through a credit lease

Value as vacant

Annual rent $5,000

Leasing commission 6.00%

Standard lease term 5 years (May or may not have options to renew)

Lease up period 9 months

Probability of renewal 75.0%

Escalation of rent upon renewal 10.0%

Discount rate 8.0%

Terminal cap rate 7.0%

Cost to sell in year 11 4.0%

(000’s omitted) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Operating cash flow

Rent 1,250 $5,000 $5,000 $5,000 $5,000 $3,750 $2,750 $5,500 $5,500 $5,500

Leasing commission (1,500) – – – – (1,650) – – – –

Net operating cash flow (250) 5,000 5,000 5,000 5,000 2,100 2,750 5,500 5,500 5,500

Assumed sale beginning of year 11

78,571

Cost to sell

(3,143)

Net cash flow (250) 5,000 5,000 5,000 5,000 2,100 2,750 5,500 5,500 80,929

DCF value $61,239 A

Value with bondable lease

Annual rent $5,000

Leasing commission 0.00%

Standard lease term 20 years (May or may not have options to renew)

Lease up period 0 months

Probability of renewal 75.0%

Escalation of rent after 5 years 10.0%

Discount rate 6.0%

Terminal cap rate 5.5%

Cost to sell in year 11 4.0%

(000's omitted) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Operating cash flow

Rent 5,000 $5,000 $5,000 $5,000 $5,000 $5,500 $5,500 $5,500 $5,500 $5,500

Leasing commission – – – – – – – – – –

Net operating cash flow 5,000 $5,000 $5,000 $5,000 $5,000 $5,500 $5,500 $5,500 $5,500 $5,500

Assumed sale beginning of year 11

100,000

Cost to sell

(4,000)

Net cash flow 5,000 $5,000 $5,000 $5,000 $5,000 $5,500 $5,500 $5,500 $5,500 101,500

DCF value $91,980 B

Difference in value $30,741 B-A

Properties that are subject to longer-dated or bondable leases are highly sought out by many investors. Their valuation is often tied more to the credit of the tenant than traditional real estate, which may be subject to additional market risks (e.g., nearer term lease renewal and market rent adjustments) and other costs. Such assets are more efficiently financed. A hypothetical example comparing the valuation of vacant real estate to that of a credit-tenant lease asset is presented below.


• Higher income from lease in place

• No leasing commissions or downtime due to length of lease

Value creation attributed to operational components

• Credit quality of tenant results in higher certainty of income stream

• Lower discount rate for credit quality tenant in place

• Reduced terminal cap rate due to reduced uncertainty around year 11 income

Value creation attributed to enhanced credit quality

1. Assets may also be more efficiently financed

2. Tax efficiency may be improved by holding the real estate in an entity that does not pay corporate level taxes (e.g., a partnership or a REIT)

Potential value creation not considered in the above


Appendix B – Other PwC real estate thought leadership

Real Estate 2020: Building the future

As confidence returns to real estate, the industry faces a number of fundamental shifts that will shape its future. PwC has looked into the likely changes in the real estate landscape over the coming years and identified the key trends which, we believe, will have profound implications for real estate investment and development.

Emerging Trends in Real Estate

This annual forecast provides a heads-up on where to invest, which sectors and markets offer the best prospects, and trends in the capital markets that will affect real estate. The Emerging Trends in Real Estate series includes:

US and Canada

Asia Pacific

Europe

Real Estate Tax Insights

This series provides timely analysis on emerging issues so you can stay abreast of significant tax or human resource services developments affecting your company in today's ever-changing legislative and regulatory environments. PwC's Insights is a must read for professionals wanting to stay ahead of the curve. Publications include:

Tax Reform and Real Estate: Impact of the Tax Cuts and Jobs Act on Real Estate

Tax Reform Bill: Implications for the Real Estate Industry

Tax Reform and Real Estate: The Senate weighs in and the House votes

Quarterly Deals Insights This

quarterly report is an analysis of transactions in the real estate industry and outlines trends impacting the sector including sub-sector and regional deal trends, and shares additional highlights such as key announced transactions.

From providing up-to-date thinking about the regulatory landscape to evaluating emerging trends, our thought leadership publications put us directly in-touch with industry leaders, allowing us to hear first-hand about the trends and ideas impacting the global real estate industry.

Our knowledgeable real estate professionals take great pride in being proactive with market trends.


Global CEO Survey

The annual survey aims to inform and stimulate the debate on how businesses are facing today’s challenges.

Current Developments for the Real Estate Industry

This publication will help real estate audit committees and executive teams remain updated on the most recent trends in real estate.

PwC Manhattan Lodging Index

This quarterly publication provides updates on Manhattan’s lodging market, widely used by lodging brands, developers, and owners

PwC Real Estate Investor Survey

The quarterly PwC Real Estate Investor Survey is widely recognized as an authoritative source for capitalization and discount rates, cash flow assumptions, and actual criteria of active investors, as well as property market information.

PwC Hospitality Directions US

This quarterly publication is a near-term outlook for the US lodging sector, commonly used by industry decision-makers and stakeholders to better understand the impact of policy and other macro-environmental factors on the sector’s operating performance.

Roadmap for a REIT IPO or conversion for traditional and non-traditional real estate companies

These PwC guides are prepared to help both traditional and non-traditional real estate companies address the IPO and REIT conversion process.

Cities of Opportunity This annual

report analyses the trajectory of 30 cities, all capitals of finance, commerce, and culture – and, through their current performance, seeks to open a window on what makes cities function best. We also investigate both the urbanization and demographic megatrends that shape our cities

Compare and contrast: Worldwide Real Estate Investment Trust (REIT) Regimes PwC has a global

team of real estate tax and legal professionals who have conceived this booklet to keep you up to speed and allow you to compare the various regimes. The booklet is a high level comparison of key attributes of selected REIT regimes.

Non-traditional REIT Transactions: An emerging trend

This free-standing guide is focused exclusively on the unique issues and considerations that REIT transactions face.

Key tax issues at year end for real estate investors

This publication gives investors and fund managers an overview of year-end to-dos and important issues in real estate taxation worldwide.


Contact us

National contacts

Real Estate Leader Byron Carlock [email protected] 214.754.7580

Real Estate REIT Practice Leader Tom Wilkin [email protected] 646.471.7090

US Real Estate Assurance Leader Cathy Helmbrecht [email protected] 214.754.7988

Real Estate National Tax Leader Paul Ryan [email protected] 646.471.8419

Real Estate REIT Tax Services Principal Adam Feuerstein [email protected] 703.918.6802

Real Estate REIT Tax Services Principal David Leavitt [email protected] 646.471.6776

Real Estate REIT Tax Services Principal Adam Handler [email protected] 213.356.6499

Real Estate Assurance Partner William Croteau [email protected] 415.498.7405

Real Estate Valuation Services Partner Andrew Alperstein [email protected] 617.530.5256

Real Estate Deals Leader Tim Bodner [email protected] 703.918.2839

Real Estate Tax Services Managing Director Robert Lund [email protected] 720.931.7358

Industry sector contacts

Healthcare Joel Jaglin [email protected] 312.298.3824

Hospitality and Gaming Warren Marr [email protected] 267.330.3062

Hospitality and Gaming Abhishek Jain [email protected] 646.471.2016

Oil & Gas Tracy Herrmann [email protected] 713.356.6583

Power/Utilities Casey Herman [email protected] 312.298.4462

Power/Utilities Robin Miller [email protected] 312.298.2357

Retail & Consumer Rebecca Byam [email protected] 646.471.3256

Telecom Infrastructure Stefanie Kane [email protected] 646.471.0465

Geographic offices

Atlanta Jill Niland [email protected] 678.419.3454

Boston Tina Pantaleo [email protected] 617.530.4599

Chicago Brett Matzek [email protected] 312.298.5821

Cleveland Marvin Thomas [email protected] 216.875.3323

Dallas Leah Waldrum [email protected] 214.756.1768

Dallas Jason Waldie [email protected] 214.754.7642

Denver Wendy McCray-Benoit [email protected] 720.931.7353

Los Angeles Erica Hanson [email protected] 213.217.3290

New York Bill Staffieri [email protected] 646.471.0047

San Francisco Emily Pillars [email protected] 415.498.6358

Washington, DC Tim Bodner [email protected] 703.918.2839

PwC is ready to serve you. For more information on real estate monetization, please contact any of the following real estate professionals:

mailto:[email protected]
























© 2018 PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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