Dangers of Compulsory DST-to-UPREIT Transformations, According to a Property Market Specialist
In a recent memorandum, David B. Mandell, an advisor, has highlighted the potential risks associated with forced UPREITs, urging property owners to exercise caution when considering these investments.
Forced UPREITs, a common structure in non-traded REITs, can create significant tax and operational risks. One of the primary concerns is the loss of assured liquidity. Unlike a traditional sale, your ability to cash out depends on the REIT's limited redemption policies, which the REIT can alter or pause at its discretion.
Regulators often warn investors about the lack of liquidity and uncertain early redemption provisions in non-traded REITs. Moreover, the timing and terms might not align with an investor's personal financial strategy. Many non-traded REITs offer periodic redemption programs, but these are typically restricted and not guaranteed.
Another concern is the illiquid nature of the partnership units you receive instead of cash. These units are not publicly traded, and even worse, if many investors seek to redeem, the REIT might simply halt redemptions.
The memo outlines four key risks of forced UPREITs. One of these risks is the potential inability to do a 1031 exchange on REIT operating partnership units. Additionally, there's the possibility of unexpected taxable gains, especially if the REIT's operating partnership were to sell the underlying property.
Furthermore, some DST 721 UPREIT sponsors do not provide tax protection agreements to their investors, leaving them exposed to potential capital gains taxes. Perpetual-life DST-sponsored REITs often use internally assessed net asset values (NAVs) for their shares, which introduces valuation opacity.
It's essential to note that investors are essentially locked into the UPREIT without the ability to change course or pursue a different 1031 exchange at sale. In a forced UPREIT, the tax bill is delayed but not eliminated, and the timing of the taxable event is out of the investor's control.
In recent DST offerings, some sponsors include forced Section 721 UPREIT conversions into perpetual-life REITs at the end of the DST's hold period. Non-traded, perpetual-life REITs resulting from a 721 UPREIT conversion offer very limited liquidity.
The memo, penned by Dwight Kay, founder and CEO of Kay Properties & Investments, addresses the risks of forced DST-UPREIT conversions. In part two of this series, we will discuss the advantages of optional UPREIT conversions and what investors should be aware of before investing in any 721 UPREIT exchange.
Readers are encouraged to check the advisor's records with the SEC or FINRA for further assurance. It's crucial to make informed decisions when it comes to your investments, and understanding the risks associated with forced UPREITs is a crucial part of that process.
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