Understanding Operating Partnership Units: Rights and Benefits
For anyone exploring the world of real estate investment trusts (REITs), especially large property contributors, Operating Partnership Units (OP Units) play a pivotal role. They offer unique benefits and financial opportunities, particularly within umbrella partnership REITs (UPREITs). If you’re unfamiliar with OP Units and how they can serve your investment strategy, this guide will walk you through everything you need to know.
What Are Operating Partnership Units (OP Units)?
Operating Partnership Units, commonly known as OP Units, are ownership interests in the operating partnership of a REIT. REITs structured as UPREITs typically use OP Units as part of their capitalization strategy. Within the UPREIT model, the operating partnership owns the real estate portfolio, while the REIT typically serves as the general partner and majority owner of the operating partnership.
For property contributors—such as real estate sponsors or family office managers—OP Units are a form of compensation for transferring property into the operating partnership. Instead of receiving cash or REIT shares outright, these contributors gain equity in the form of OP Units. This mechanism facilitates tax advantages, aligns interests with other investors, and provides opportunities for long-term wealth creation.
OP Units in UPREITs
The UPREIT structure simplifies the process for property owners who wish to participate in a REIT. By contributing their property to the REIT’s operating partnership, owners receive OP Units instead of selling the property in a taxable transaction. This creates a direct and significant alignment between the property contributor and the REIT’s ongoing success.
Here’s how OP Units function within UPREITs:
Proportional Ownership
Each OP Unit represents a proportional ownership interest in the operating partnership, giving the owner a share of the income and potential appreciation of the REIT’s assets.
Alignment with REIT Dividends
OP Units typically entitle their holders to receive distributions equivalent to the dividends paid on REIT shares. This ensures that OP Unit holders benefit in real-time from the income-producing capabilities of the portfolio.
Conversion to REIT Shares
After a designated holding period, OP Unit holders usually have the option to convert their units into REIT shares, offering further liquidity and diversification potential.
The Rights and Benefits of OP Units
Operating Partnership Units aren’t just a representation of ownership. They provide various rights and financial advantages tailored to the needs of property contributors, including tax deferral, long-term growth opportunities, and estate planning benefits. Below, we unpack the primary advantages of holding OP Units.
1. Tax Deferral
One of the most significant benefits of receiving OP Units in exchange for property is tax deferral. Normally, selling a property triggers a taxable event and creates a capital gains tax liability. However, by contributing the property to a REIT’s operating partnership in exchange for OP Units, property owners can defer this tax burden. This structure allows investors to reinvest in diversified real estate without the immediate tax drag, preserving more capital for growth.
2. Long-Term Upside
OP Units offer exposure to the long-term appreciation of the REIT portfolio. Unlike selling your property for cash, which caps your upside at the sale price, holding OP Units provides potential access to rising property values, lucrative lease agreements, and operational efficiencies driven by the REIT. This long-term exposure aligns with the goals of property contributors seeking consistent growth.
3. Access to Permanent Capital
For contributors tired of high-cost, deal-by-deal fundraising, OP Units grant access to a vastly different financial structure. UPREITs provide what’s known as “permanent capital,” enabling contributors to step away from managing individual projects. This type of capital ensures continuous reinvestment in diverse sectors, creating less stress and more predictability for investors seeking stable income streams.
4. Income Stability Through Dividends
OP Unit holders benefit from distributions tied to the REIT’s performance. Because REITs are required to distribute at least 90% of their taxable income annually, OP Units generate regular income that mirrors the REIT’s dividend structure. This ensures that holders have a steady cash flow, which is particularly attractive to those seeking passive income.
5. Building a Transferable Legacy
For real estate owners planning their estate, one of the most compelling benefits of OP Units is their role in creating a clear, transferable legacy. OP Units can be seamlessly transitioned to heirs, ensuring that wealth passes efficiently from one generation to the next. Furthermore, upon inheritance, the tax deferral on the OP Units is typically reset at the new basis, reducing the overall tax liability for your estate.
6. Liquidity Through Conversion
After the required holding period, OP Units can generally be converted into publicly traded REIT shares. This conversion provides contributors with access to liquidity, a benefit not readily available in direct property ownership. The ability to sell shares as needed gives investors the ultimate flexibility in managing their financial strategies.
How OP Units Support Investor Goals
Operating Partnership Units are particularly appealing to mature investors seeking simplicity, income, and tax efficiency. Whether you are managing a family real estate portfolio or transitioning out of active asset management, OP Units align with key investor goals. Here’s a closer look at how they support financial objectives:
Tax Efficiency
Avoid immediate capital gains taxes by participating in a structured UPREIT transaction.
Portfolio Diversification
Contribute a single property and gain fractional equity across a diversified real estate portfolio spanning multiple sectors.
Investment Liquidity
While maintaining exposure to real estate, enjoy the option to convert OP Units into liquid REIT shares.
Passive Income Generation
Benefit from income streams tied directly to the REIT’s dividend payouts.
Estate Readiness
Simplify estate planning with an asset type that is easier to transfer and manage than individual properties.
Is Contributing Property for OP Units Right for You?
For real estate sponsors, family office managers, or private property owners, the decision to exchange property for OP Units depends on your unique financial situation. Key considerations include:
The need to defer taxes while maximizing financial growth
A desire for passive income from diversified real estate investments
Long-term goals for estate planning or wealth transfer
The need for liquidity and flexibility over time
By collaborating with experienced REIT sponsors, contributors can carefully structure transactions that address these critical objectives while unlocking the full potential of their real estate assets.
Final Thoughts
Operating Partnership Units offer a powerful strategy for real estate owners looking to align their assets with professional investment management and long-term financial growth. From tax deferral to estate planning benefits, OP Units provide tools that not only simplify ownership but also expand opportunities for wealth building.
If you’re considering contributing property to a UPREIT in exchange for OP Units, ensure you work with advisors who understand the complexities of the process. Done carefully, entering the world of OP Units can open a new chapter for your portfolio, offering consistent income, flexibility, and the chance to build a lasting legacy.
