The review of strategic alternatives can be a daunting task even for the most seasoned executives and directors of real estate companies and real estate investment trusts. This is particularly true in today’s real estate environment in which tax reform, concerns regarding the current stage of the real estate cycle, and political turmoil all must be taken into account. This is the second piece in a five-month series in K&S REIT Advisor that provides a high-level overview of the advantages and disadvantages of individual strategic alternatives for private real estate portfolios. This month’s REIT Advisor focuses on the repositioning of a real estate portfolio.

An Overview of How to Reposition a Portfolio

Real estate portfolios often include some assets that no longer neatly fit with the current strategy, targeted asset class, target markets or other defining characteristics of a real estate company. The repositioning of a portfolio involves the generation of proceeds (typically through a sale of some component of the portfolio) which can be distributed to equityholders or used to recycle capital to refine the portfolio. A repositioning of the portfolio may also involve establishing a strategic joint venture with a third-party capital source.

Benefits

Repositioning a portfolio has the following benefits:  

• Distributions to Equityholders. The repositioning may result in a liquidity event, which allows the owner to make distributions to existing investors, who can then redeploy their capital.
• Refocus on Core Strategy. As portfolios mature, some of the assets may no longer fit within the parameters of the core strategy. Selling portions of the pool allows the existing owner to keep assets that most closely match the fund strategy and dispose of others that no longer fit within the investment plan.
• Shed Burdensome or Non-Conforming Assets. Certain assets may be less desirable or less suitable for a portfolio, whether because they are not meeting financial targets or because they have evolved to fit a different asset class. Selling these assets will allow the owner to focus on any prized core assets and on a targeted asset class that most closely matches the owner’s strengths and goals.

Considerations

Setting in motion a plan to reposition a portfolio can be a challenging endeavor. Tax structuring and analysis will be a key driver of whether this alternative makes economic sense, including with respect to both the distribution and the character of the gains to equityholders.

Repositioning a portfolio also raises the following additional considerations:

• Third Party Consents. The consent of the equityholders and/or third party lenders may be required to sell individual assets or a portion of the portfolio and/or to transfer other assets to another portfolio, which may require additional time and cost to complete.
• Transaction Expenses. As repositioning a portfolio involves several different moving parts, the transaction expenses incurred may be significant. The owner will likely have to engage legal counsel, solicit tax advice and hire a local broker, among other costs and expenses. In addition, if the repositioning involves the creation of a new joint venture, other deal costs may apply.
• Pricing and Valuation of Assets. The valuation of any assets to be sold in connection with restructuring must be carried out in accordance with any governing documents, which may give certain equityholders the right to challenge such valuation. In addition, the undesirable assets that the portfolio seeks to shed may not be priced at optimal levels.
• Tax Structuring. The structuring required to complete a restructuring is often complex, particularly the tax component. Tax analysis must carefully consider all economic factors related to the sale of some component of the portfolio and any transition to another portfolio, as well as how to characterize any gains distributed to equityholders.
• Portfolio Team. The owner must carefully consider the impact on the employees working on the portfolio. While in some situations it may be possible to transfer employees with the assets with minimal disruption, in others, significant retraining of personnel or downsizing may be necessary.