Real estate investment trusts (“REITs”) and other real estate companies seeking to access the public and private capital markets should not overlook certain recent federal government initiatives:
JOBS Act. On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”). The JOBS Act includes provisions that:
- IPOs. Streamline the initial public offering (“IPO”) process for a new category of issuers called “emerging growth companies” that have gross annual revenues of less than $1 billion, and reduce the post-IPO public reporting obligations for these companies.
- Private Capital. Liberalize access by both public and private companies to private capital by:
- directing the Securities and Exchange Commission (“SEC”) to eliminate publicity restrictions in connection with many private offerings, and
- increasing the shareholder threshold above which a private company must register as a reporting company with the SEC.
- Repeal of Preferential Dividend Rule. In addition, the Obama Administration’s 2013 Budget Proposal contains a proposal to repeal of the preferential dividend rule under Section 562(c) of the Internal Revenue Code as it applies to “publicly offered” REITs. As discussed further below, the rigidness of this rule can produce harsh results, and the rule’s repeal would result in greater ease in using the REIT format.
The JOBS Act: An Overview for REITsThe JOBS Act’s intended aim of facilitating growth, generally viewed as a boon to technology start-ups and other traditional emerging growth companies, applies in equal measure to many private real estate operators seeking to access the public capital markets in connection with REIT formation and related transactions, as well as certain public REITs and other real estate companies.
The following are the highlights of the JOBS Act as they relate to REITs and other real estate companies that (i) qualify as “emerging growth companies” and are considering an IPO or have recently completed an IPO or other going-public transaction, and/or (ii) seek to raise capital through the private placement market.
For a more detailed overview of the JOBS Act and the provisions highlighted below, please see Goodwin Procter’s April 25, 2012 Client Alert, “The JOBS Act: A New IPO Playing Field for Emerging Growth Companies."
IPO "On Ramp" Provisions
The JOBS Act makes significant changes to the IPO process, IPO registration statement disclosure requirements and post-IPO reporting and other requirements for emerging growth companies, including:
- Confidential Form S-11 IPO Submission. REIT IPO candidates that qualify as emerging growth companies may confidentially submit draft IPO registration statements and subsequent amendments to the SEC for confidential nonpublic review, provided the initial confidential submission and all amendments are publicly filed at least 21 days prior to the IPO “road show.”
- Reduced Financial Statement Disclosure. REIT IPO candidates that qualify as emerging growth companies may provide only two years of audited financial statements in their Form S-11 IPO registration statements instead of three years.
- Test the Waters. Oral and written communications between the REIT IPO candidate and certain institutional investors before and after filing a registration statement are permitted to “test the waters” to determine whether the investors might have an interest in the contemplated securities offering. Given increased volatility in the REIT new-issues sector in recent years, we believe that the ability to solicit and receive real-time feedback from institutional investors both before and after the filing of an initial registration statement should result in fewer failed or otherwise “unsuccessful” REIT IPOs.
- Post-IPO Use of Research Reports/Analysts. Investment banks may publish or distribute research reports about or have analysts make public appearances regarding a REIT that qualifies as an emerging growth company following its IPO or within any period prior to the expiration of a lock-up agreement between the investment bank and the stockholders of the REIT.
- Pre-IPO Use of Research Reports/Analysts. Investment banks that are participating or will participate in a in a REIT IPO may publish or distribute a research report about or have analysts make public appearances regarding, a REIT that qualifies as an emerging growth company that proposes to file a registration statement or is in registration, without having such research report deemed to be a prospectus or an “offer” under the Securities Act.
- Reduced Disclosure Requirements. REIT IPO candidates that qualify as emerging growth companies may (i) comply with reduced disclosure requirements in their initial S-11 registration statements, in addition to the ability to provide only two years of audited financial statements, and (ii) delay complying with new or revised accounting standards that do not yet apply to private companies.
- Phase in of Post-IPO Disclosure Requirements. Newly public REITs that continue to qualify as emerging growth companies may gradually “phase-in” certain disclosure and other requirements for as many as five years.
All of these changes became effective upon enactment of the JOBS Act without further rule-making by the SEC or other organizations. We expect additional clarifying rules and/or guidance from the SEC and FINRA regarding these changes. We expect that REITs and other companies contemplating an IPO, as well as those currently in registration and those that are newly public, to carefully evaluate and discuss with their advisors the alternative process and disclosure requirements now available to emerging growth companies.
REITs as “Emerging Growth Companies”. The JOBS Act offering and disclosure reforms discussed above are limited to “emerging growth companies.” These are defined as companies (i) with total gross annual revenues as presented under GAAP of less than $1 billion during their most recently completed fiscal year, and (ii) whose first public offering of common equity securities occurred on or after December 9, 2011. Once qualified, a company will be able to retain its status as an emerging growth company until the earliest of:
- the last day of the fiscal year in which its total gross revenues equaled $1 billion or more;
- the last day of the fiscal year following the fifth anniversary of its first sale of common equity securities pursuant to an effective registration statement;
- the date on which the company has, during the previous three-year period, issued more than $1 billion in non-convertible debt; and
- the date on which the company is deemed to be a large accelerated filer under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
We believe most REIT IPO candidates and recent market entrants are likely to initially qualify as emerging growth companies under the JOBS Act, as none except the largest REITs will have in excess of $1 billion in annual revenues. We note, however, that once a newly public REIT’s public float exceeds $700 million, the REIT may become a “large accelerated filer” under the Exchange Act – and thus lose its emerging growth company status – as early as the end of its first full fiscal year after its IPO. Many new REITs with initially less than $1 billion in annual revenues might still be expected to more quickly achieve a $700 million market cap. This would reduce the amount of time the REIT would be eligible for the reduced disclosure and compliance obligations applicable to emerging growth companies under the JOBS Act.
Liberalized Access to Private Capital
Threshold for Exchange Act Registration. In addition to the provisions described above aimed at streamlining the registration and ongoing reporting requirements for emerging growth companies, the JOBS Act also amended a critical section of the Exchange Act that has historically required the registration and ongoing reporting of private companies once they cross prescribed asset and stockholder thresholds.
Prior to adoption of the JOBS Act, Section 12(g) of the Exchange Act and applicable SEC rules provided that an issuer with total assets exceeding $10 million (measured as of the last day of the fiscal year) and a class of equity securities held of record by 500 or more persons was required to register as a reporting company with the SEC within 120 days following the end of the relevant fiscal year. Pursuant to the JOBS Act, the equity holder threshold of Section 12(g) has now been raised to either 2,000 holders or 500 holders that are not accredited investors. Effectively, this means that a private company may now have up to 2,000 holders of record before the registration and reporting requirements of Section 12(g) are triggered, so long as fewer than 500 of the holders are not accredited investors. Furthermore, holders that received their securities under employee compensation plans in exempt transactions are not included in the calculation of the holders of record for this purpose.
Prior to this amendment of Section 12(g), REITs and other sponsors of small portfolio or single-asset investment vehicles (which can include standalone private REITs) were limited in the number of investors that could participate in private offerings of interests in specific assets. For example, a public REIT or other asset manager may sponsor a single-asset REIT or other vehicle owning a particular asset in a particular location and solicit the participation of local investors to fund the acquisition or refinancing of the asset. To the extent the number of record holders exceeded 500, either as a result of primary issuances or sales in the secondary market, the single-asset REIT or other vehicle was required to become an independent reporting company with the SEC, resulting in significant reporting and compliance costs, regardless of whether investors were accredited or not. Under Section 12(g) as amended by the JOBS Act, sponsors will have the ability to include up to 2,000 accredited investors in these types of targeted financings without triggering onerous registration and reporting requirements.
- Elimination of Prohibition on Advertising/Marketing. Rule 506 of Regulation D provides an exemption from the registration requirements of the Securities Act of 1933 that companies often utilize when raising capital through the private placement of securities. Similarly, Rule 144A provides an exemption from these registration requirements for certain private resales of securities. Under the JOBS Act, the SEC has 90 days after the enactment of the JOBS Act to amend Regulation D and Rule 144A to provide as follows:
- Regulation D. Allow general solicitations and general advertising in private placements conducted under Rule 506 if all purchasers in the offering are accredited investors and the company takes reasonable steps to verify that such purchasers are accredited investors using methods that the SEC will determine.
- Rule 144A. Allow general solicitations and general advertising in private offerings conducted under Rule 144A if all purchasers in the offering are reasonably believed to be qualified institutional buyers.
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Given the fluidity of these requirements, we expect market participants to proceed with caution on the new IPO and private placement playing field that has been created by the JOBS Act. Goodwin Procter will continue to provide updates on the practical impact of the JOBS Act and related SEC guidance and rulemaking for REITs as rules are implemented and practice develops.
Repeal of Preferential Dividend Rule
On February 13, 2012, the Obama Administration released its fiscal year 2013 budget proposals and, on the same day, the Treasury Department released its General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals (known as the “Greenbook”), which provides short summaries of many proposals in the budget. One of the proposals is the repeal of the preferential dividend rule under Section 562(c) of the Internal Revenue Code as it applies to “publicly offered” REITs.
REITs are allowed a deduction for dividends paid to their shareholders and, to maintain REIT status, generally must pay deductible dividends at least equal to 90% of their ordinary income. In order to qualify for the deduction, a dividend must not be a “preferential dividend”. For this purpose, a dividend is preferential unless it is distributed pro rata to shareholders, with no preference to any share of stock compared with other shares of the same class, and with no preference to one class as compared with another except to the extent the class is entitled to a preference. Before last year, a similar rule had applied to all regulated investment companies, or RICs, until the rule was repealed for RICs under the Regulated Investment Company Modernization Act of 2010.
While many REIT capital structures (e.g., a single class of common and plain vanilla preferred) do not implicate the preferential dividend rule, long-standing IRS interpretations of the rule arguably would not allow certain more complex capital structures and shareholder arrangements. Moreover, the scope of the rule and its proper application to many transactions is unclear. Because the consequences of violating the preferential dividend rule can be difficult or impossible to cure and raise unacceptable issues as to REIT qualification, public REITs generally have little tolerance for risk on these issues and may forego legitimate transactions. REITs with a higher risk tolerance may enjoy unfair competitive advantages. The difficulties in curing violations also mean that the preferential dividend rule has the effect of disproportionately penalizing inadvertent or minor violations.
The proposal would repeal the preferential dividend rule for publicly traded REITs and publicly offered REITs. That is, the preferential dividend rule would not apply to a distribution with respect to stock if:
- As of the record date of the distribution, the REIT was publicly traded; or
- As of the record date of the distribution:
- The REIT was required to file annual and periodic reports with the Securities and Exchange Commission under the Securities Act of 1934;
- Not more than one-third of the voting power of the REIT was held by a single person (including any voting power that would be attributed to that person under the rules of Section 318); and
- Either the stock with respect to which the distribution was made is the subject of a currently effective offering registration, or such a registration has been effective with respect to that stock within the immediately preceding 10–year period.
The proposal also would give the Treasury Department explicit authority to provide for cures of inadvertent violations of the preferential dividend rule where it continues to apply and, where appropriate, to require consistent treatment of shareholders.
The proposal would apply to distributions that are deductible (without regard to the “spillback” rules of section 858 of the Internal Revenue Code) in taxable years beginning after the date of enactment.
Please contact any of the attorneys below if you have questions about the issues raised in this REIT Alert
|Gilbert G. Menna|
|Ettore A. Santucci||Yoel Kranz|
|Daniel P. Adams||Mark S. Opper|
|Edward L. Glazer (Tax)||H. Neal Sandford (Tax)
|Andrew H. Goodman||Mark Schonberger
|John T. Haggerty||Karen F. Turk (Tax)
|Robert G. Kester (Tax)
 Market practice is likely to evolve differently as between testing the waters before or after the filing of an IPO registration statement, in part as a result of technical requirements and possible interplay with confidential filing of the registration statement and road show planning.
 In its recent FAQs dated April 16, 2012, the SEC stated that an issuer that qualifies as an emerging growth company and has filed a registration statement prior to April 5, 2012 may provide the scaled disclosure available to emerging growth companies in a pre-effective amendment to a pending registration statement or in a post-effective amendment.
 The term “large accelerated filer” means an issuer after it first meets the following conditions as of the end of its fiscal year: (i) the issuer had a public float of $700 million or more, as of the last business day of the issuer's most recently completed second fiscal quarter; (ii) the issuer has been subject to the periodic reporting requirements of the Exchange Act for a period of at least 12 calendar months; (iii) the issuer has filed at least one annual report under the Exchange Act; and (iv) the issuer is not eligible to use the requirements for smaller reporting companies for its annual and quarterly reports.
 Note that until such time as the SEC adopts the applicable amendments to Rule 506 and Rule 144A, these rules remain in effect in their current form.
 Note that in limiting the use of general advertising to offerings in which all of the investors are accredited investors, the JOBS Act appears to eliminate the ability to include up to 35 non-accredited investors in the offering if a sponsor takes advantage of the liberalized solicitation provision. We expect that this will be the subject of comments in the rulemaking process.
 We note that the "reasonably believes" standard specified here for identifying qualified institutional investors is not used above in the rules permitting general solicitation in sales to accredited investors pursuant to Rule 506. We expect that this will be the subject of rulemaking comments and the SEC may adopt the same standard for accredited investors.
 The proposal in the fiscal year 2013 Greenbook expands a similar proposal included in the fiscal year 2012 Greenbook which would have repealed the preferential dividend rule only for “publicly traded” REITs.