Houston-Based REIT Turns To 721 Exchanges To Propel ‘Heavy Growth Mode’

A Houston-based REIT that specializes in 721 or UPREIT exchanges is using the structure to make its largest acquisition ever, bringing its portfolio to 76 unanchored shopping centers across Texas and the Southwest.

KM Realty is acquiring a portfolio of 17 shopping centers in El Paso from its longtime family owners. KM Realty Managing Principal Randy Keith said the UPREIT structure, which has grown in popularity in recent years as older landlords phase out, is a win-win on both sides, helping owners avoid sales taxes while helping REITs grow their own portfolios without having to deal with a difficult lending environment.

Similar to a 1031 exchange, an UPREIT exchange lets property owners roll their property into a REIT in exchange for operating partnership units, Keith said. The trade means no one has to pay transfer taxes from a traditional sale while still allowing the owner to get rid of the day-to-day operations of the property, with the REIT taking care of it instead. These benefits have made the structure an increasing favorite among aging property owners. 

In this case, KM Realty Trust Operating Partnership will own the properties and issue operating partnership units. KM Realty Investment Trust is the REIT and general partner of the operating partnership. 

Keith learned the UPREIT structure in a past role with a grocery-anchored REIT where he served as the chief operations officer and handled acquisitions. Two decades ago, he started KM Realty as a syndicator-developer for small, unanchored centers, eventually seeing the opportunity to refinance the centers, pay investors back and keep the properties for cashflow, he said.

Once the company had 19 centers and about 200 investors in early 2018, it created a REIT and has used the UPREIT structure to expand ever since.

The benefits for REITs like KM Realty are twofold. If both parties agree to roll a property with no debt under the REITs umbrella, it grows the REIT’s assets and equity, Keith said.

And “instead of going out to raise $7M in cash and buy your property for $7M, we do it in one transaction, effectively,” Keith said.

The agreement requires a property owner to give up control of and liquidity from the property. That can be a difficult conversation to have with a client, but KM Realty pays quarterly dividends, he said. 

KM Realty’s properties are scattered throughout Texas, New Mexico and Arizona, with the largest concentration, 57, in Houston. The REIT is growing its portfolio by acquiring unanchored shopping centers, which are usually smaller and family-owned, Keith said.

That means there is an opportunity to aggregate those centers, which is the REIT’s goal, he said. What started with acquiring properties and building a leasing, management and operations infrastructure could ultimately allow it to go public, he said.

“We've been in a heavy growth mode,” Keith said, adding that up until now, “we've been a friends and family equity company, so we haven't really pursued the big institutional equity at this point.” 

Keith first contacted the owner of the El Paso centers four years ago, he said. They weren’t interested in selling then, but now that the original owner’s son is older and ready to retire, they contacted KM Realty.

The REIT gets a 400K SF, 17-property portfolio with no debt, and the owners get operating partnership units and a spot on the REIT’s board, he said. 

“They called us and said ‘We’ve got a massive tax problem here. We don’t want to just sell for cash. Your REIT makes a lot of sense,’” Keith said.