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1. Interval Ownership and Leasing
The type of participation closest to a traditional REIT investment is to
acquire fee interests in real property to be developed or converted to
interval-ownership. The property is then master-leased to an interval-
ownership developer or nonstock club corporation, which creates the
products that are conveyed to individual timeshare owners and are
subject to the REIT’s master lease. The structure is most compatible
with limited-term programs. Such a master lease might consist of a
ground lease of the underlying land, or possibly a lease of the building
as well as land.
While REITs may act as lessors of real estate, they are generally
precluded by the tax law from acting as sellers of inventory or dealer
property (except where they do so through a taxable subsidiary).
Accordingly, direct-equity involvement would be viable for projects
structured as long-term leases, but not for projects structured as
permanent sales to individual owners — unless through a taxable
subsidiary of the REIT.
Alternatively, the REIT might own the land and the building and
enter into long-term leases directly with individual timeshare owners
(who would be the actually lessees). In that case, any resort-type or
hotel-like services would need to be provided through a third-party
independent contractor due to restrictions under the tax laws on the
types of services that may be provided by REITs and their subsidiaries.
This requirement might be met by third-party timeshare association
management contracts, already in widespread industry use.
Rental payments under a REIT master lease may continue after
individual sales through interval owners’ associations that have
assessment powers and powers of foreclosure over individual interval
owners. The associations can assure that the master-lease payments
are made regardless of changes in ownership of individual intervals.
2. Interval Ownership Financing
Secured receivables financing can be provided by mortgage REITs or
hybrid REITs. Because of the traditional high-leverage financing model
for interval-ownership sales in the U.S., very large portfolios of secured
timeshare mortgages are assembled and placed with lenders each
year by major interval-ownership developers.
The historical default statistics for interval-ownership notes have
been monitored over the years and remain relatively low compared
with other secured instruments at similar interest-rate levels. Recent
typical interval-ownership financing has been for an average of more
than eight years at annual rates averaging around 14 percent.
3. Joint Ventures
A number of more complex projects have attracted REIT participation
at multiple levels. In addition to involvement in limited-term,
interval-ownership structures (such as long-term leases) and in mortgage
financing structures, it is also possible for REITs to indirectly share in
development profits through the use of taxable REIT subsidiaries (TRSs).
While the income of a TRS is subject to corporate income tax, the
use of a TRS permits a REIT to indirectly participate in sales of
timeshare interests to individuals, otherwise precluded by tax laws.
Participation through a TRS in the development profits from the sale of
interval-ownership products — combined with the qualified participation
in interval product leasing and purchase money financing — assures
maximum REIT value and control over interval-ownership investments.
Structures to Attract
Interval-Ownership Developers
Interval-ownership developers have not been generally considered as
targets for REIT partnerships or investments and instead have had to
use more complex structures to access balance sheet–friendly
financing. But they may be attracted to well-structured REIT strategies
for ordinary and preferred operating partnership (OP) units in so-called
UPREIT or DownREIT structures. This strategy allows a developer to
convey owned property to a REIT in exchange for interests in an OP
controlled by the REIT. The exchange would not result in any immediate
tax to the developer, and would provide the developer with the benefits
of liquidity and diversification.
The OP might create a taxable TRS to participate indirectly in active
development or sales activities with the development partner, while
keeping leasing and mortgage financing operations in nontaxable
entities, the income of which can generally pass through the OP to the
REIT and developer partner without incurring an entity-level tax.
Meanwhile, the developer’s interests in the OP, which are typically
exchangeable for shares of stock of the parent REIT, will provide the
developer with cash flow from ongoing distributions, as well as
liquidity when it is ready to sell if the REIT’s shares are publicly traded.
In addition, where a REIT and OP hold interests in numerous projects,
the developer’s equity interest in the OP reflects the economics of
multiple projects, thereby diversifying the developer’s risk.
Ample opportunities exist for REITs to participate in the growing
interval ownership industry that have, to date, gone largely untapped.
Since investment in this sector has not been closely considered by the
REIT community so far, a number of REIT pioneers have started to
create a more customized approach to the investment. Competition
among REITs to participate in the sector is not yet intense and there
are many qualified developers seeking capital-light deal structures and
would likely be attracted to an innovative REIT offering as the industry
reaches for annual sales exceeding US$10 billion. It is time for creative
and opportunistic REIT managers to take a look.
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Richard F. Davis
is co-chair
of the Global Hospitality Practice
of Greenberg Traurig, LLP. He
focuses his practice on U.S. and
international hotel, resort, and
hospitality real estate, business,
and finance law.
Carl Riley
is a shareholder in
the REIT and Tax practice areas
of Greenberg Traurig, LLP. He
specializes in real estate–related
tax matters.