Melcor

Overview

Offering of 8.3M units by the REIT at $10 per unit. The REIT, an Alberta unit trust, will acquire interests in a real estate portfolio by acquiring the Class A units of a subsidiary limited partnership (the "Partnership"). The portfolio (the "Initial Properties") will consist of 27 western-Canadian rental properties - mostly office (65%) and retail (31%) - with appraised and market values of $393M (reflecting a cap rate of 6.43%) and $407M, respectively. Melcor's current intention is offer to sell further properties to the REIT: nine rental "Retained Commercial Properties;" eight "Properties Currently Under Development," following stabilization; and properties that may be developed in the future. The REIT will be granted a related right of first offer and an acquisition option, including a right to purchase Melcor development properties at a 5% discount to appraised fair market value where it has provided mezzanine financing.

Melcor

Melcor, which is TSX-listed, had a market cap of $565 million on March 1, 2013. It apparently will maintain its listing. The Initial Properties represent the majority of the investment properties of Melcor, so that in effect it will mostly be a development company and an investor in the REIT.

Structure

Melcor will hold an approximate 55.5% (majority) interest (51.1% after any exercise of the over-allotment option) in the REIT through ownership (by a subsidiary LP – "Holdings LP") of all the Class B LP units of the Partnership (as well as an equivalent number of special voting units of the REIT with no economic attributes). It will also hold Class C LP units of the Partnership, which will track debt retained by it respecting some of the Initial Properties. The REIT will hold Class A LP units of the Partnership, together with the GP thereof, which will hold Class A GP units (representing a 0.001% profits interest).

Retained Debt/Class C units deferral structure

The consolidated indebtedness of $187M of the REIT at closing will include debt of $95M (the "Retained Debt") that is secured on some of the Initial Properties, but which will remain as Melcor debt rather than being assumed by the Partnership. Instead, Melcor will receive Class C LP units on the transfer of the Initial Properties to the Partnership, with preferred payments on the Class C LP units being in the amount of required interest and principal payments of Melcor on the Retained Debt. The Partnership will guarantee the Retained Debt; and Melcor will indemnify the Partnership and the REIT for any losses suffered by them if payments are not made on the Retained Debt (provided the Partnership services the Class C LP units).

Class C structure tax indemnity

The Class C LP units "achieve a deferral of certain income tax consequences" to Melcor (p. 53). In the event that capital gains are triggered on the (low basis) Class C LP units held by Holdings LP as a result of a distribution of sale proceeds of the Initial Properties (or a determination of the Partnership to reduce the level of Retained Debt), the Partnership will be required to make an additional distribution on the Class C LP units in an amount equal to the difference between (i) Melcor's estimated tax liability at the date of sale (or refinancing), and (ii) the net present value of the tax liability assuming such property had been held to the maturity of the existing mortgage (or that the Retained Debt had been held to maturity). (There is no disclosure of an existing arrangement to extend the Class C LP units structure beyond the maturity of the Retained Debt.)

Closing transactions

At closing:

• The unit public offering will close for estimated gross proceeds of $83M
• Melcor and its subsidiaries will transfer the Initial Properties to the Partnership for the assumption of mortgages (excluding the Retained Debt) in the amount of $92.4M, Class B units (accompanied by the equivalent number of special voting units in the REIT), estimated in the forecast to have a value of $103.6M, Class C LP units in respect of the Retained Debt with a fair value of $96.5M, and a non-interest bearing demand promissory note for $63.7M (p. F-4).
• The REIT will use a portion of the proceeds of the public offering to purchase the promissory note, and then will contribute the promissory note to the Partnership in exchange for its Class A LP units
• Melcor will contribute its Class B and C LP units to Holdings LP under s. 97(2) in exchange for Holdings LP units

Subsidies

The purchase price otherwise payable by the REIT for the Initial Properties will be reduced by $3.6M, and the REIT will retain such amount to subsidize its interest payments on any debt with a coupon rate in excess of 4.0%. The purchase price will be further reduced by $0.8M and $1.7M, respectively, in order for the REIT to retain such amounts to subsidize (i) capital expenditures, and (ii) tenant improvements and lease costs.

Distributions

Monthly, of $0.05625 per unit, estimated to be 93% of AFFO. Estimated 25% tax deferred percentage for 2013.

Management

The REIT will be externally managed by Melcor.

Canadian tax disclosure

SIFT status. The REIT believes "based on the advice of one of its other external advisors" that it will satisfy the REIT exception for 2013. The Partnership is expected to qualify as an excluded subsidiary entity.

Reduced UCC under s. 97(2)

Because the Initial Properties will be acquired on a rollover basis, the initial tax deferred percentage will only be 25% notwithstanding distributions of 93% of AFFO (p. 138).

Withholding

Part XIII and XIII.2 withholding on distributions to non-residents.