NexPoint -- summary under Cross-Border REITs

Overview

Nexpoint Hospitality Trust (the “REIT”) is proposing to use the proceeds of an IPO to invest in 11 U.S. hotels. An affiliate of its advisor also is the advisor to the NYSE-listed NexPoint Residential Trust. The hotels will be held through an LLC that will elect to be a REIT for Code purposes. In order to comply with the U.S. REIT rules, the hotels will be leased to a taxable REIT subsidiary and will be managed by a third party manager. Part of the consideration received by affiliates of the Advisor for transferring the hotels into the structure will be Class B redeemable units of the hotel LLC owner. The REIT itself will elect to be a REIT for Code purposes. There will be a resulting prohibition against any unitholder or deemed unitholder holding more than 5% of its units.

For Canadian SIFT taxation purposes, the REIT will rely on not holding any non-portfolio property. Anticipated distributions may be sufficient to avoid significant issues arising under the FAPI rules.

The REIT

The REIT is a newly-created, unincorporated, open-ended real estate investment trust established under the laws of the Province of Ontario. It has applied to have its units traded on the TSX.

Structure

The REIT will wholly-own NHT Intermediary, LLC (“US Holdco”) which will wholly-own NHT Holding, LLC (“NHI”). NHI will hold all the Class A Units of NHT Operating Partnership, LLC (the “OP”), which will hold the Initial Portfolio. The managing member is an LLC not held directly or indirectly by the REIT and the Class B Units of the OP are held by the contributors of the Initial Portfolio and minority investors. In order for NHI, and thus the REIT, to be eligible to elect to be taxed as a real estate investment trust under the Code, the properties will be leased to taxable subsidiaries of the REIT (the “TRS Entities”), which will in turn contract with eligible independent contractors (as defined in the Code) to manage the day-to-day business operations of the hotels. The property managers for the properties in the Initial Portfolio are affiliates of AimBridge Hospitality Holdings, LLC (collectively, the “Manager”). The board of directors of NHI shall always be comprised of a majority of (a) U.S. residents; and (b) individuals who are neither employed by, affiliated with, and who are otherwise independent of, the Advisor.

Initial Portfolio

The Initial Portfolio is comprised of 11 properties located throughout the U.S. in the select service and extended stay hospitality categories. Each property has a long-term franchise agreement with Marriott, Hilton or InterContinental Hotels Group sponsored brands.

Advisor

A newly-formed Delaware LP (the “Advisor”) will manage the REIT. Its affiliate also advises NYSE-listed NexPoint Residential Trust (focusing on multi-family properties). As consideration for the Advisor’s services, the REIT will pay an advisory fee at an annualized rate of 1.00% of gross assets of the REIT, with certain adjustments, paid monthly (the “Advisory Fee”), together with reimbursement of certain general and administrative expenses. Additionally, a long term incentive plan (the “LTIP”) will be put in place pursuant to which restricted Units (the “RUs”) may be granted periodically by the Independent Trustees of the Board to officers and trustees. The LTIP plan implemented and effective on the date of the listing of the Units on the TSX will represent 10% of the market capitalization of the REIT.

Manager

All of the REIT’s hotel properties will be operated pursuant to hotel management agreements (the “Hotel Management Agreements”) between the Manager, a professional third-party hotel management company, and the TRS Entities that lease the property from the OP and its subsidiaries. The Hotel Management Agreement will require the TRS Entities to pay a base fee to the Manager calculated as a percentage of hotel revenues generated by the hotel operations plus an incentive fee.

OP Units

Upon Closing, the OP will have outstanding (i) Class A OP Units, all of which will be held by NHI, and (ii) Class B OP Units, all of which will be held by NREO (see below) and certain minority partners. The Class B OP Units will, in all material respects, be economically equivalent to the Units on a per unit basis, subject to certain customary anti-dilution adjustments. After holding Class B OP Units for at least 12 months (subject to acceleration in certain circumstances), the holders of Class B OP Units, acting individually, have the right to cause the OP to redeem all or a portion of such Class B OP Units for a cash payment of equivalent value or Units, as determined by the OP and as directed by the REIT in their sole discretion. If the OP elects to redeem Class B OP Units for Units, the REIT will generally deliver (indirectly) one Unit for each Class B OP Unit redeemed (subject to customary anti-dilution adjustments).

Distributions

The REIT initially intends to adopt a distribution policy pursuant to which it will make monthly cash distributions to Unitholders equal to, on an annual basis, approximately 65% of estimated Core FFO.

Hotel exit strategy

Generally, for each property the REIT may seek a liquidity event within three to five years after the original acquisition date of a property. In pursuing a liquidity event for a property, the REIT will take into consideration the prohibited transaction tax rules under the Code. Management’s primary goals of shareholder friendly capital allocation may potentially include a liquidity event involving the sale of assets, the entire company, a merger into an existing publicly traded real estate investment trust or other publicly traded vehicle, or a listing of its shares on a national securities exchange.

Contributions of the hotels

Ten of the 11 hotels in the Initial Portfolio will be contributed by four different groups of parties (the “Contributors”) to the REIT or the OP (the “Contributions”). The four groups of Contributors will be three Maryland or Delaware corporations wholly owned by affiliates of the Advisor (“NMCT,” “HCBH” and “Meritage”), a Delaware limited liability company wholly owned by affiliates of the Advisor; and a LLC (“NREO”), along with minority investors in the properties being contributed by NREO. Upon completion of the Contributions and related transactions, the contributed assets and assumed liabilities will be held by the OP and its subsidiaries, and each hotel property will be leased to the TRS Entities under a long-term lease. In order to fund the Contribution, the REIT, through NHI and the OP, will assume or enter into multiple mortgages collateralized by the properties. Upon completion of the Contributions and Acquisition (as defined below), the REIT will have a consolidated gross book value of approximately $368.4 million with an equity value of approximately $115.8 million, exclusive of preferred equity issued by NMCT.

• NMCT Shareholders will, indirectly through a series of transactions, contribute 100% of the shares of NMCT to the REIT in exchange for Units of the REIT.
• HCBH will contribute 100% of its PLC interests in four LLCs to HCRE Hotel Partner, LLC (“HCREHP”). HCBH will then, indirectly through a series of transactions, contribute 100% of its LLC interests in HCREHP to the REIT in exchange for Units of the REIT.
• Meritage will, indirectly through a series of transactions, contribute 100% of its interest in a Delaware LLLC to the REIT in exchange for Units of the REIT.
• NREO and minority members will contribute 100% of the LLC interests in two LLCs - one of which, in turn, holds five hotel-specific LLCs – to the OP in exchange for Class B units of the OP.
• NHT Nashville, LLC, a subsidiary of NMCT, will exercise its rights under a purchase agreement to acquire Holiday Inn Express Nashville.

Canadian tax consequences

Non-SIFT

The REIT will not be considered to be a SIFT trust in respect of a particular taxation year and, accordingly, will not be subject to the SIFT Rules in that year, if it does not own any non-portfolio property and does not carry on business in Canada in that year. Management has advised counsel that the REIT has not and does not currently intend to own any non-portfolio property or carry on a business in Canada.

Treatment of FAPI

US Holdco will be a “foreign affiliate” and a “controlled foreign affiliate” of the REIT for purposes of the Tax Act. To the extent that US Holdco earns foreign accrual property income in a particular taxation year, the FAPI allocable to the REIT must be included in computing the income of the REIT for its taxation year in which the taxation year of US Holdco ends. If FAPI is included in the income of the REIT, an amount may be deductible in respect of the “foreign accrual tax” (“FAT”) applicable to the FAPI. The adjusted cost base to the REIT of its shares in US Holdco will be increased by the net amount of FAPI included in the income of the REIT. As the REIT receives a dividend of amounts that were previously included in its income as FAPI, that dividend will effectively not be taxable to the REIT and there will be a corresponding deduction in the adjusted cost base to the REIT of its shares in US Holdco.

Foreign tax credit

The U.S. withholding tax deducted in respect of a distribution paid on a Unit in a taxation year will generally be characterized as “non-business income tax”, as defined in the Tax Act, and may be deductible as a foreign tax credit from the Holder’s Canadian federal income tax otherwise payable for that year where the Holder has sufficient non-business income from U.S. sources, to the extent permitted by the Tax Act and that such tax has not been deducted in computing the Holder’s income. Alternatively, such non-business income tax (including any amount not deductible from tax otherwise payable as a foreign tax credit) generally may be deducted by the Holder in computing the Holder’s net income for the purposes of the Tax Act.

U.S. tax consequences

Election by the REIT and NHI to be REITs

The REIT intends to take the position that, pursuant to s. 7874 of the Code, the REIT is treated as a U.S. corporation for all purposes under the Code and, as a result, it is permitted to elect to be treated as a real estate investment trust under the Code, notwithstanding the fact that it is organized as a Canadian entity. Baker & McKenzie LLP, U.S. counsel to the REIT, will render an opinion in connection with the Closing in respect of the treatment of the REIT as a U.S. corporation under s. 7874. The REIT and NHI each will elect under the Code to be a real estate investment trust, commencing with its taxable year ending December 31, 2019. The REIT expects to receive an opinion of Baker & McKenzie LLP with respect to its qualification as a real estate investment trust.

TRS

A real estate investment trust may jointly elect with a subsidiary corporation, whether or not wholly-owned, to treat such subsidiary corporation as a TRS. A TRS or other taxable subsidiary corporation generally is subject to U.S. federal income tax on its earnings. A real estate investment trust is not treated as holding the assets of a TRS or other taxable subsidiary corporation (including a subsidiary that is also a real estate investment trust) or as receiving any income that the subsidiary earns. NHI will indirectly own, through the OP, shares of NMCT, a taxable subsidiary that will elect real estate investment trust status beginning with its taxable year ending December 31, 2019. NHI will not be treated as holding the assets of NMCT or currently earning any income that NMCT earns.

Eligible independent contractor rule

A TRS will not be considered to operate or manage a qualified lodging facility solely because the TRS directly or indirectly possesses a licence, permit, or similar instrument enabling it to do so. Rent that the REIT receives from a TRS will qualify as “rents from real property” as long as the property is operated on behalf of the TRS by an “independent contractor” who is adequately compensated, who does not, directly or through its shareholders, own more than 35% of the Units, taking into account certain ownership attribution rules, and who is, or is related to a person who is, actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to the REIT and the TRS lessee (an “eligible independent contractor”).

UPREIT

The REIT is considered an umbrella partnership real estate investment trust (an “UPREIT”) for U.S. federal income tax purposes. An UPREIT is a structure that REITs often use to acquire real property from sellers on a tax deferred basis for U.S. federal income tax purposes because the sellers can generally accept equity interests and defer taxable gain otherwise required to be recognized by them upon the disposition of their properties.

FIRPTA exception for “regularly traded”

A Non-U.S. Holder’s sale of Units will not be subject to tax under FIRPTA as a sale of a USRPI provided that the Units are “regularly traded” on an “established securities market” and the selling Non-U.S. Holder owned, actually and constructively, 10% or less of the outstanding Units at all times during the five-year period ending on the date of disposition or such shorter period that the Units were held.

Difficulties with reliance on TSX trading

The TSX s an established securities market, but the REIT will not satisfy the “regularly traded” exception in relation to the TSX (a non-U.S. national securities exchange) as of the Offering.

U.S. Publicly Traded Exception

The REIT has received indications that at least two brokers or dealers are willing to regularly quote and make a market in the Units on the OTC Pink and/or the OTCQX. For each calendar quarter during which the Units are regularly quoted on the OTC Pink and/or the OTCQX, the Units should be treated as “regularly traded” on an established securities market in the U.S. (the “U.S. Publicly Traded Exception”) and, accordingly, gain on sales of Units by Non-U.S. Holders that own 10% or less of the outstanding Units during the applicable testing period would not be subject to U.S. federal income tax. Management believes that the Units may satisfy the U.S. Publicly Traded Exception and may satisfy the TSX Publicly Traded Exception in the future.

FIRPTA notice requirements re 5% limitation

In order for the REIT to comply with its withholding obligations under FIRPTA (and certain other regulatory requirements), the Units are subject to notice requirements and transfer restrictions. Non-U.S. persons holding Units are required to provide the REIT with such information as the REIT may request. Furthermore, any non-U.S. person that would be treated as having acquired sufficient Units to be treated as owning more than 5% of the Units is required to notify the REIT by the close of the business day prior to the date of the transfer that would cause the non-U.S. person to own more than 5% of the Units.

Transfer of excess (over 5%) units

If any non-U.S. person that would otherwise be treated as having acquired sufficient Units to be treated as owning more than 5% of the Units fails to comply with the FIRPTA notice provisions described above, the excess Units (i.e., the excess of the number of Units it would be treated as owning over an amount equal to 5% of the outstanding Units) will be sold, through the mechanism described below, with such non-U.S. person receiving the lesser of (i) its original purchase price for the excess Units, and (ii) the sale price of the excess Units (net of commissions and other expenses of sale). Non-U.S. persons holding Units are strongly advised to monitor their actual and constructive ownership of Units.

6.2% REIT limitation

The relevant sections of the Declaration of Trust generally provides that no person or entity may actually or beneficially own, or be deemed to own by virtue of the applicable constructive ownership provisions of the Code, more than 6.2% of the Units. Any purported transfer of the Units or any other event would otherwise result in any person violating such ownership limits, or if a non-U.S. person would otherwise be treated as owning more than 5% of the Units and has not complied with the notice provisions described above, then the number of Units that exceeds the applicable ownership limit (rounded up to the nearest whole Unit) will be automatically transferred to, and held by, a charitable trust for the exclusive benefit of one or more charitable beneficiaries selected by the REIT.

Publicly traded partnership rules

The Operating Agreement contains provisions intended to ensure that the OP is not considered a “publicly traded partnership”. Accordingly, management does not anticipate that the OP will be treated as a publicly traded partnership that is taxable as a corporation. However, if the OP were classified as a “publicly traded partnership”, the OP would be treated as a corporation rather than as a partnership for U.S. federal income tax purposes. In such case, the REIT would not be treated as owning its proportionate share of the assets and income of the OP for the purposes of the real estate investment trust asset and income test requirements (and, instead, would be treated as owning the stock of a corporation). This could cause the REIT to fail to qualify as a real estate investment trust. In addition, the income of the OP would become subject to U.S. federal corporate income tax.