BSR REIT -- summary under Cross-Border REITs

Overview

A closely-held Delaware LLC with a portfolio of apartment buildings in the southern U.S. appraised at U.S.$890M (“BSR”) is proposing to effectively go public in Canada. This would occur as follows:

• a newly-formed Ontario s. 108(2)(a) unit trust (the REIT) will complete an offering of its Units in Canada for about U.S.$135M, with a view to trading on the TSX
• the REIT will use those proceeds to fund a newly-formed Delaware “C Corp” subsidiary of the REIT (“US Holdco”) which, in turn will fund a new wholly-owned Delaware LLC subsidiary (“MergerSub”)
• MergerSub will be merged into BSR, with BSR as the survivor
• on the merger, US Holdco will be issued Class A units of BSR and the existing BSR unitholders will receive Class B exchangeable units of BSR (valued at around U.S.$270M)

Although the REIT will be deemed by the U.S. anti-inversion rules in Code s. 7874 to be a U.S. corporation, it is expected to qualify as a REIT for Code purposes. The disclosure does not discuss whether it will also qualify as a REIT for ITA purposes, but states that it is not expected to be subject to SIFT tax by virtue of not holding any non-portfolio property.

REIT

An Ontario unit trust whose Units are proposed to be listed on the TSX.

BSR

BSR Trust, LLC, which holds the Initial Portfolio through special-purpose entities as well as: a 45.67% ownership interest in Ledic Realty Company, LLC (“LEDIC”), which owns and operates affordable-rate multifamily properties; and all of the shares of Peace of Mind Insurance Company, Inc. (“POM”), BSR’s wholly owned captive insurance company. BSR has approximately 400 unitholders. Its principal unitholders are the Bailey/Hughes Holders.

Portfolio of Initial Properties

The REIT has been formed to own and operate a portfolio of multifamily real estate properties in the United States. The REIT will indirectly own a 48-property portfolio of multifamily garden-style residential properties (collectively, the “Initial Properties”), comprising 9,879 apartment units, located across five bordering states in the Sunbelt region of the U.S. The aggregate market value of the Initial Properties on a portfolio basis, as at January 1, 2018 has been appraised at approximately $890M including a portfolio premium of approximately 5%.

Bailey/Hughes Holders

Members and affiliates of the Bailey and Hughes families. Mr. Bailey serves as a Trustee of the REIT and Chief Executive Officer; and Mr. Hughes serves as a Trustee of the REIT. Mr. Hughes has served as the Chairman of LEDIC. Pursuant to the Investor Rights Agreement, the Bailey/Hughes Holders will be granted the right to nominate three Trustees subject to owning, in the aggregate, at least 30% of the then-outstanding Units.

US Holdco

A Delaware corporation (BSR REIT Holdings, Inc.) to be wholly-owned by the REIT.

MergerSub

A Delaware LLC (BSR Merger Sub, LLC) formed by US Holdco.

BSR II

A Delaware LLC (BSR Merger Sub, LLC) formed by US Holdco.

Distribution policy

The REIT initially intends to adopt a distribution policy pursuant to which the REIT will make cash distributions to Unitholders and, through BSR Operating LLC, holders of Class B Units, on each Distribution Date equal to, on an annual basis, approximately 77% of estimated AFFO.

Transaction steps

1. BSR will contribute to BSR II its approximate 46% interest in LEDIC and all of the shares of POM, BSR’s wholly owned captive insurance company.
2. BSR will distribute all of the equity of BSR II to the current BSR unitholders proportion to their unitholdings, so that effectively, BSR II will become a mirror “sister” of BSR holding excluded assets.
3. The REIT will complete the offering of its Units and the Unit held by the initial Unitholder of the REIT will be redeemed for $10. The consolidated financial forecast assumes that the REIT will raise gross proceeds of $135M (excluding any overallotment option) pursuant to the Offering through the issuance of 13.5M REIT Units.
4. Approximately $30 million of principal amount (plus interest) owing by BSR to an affiliate of John S. Bailey will be converted into Units at the Offering Price.
5. The REIT will contribute the net proceeds of the Offering to US Holdco in subscription for preferred shares and common shares of US Holdco.
6. BSR II will transfer all of the shares of POM to US Holdco in consideration Units with an aggregate equivalent fair market value.
7. US Holdco will contribute the proceeds received from the REIT to MergerSub.
8. MergerSub will merge with and into BSR, (the “Merger”) with BSR continuing as the surviving entity (such surviving entity, “BSR Operating LLC”). BSR Operating LLC will be treated as a partnership for U.S. federal income tax purposes.
9. Concurrently with the Merger, the operating agreement of BSR Operating LLC will be amended and restated so that the capital of BSR Operating LLC will be restated to consist of Class A Units and Class B Units.
10. Upon the Merger, each issued and outstanding class A unit of BSR, class C unit of BSR, and common unit of BSR held by the existing unitholders will be exchanged for new Class B Units pursuant to a prescribed exchange formula taking into account the relative economic terms of the different securities of BSR; and each issued and outstanding class A unit of MergerSub held by US Holdco will be exchanged for new Class A Units.

Upon completion of the Merger, the Initial Properties will be indirectly held by the REIT, through its indirect ownership of BSR Operating LLC and POM will be indirectly held by the REIT through US Holdco.

Class B Units

Upon Closing and the related transactions, BSR Operating LLC will have outstanding (i) Class A Units, all of which will be held by US Holdco, and (ii) Class B Units, all of which will be held by the legacy BSR Holders, including the Bailey/Hughes Holders. The consolidated financial forecast treats the Class B Units of BSR Operating LLC having a value of $269.5M. The Class B Units are economically equivalent to Units and are redeemable by the holder thereof for cash or Units (on a one-for-one basis subject to customary anti-dilution adjustments). In particular, after holding Class B Units for at least 12 months, the holders of Class B Units, acting individually, have the right to cause BSR Operating LLC to redeem all or a portion of such Class B Units for a cash payment of equivalent value or Units, as determined by BSR Operating LLC and as directed by the REIT in their sole discretion. If BSR Operating LLC elects to redeem Class B Units for Units, the REIT will generally deliver (indirectly) one Unit for each Class B Unit redeemed (subject to customary anti-dilution adjustments).

REIT Units

A Unit of the REIT will be redeemable its holder for the lesser of 90% of the “Market Price” (based on the weighted average trading price of a Unit during the 10 trading days ending on the redemption date) and 100% of the “Closing Market Price” on the redemption date. To the extent a Unitholder is not entitled to receive cash upon the redemption of Units as a result of specified limitations, then the balance of the Redemption Price will generally be paid by way of a distribution in specie to such Unitholder of unsecured subordinated promissory notes of the REIT or a REIT subsidiary.

Canadian tax consequences

SIFT status

The REIT is not anticipated to not be a SIFT trust on the basis of not holding a non-portfolio property or carrying on business in Canada.

FAPI

As the REIT intends to qualify as a real estate investment trust for U.S. federal income tax purposes, the amount of U.S. federal income tax payable by US Holdco and the REIT on its operating income is not expected to be material, and it is not expected that there would be a material related FAT deduction available to apply against any FAPI in respect of US Holdco or any other controlled foreign affiliate of the REIT. 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 in respect of FAPI earned directly or indirectly by US Holdco. At such time 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. Under circumstances currently contemplated by management in respect of the Initial Properties, a portion of the income earned directly or indirectly by US Holdco (including income earned through subsidiary partnerships) will be FAPI and, accordingly, will be required to be included in computing the income of the REIT for Canadian federal income tax purposes on an accrual basis.

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.

U.S. tax consequences

Classification as U.S. corporation

The REIT is classified as a corporation for Code purposes and, pursuant to Code s. 7874 will be treated as a U.S. corporation (and will not have “substantial business activities” in Canada within the meaning of s. 7874) for all purposes under the Code and, as a result, it should be 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.

Classification as REIT

Mitchell, Williams, Selig, Gates & Woodyard, PLLC, U.S. counsel to the REIT, will render an opinion to the REIT to the effect that, commencing with its first taxable year ending December 31, 2018, the REIT is organized and operates in conformity with the requirements for qualification and taxation as a real estate investment trust under the Code, and that the REIT’s organization and current and proposed method of operation will enable it to continue to meet the requirements for qualification and taxation as a real estate investment trust under the Code. The REIT owns its interest in BSR Operating LLC through US Holdco, which is treated as a disregarded qualified real estate investment trust subsidiary (“QRS”). For purposes of the real estate investment trust status tests discussed below, all of the assets and income and loss of a QRS will be treated as assets and income and loss of the REIT.

UPREIT structure

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.

Withholding tax

A Non-U.S. Holder that is a qualified resident of Canada generally is entitled to a 15% withholding rate under the Treaty if: (i) the Non-U.S. Holder is an individual and holds no more than 10% of the outstanding Units, (ii) the Units are publicly traded and the Non-U.S. Holder owns no more than 5% of the outstanding Units or (iii) the Non-U.S. Holder (other than an individual) holds no more than 10% of the outstanding Units and the REIT is diversified. For this purpose, the REIT will be treated as diversified if the gross value of no single interest in real property of the REIT exceeds 10% of the gross value of the REIT’s total interest in real property. Qualified residents of Canada that are tax-exempt entities established to provide pension, retirement or other employee benefits (including trusts governed by an RRSP, an RRIF or a DPSP) may be eligible for an exemption from U.S. federal tax withholding on dividends under Article XXI of the Treaty.

FIRPTA withholding

Distributions of proceeds attributable to gains from the sale or exchange by the REIT of U.S. real property interests (“USRPIs”) are subject to U.S. federal income and withholding taxes pursuant to FIRPTA. Under FIRPTA, such gains are considered effectively connected with a U.S. trade or business of the foreign shareholder and are taxed at the normal graduated rates applicable to U.S. Holders. Moreover, such gains may be subject to branch profits tax in the hands of a shareholder that is a foreign corporation at a rate of 30% unless reduced by an applicable income tax treaty (5% under the Treaty). However, a distribution of proceeds attributable to the sale or exchange by the REIT of U.S. real property interests will not be subject to tax under FIRPTA or the branch profits tax, and will instead be taxed in the same manner as distributions of cash generated by the REIT’s real estate operations other than the sale or exchange of properties if (i) the distribution is made with regard to a class of shares that is regularly traded on an established securities market located in the United States (as management believes is the case with respect to the Units) and (ii) the recipient Unitholder does not own more than 10% of that class of Units at any time during the 1-year period ending on the date the distribution is received.