What Is an Operating Company/Property Company Deal (Opco/Propco)?
An opco/propco arrangement separates a business’s operating activities (opco) from ownership of real estate and other income-generating property (propco). The propco—typically a subsidiary—holds the title to buildings, land, or other property and leases them back to the opco under long‑term lease or rental agreements. The two entities remain part of the same corporate group but are legally distinct for financing, tax, and credit purposes.
Key takeaways
– Opco/propco splits operations from property ownership so each subsidiary can have separate financing, debt profiles, and (sometimes) tax treatments.
– Commonly used in real estate transactions, REIT formations, and sale–leaseback strategies.
– Advantages include clearer capital structures and potential tax or rating benefits; downsides include loss of operational flexibility, lease burdens, and legal/tax complexity.
– Proper structuring requires careful legal, tax, accounting, and credit analysis plus clear intercompany agreements.
How an opco/propco deal works (basic mechanics)
– The parent group creates (or designates) a propco subsidiary that legally owns income-producing property.
– The operating company (opco) occupies and uses the property and pays rent or lease payments to the propco.
– Propco typically finances property acquisitions or refinancing (mortgages or bonds) and services that debt from rents paid by opco.
– Because propco and opco are separate legal entities, lenders, credit-rating agencies, and tax authorities can treat their creditworthiness and taxable income separately—if the separation is real and complies with law.
Why companies use opco/propco structures
– Financing separation: Propco can raise secured property debt while opco maintains operational borrowings; this can reduce cross‑collateralization and contagion risk.
– Rating & risk isolation: Losses from operations are ring-fenced from the property owner (and vice versa), potentially yielding better rates on property finance or protecting the operating business.
– REIT formation: A parent can move income‑producing real estate into a propco and then spin it off as a REIT to obtain pass‑through tax treatment (see IRS rules).
– Sale–leaseback economics: Allows extraction of capital from real estate while keeping operational control under a lease.
Practical steps to implement an opco/propco structure
1. Strategic assessment
– Define objectives (raise capital, isolate asset risk, create a REIT, improve balance-sheet ratios).
– Identify which properties are suitable (income-producing, stable occupancy, easy to value).
2. Legal and corporate structuring
– Form or designate the propco legal entity with separate governance and capitalization.
– Ensure arms‑length documentation for sales/leases to withstand related‑party scrutiny.
3. Valuation and accounting
– Obtain independent property valuations and prepare pro forma financials for both opco and propco.
– Assess accounting treatment (sale vs. financing, lease classification under relevant standards).
4. Tax analysis
– Model tax effects for the group and for each entity; evaluate local tax rules and transfer pricing.
– If REIT formation is contemplated, review REIT eligibility and distribution requirements (see IRS Form 1120‑REIT guidance).
5. Financing
– Decide capital structure for propco (mortgage vs. securitization vs. bond).
– Negotiate lease terms (rent level, duration, escalation, break options, subordination to lenders).
6. Intercompany agreements and governance
– Draft lease agreements, service agreements, and any guarantees or covenants.
– Decide whether the opco will provide any credit support (e.g., parent guarantees) to propco lenders.
7. Due diligence and regulatory compliance
– Review property title, environmental liabilities, zoning, tenant contracts, and insurance.
– Check debt covenants in existing agreements to ensure transfers are permitted.
8. Execution and post‑transaction monitoring
– Transfer assets, record loans, and confirm regulatory filings.
– Monitor covenant compliance, lease performance, and tax/reporting obligations.
Illustrative example (simplified)
– Opco operates a retail chain and owns stores worth $200 million.
– The group forms Propco and transfers the stores for $200 million (cash paid to parent or capitalized).
– Propco borrows $120 million (60% LTV) against the portfolio.
– Opco leases the stores from Propco and pays annual rent that covers Propco’s interest and principal service plus return.
– Result: Opco gains liquidity (cash proceeds) and avoids property‑side debt on its balance sheet; Propco has property collateral to secure financing.
Tax and regulatory considerations
– REIT spin‑off: In jurisdictions like the U.K. and U.S., a propco can become a REIT if it meets statutory asset, income, and distribution tests. In the U.S., rules and filing requirements are in IRS guidance for Form 1120‑REIT (see Sources).
– Pass‑through entities: Some groups instead use MLPs/partnerships for pass‑through taxation, especially in energy sectors.
– Transfer pricing and related‑party rules: Authorities will examine whether the sale was at arm’s length and whether lease terms reflect market rates.
– Consolidation risk: Creditors or rating agencies may “look through” the group in stressful conditions and consolidate risk if ring‑fencing is incomplete.
Common criticisms and risks
– Operational inflexibility: Opco may be locked into paying rent on unused properties if closures are needed; propco’s need to service debt can impede property sales.
– Financing constraints: Lenders to propco expect stable rents; opco financial stress can imperil both entities.
– Tax and regulatory challenges: Tax authorities may challenge transfers or seek to recharacterize transactions; REIT qualification imposes strict rules.
– Complexity and cost: Legal, tax, and accounting costs can be substantial, and operational management becomes more complex.
– Credit rating treatment: Rating agencies may treat the group as more highly leveraged if guarantees or interdependencies exist.
Due‑diligence and negotiation checklist
– Clear title and environmental reports on all properties.
– Independent property appraisals and market rent studies.
– Lease length, rent escalation, break options, sublease rights, repair/maintenance allocations.
– Intercompany guarantees, parent support, and ranking of claims (subordination).
– Debt covenants, cross‑default provisions, and restrictions in shareholder or lender agreements.
– Tax opinion covering transfer pricing, VAT/GST, capital gains, and REIT qualification if relevant.
– Accounting treatment confirmation (impairment, lease accounting).
Accounting and credit‑rating issues
– Lease accounting: Determine classification (operating vs finance) under IFRS/US GAAP and effects on balance sheets.
– Consolidation: Ensure that legal and economic separateness meets accounting and regulatory tests to avoid forced consolidation of propco and opco.
– Rating impact: Rating agencies evaluate the legal and practical separateness; guarantees or cash pooling can erode benefits.
Steps to spin off a propco as a REIT (practical overview)
1. Ensure the propco’s assets and income mix meet REIT statutory tests (asset percentages, income source tests).
2. Structure corporate governance and capitalization to meet REIT shareholder and ownership limits.
3. Transfer qualifying real estate into the propco in a tax-efficient manner (seek tax opinions).
4. Apply for and file required tax forms (e.g., in the U.S., timely election as a REIT and follow Form 1120‑REIT guidance).
5. Maintain ongoing distribution requirements and record‑keeping to preserve REIT status.
When an opco/propco is not appropriate
– Business with many short‑term or highly mobile locations where closures are frequent.
– Small companies where the cost and complexity outweigh benefits.
– When tax/regulatory regimes make related‑party transfers unattractive or risky.
Who to involve
– Corporate and tax lawyers experienced in related‑party transfers and REIT/MLP rules.
– Real estate and valuation specialists.
– Accountants for financial reporting and consolidation analysis.
– Lenders and rating‑agency advisors to structure debt and covenant packages.
– Tax authorities or external tax counsel where cross‑border issues exist.
Sources
– Investopedia. “Operating Company/Property Company Deal (Opco/Propco).” https://www.investopedia.com/terms/o/opco-propco.asp
– Legal Information Institute. “Pass‑Through Taxation.” (overview of pass‑through concepts).
– Internal Revenue Service. Instructions for Form 1120‑REIT (see REIT qualification and filing requirements).
If you want, I can:
– Draft a sample intercompany lease and key clauses to watch for.
– Run a simple numerical model showing the balance-sheet impact of a proposed opco/propco transfer.
– Summarize U.S. REIT qualification tests or provide a checklist tailored to your jurisdiction. Which would you prefer?